15 Dec 2014 Research & Ideas

Deconstructing the Price Tag

A new study by Bhavya Mohan,Ryan Buell, and Leslie John hasan important conclusion forretailers: Companies that explainwhat it costs to produce a productcan charge more for it.

by Dina Gerdeman

When a company sets a price for aproduct, shoppers typically have noidea what it costs to produce thatitem. But it turns out thatconsumers reward efforts to lay outthese figuresto deconstruct theprice tag.

In fact, new research shows thatwhen a company selling T-shirts,for example, itemizes what itspends on cotton, cutting, sewing,dyeing, finishing, and transportingeach shirt, consumers becomemore attracted to the brand andmore likely to purchase.

"By unpacking the costs,you have the opportunity toexplain everything you didfor the customer in puttingthat product or servicetogether"

"By unpacking the costs, you havethe opportunity to explaineverything you did for thecustomer in putting that product orservice together," says BhavyaMohan, a Harvard Business Schooldoctoral student in marketing."When firms communicate theeffort that went into making agood, consumers tend to value theproduct more."

Mohan is an author of the paperLifting the Veil: The Benefits ofCost Transparency, written withHBS assistant professors Ryan W.Buell and Leslie K. John.

INTIMATE DISCLOSURE

Since cost breakdowns are so oftentightly guarded secrets, theresearchers say that when a firmdoes share this information,consumers consider it a form of"intimate disclosure"--and peopleare often more attracted to brandsthat disclose intimate information.

"If we think about ourinterpersonal relationships, whenpeople share things with usaslong as they don't oversharewetend to like them better," Buellsays. "We find it interesting thatwe're seeing evidence of the samething in our relationships withcompanies."

To gather data about consumerpricing sentiment, the researchersconducted six lab experiments inwhich participants answeredquestions about a simulatedwebsite of a fashion retailer sellingT-shirts. The research alsoincluded a field study of salesfigures at a real online retailer, tolook at how spelling out a firm'svariable costs of production couldaffect consumer purchase behavior.The researchers found:

When a firm voluntarilydiscloses its costs, theconsumer is more attractedto the brand, whichincreases willingness tobuy. "There's this layintuition that whencustomers find out that acompany is making aprofit off of them, theymight get upset," Johnsays. "But that's notnecessarily the case."

Consumers enmeshed inprivate, longstandingrelationships with thebrand were just as likely asnewcomers to respondfavorably to costtransparency.

Cost transparency benefitsweaken as a company'sprofit margins grow largerrelative to costs.Interestingly, a companythat exposes costs still sees

COPYRIGHT 2013 PRESIDENT AND FELLOWS OF HARVARD COLLEGE 1

a decent level of purchaseintent even with a fairlyhigh price markup.

"We wanted to understandwhen cost transparencywould be harmful," Buellsays. "With a T-shirt thatcost $6.50 to produce, itseemed reasonable to usthat cost transparencywould be helpful [inmotivating buyers] if theprice of the shirt was $10.But even at $35, we stillsaw an advantage torevealing the cost ofproduction, which isinteresting because themarkup was five times thecost."

Cost transparency failsonly when prices becomeso high that they are wayout of whack with themarket normand whenthe firm makes it clear thatits own markup is muchhigher than whatcompetitors charge. Forinstance, if a companycharges $30 for a T-shirt,but emphasizes thatcompetitors are chargingonly $25, that their costsare the same, and that thecompetitor's markup islower, the consumerbecomes less attracted tothe higher-priced brandand less willing to buy thebrand's products.

"It is possible for costtransparency to backfire,but only when a companyreveals it is being unfairwith customers," Buellsays. "It was shocking tous how heavy-handed wehad to be." John puts it

another way: "Costtransparency doesn't fallapart until we say, 'Heyguys, we're ripping youoff.'"

MEANWHILE IN THEREAL WORLD

The researchers took the academicexperiments into the real world byexamining customers interactingwith an online retailer. Inanticipation of the holiday season,the retailer introduced a $115leather wallet on its website thatcame in five colors. In an effort topromote sales after the holiday, theretailer included an infographicgraphic on each product pages thatpresented the cost of leather($14.68), construction ($38.56),duties ($4.26), and transportation($1.00), as well as the total cost of$58.50 to produce the product. Butthe retailer made a fortuitous error,including the costs infographic foronly three of thecolorsburgundy, black, and gray.

