Price Has Nothing to Do With Costs

pricemoneyWhen I talk about this, people look at me puzzled. A couple years ago, Michael Kaiser, smart guy and Big Chief of the Kennedy Center, wrote an article on Huffington Post that gives me a starting point for what I want you to understand about prices:

“The central challenge facing arts managers is to fill the ever-widening gap between rapidly increasing expenses and earned income, primarily from ticket sales. This gap continues to grow each year since the number of seats we have to sell does not increase but expenses do.

Unfortunately, the favored technique used to fill budget gaps has been increasing ticket prices. When we increase prices, typically at budget time, we hope that a small increase will not be noticeable and we need the added revenue to break even. However, we have been doing this for so long that tickets prices are now too high for many people to afford regularly.”

Here’s a widely held basic assumption about how business works: There are costs that we must pay. If our costs go up, we have to charge more, because otherwise we lose money. In a sense, this is true. You need your revenue to exceed (or at least match) your expenses, or you lose money.

But I’m going to say something you won’t believe at first. Price (that is, the price that you charge for your shows) has nothing to do with costs. Suppose, for example, that you hired Brad Pitt as your janitor. Your costs would go up.

But your price? I don’t see a lot of people willing to pay twice as much just because there’s a hunky celebrity janitor (who works the night shift, when no one is around to see him). But your costs went up, so don’t you need to charge more? No. Your price should be based entirely on the value your audience places on seeing your show.

If your costs are going up faster than the rate of inflation, you need to find out why. You need to determine which of these accelerating costs are contributing to the value of the production and which are dead weight. This goes right along with being audience-oriented. Rather than building the production and then figuring out how much to charge, start by identifying what your audience wants, and then build the production to give them that value.

Take Apple as an example. What if Apple had built the iPhone first, and then determined what they would have to charge for it — only to discover that the price would have to be $2,000 per unit. But they didn’t do that. First, they developed an understanding of what people were likely to be willing to pay for the product they were envisioning, and then they built to that price point.

Because price has nothing to do with cost. To quote the movie Boogie Nights, costs are “YP” (your problem) — not the ticket buyer’s. Your need to charge more because you’ve got accelerating costs works fine as long as consumers continue to value your product at the price you’re charging.

When they don’t, you’ll find you’re in a thing called a Death Spiral: You charge more to “cover costs,” and fewer people buy. Your total net revenue drops. You didn’t cover costs, and now you have fewer patrons. Naturally, since you believe that price is about getting your costs back, you raise prices more to “cover the ever-widening gap between rapidly increasing expenses and earned income,” and even fewer units are sold, and net revenue drops some more.

The way out is to think about value. How much is your show, if delivered as envisioned, going to be worth, and to how many people? Now, make some estimates about revenue, build in a nice cushion and then start building your budget. You’ll find you often need to innovate and do quite a bit of creative tap dancing to figure out how to deliver such a thing profitably. But that’s the game. You’ll find enduring new sources of value by doing that and, ultimately, a profitable model can emerge.

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