"Companies may trulystand to benefit from beingmore open"

This discrepancy was overlookedfor a five-week period, creating anatural experiment that comparedhow customers reacted to the threewallets that outlined costs versusthe twobone and tan colorsthatdid not. The researchers found thatthe introduction of the costtransparency infographic increaseddaily unit sales on a per-color basisby 44 percent.

NOT ALL COSTS ARETHE SAME

Consumers seem to have varyinglevels of tolerance for differentcost variables. Shoppers seem toappreciate the cost of rawmaterials, such as cotton, butcertain expenses, like the cost oftransportation, "seem like a wasteof money to people," Johnsayseven though it is indeed avery real cost for the company.

Yet even if the costs don't seemallocated in an ideal way from thecustomer's point of view, thecustomer still applauds thecompany's willingness to share itsproduction expenses. "Even if itisn't exactly what the customermight envision, the customerappreciates the act of disclosure,"Mohan says.

It's unclear whether a companymight see these benefits on asustained basis, particularly if anumber of retailers selling similaritems all started revealing theircosts. Presently, only a fewretailers practice cost transparency.

For example, Everlane(www.everlane.com), is a SanFrancisco-based online retailer thatreveals the variable costs ofproduction for each of its products,as well as images and descriptionsof the factories where products aremade. And Honest By(www.honestby.com), a Belgianretailer, augments costtransparency on its website withdetailed supply chain informationfor each component of eachgarment, right down to the hangtag. "This was a novel thing to do,and the advantage is probablygreatest when it's perceived asnovel," John says.

The paper also noted certain cost

HARVARD BUSINESS SCHOOL | WORKING KNOWLEDGE | HBSWK.HBS.EDU

COPYRIGHT 2013 PRESIDENT AND FELLOWS OF HARVARD COLLEGE 2

transparency caveats for retailers.A firm may not want to shareproduction costs if the coststructure provides a competitiveadvantage. In addition, contractswith suppliers may prevent makingcertain information public. And itjust may be that companies don'thave the information readilyavailablefor example, in caseswhere goods are produced by avariety of manufacturers.

For companies with goods andservices that depend on high fixedcosts, such as research anddevelopment and overhead, simplyproviding variable costs may notaccurately reflect to consumersmany of the other expensesincurred. For example, R&Dexpenditures in the pharmaceuticalindustry involve more than just thecost of producing one particulardrug. Many drugs may have to failbefore one succeeds, and that onehit drug ends up subsidizing theother busts.

"It would be a lot trickier for anindustry that spends millions oreven billions in developing aproduct to reveal its costs," Buellsays.

RAW HONESTYAPPRECIATED

Yet in the retail industryandperhaps in other industries wherecustomers may take for grantedhow much effort and money goesinto producing a goodmanyfirms may benefit greatly fromsharing cost figures. Perhaps itmakes the price a company chargesseem more fair and justifiable. Orperhaps it's simply a matter ofconsumers appreciating a little rawhonesty from the corporate world.

"Our evidence suggests you shouldopen yourself up and say, 'Here Iam, warts and all,'" John says."When you make yourselfvulnerable, people like you more."

Buell hopes the research findingsget company executives thinkingabout finding ways to engage moreopenly with consumers in generalas a potential way of piquinginterestand even boosting sales.

"One of the big takeaways frommy perspective is that this opens upthe door to companies consideringengaging their customers in a moremeaningful dialogue. Costs are oneof those things historically that wemight have thought of as taboo in adialogue between consumers andcompanies. It's interesting to thinkhow revealing something that isusually hidden can change thenature of the relationship.Companies may truly stand tobenefit from being more open."

About the author

Dina Gerdeman is a writer basedin Mansfield, Massachusetts.

HARVARD BUSINESS SCHOOL | WORKING KNOWLEDGE | HBSWK.HBS.EDU

COPYRIGHT 2013 PRESIDENT AND FELLOWS OF HARVARD COLLEGE 3

Deconstructing the Price TagINTIMATE DISCLOSUREMEANWHILE IN THE REAL WORLDNOT ALL COSTS ARE THE SAMERAW HONESTY APPRECIATEDAbout the author