Pricing, Market Value, and Economic Damage

In a previous article I discussed a pricing formula that involves calculating your costs and adding a markup for profit based on market value. Today I will expand on what market value is, how to avoid damaging your local market by underpricing, and what to do if economic damage has already been done.

In economics, the market value of a product or service is the amount a willing and independent buyer and seller would exchange after proper marketing when each party acts knowledgeably and prudently. The key elements of this definition are proper marketing and knowledge on the part of the buyer. Unfortunately, this industry has a number of factors that are working against sellers by applying downard pressure on the perceived value of cake decorating services in the minds of customers.

Most customers don’t purchase custom cakes that often. More often than not, a customer’s only frame of reference for how much a cake should cost will come from the grocery store, so when it is time to shop for a more premium cake that grocery store price will be a psychological anchor dragging down the expectation of value.

The explosion of TV shows dedicated to cake decorating doesn’t help. A show that realistically portrayed the process involved in creating a decorated masterpiece would not be very exciting, so they edit the shows to compress what may be a 22 hour process into 22 minutes. The price of the resulting cake is usually not shown, so viewers without industry knowledge will dramatically underestimate the labor required.

These two issues alone wouldn’t be so bad if sellers were diligent about setting firm prices based on their costs, paying themselves a reasonable wage, consistently marketing their products, and educating customers about how long their designs will cake. In reality, this business has such a low barrier of entry, some sellers may not take the time for due diligence and as a result set prices far below what they should be. This only reinforces the low value of custom baked goods in the eyes of customers.

The reasons for this may vary — it could be a lack of confidence, there could be an outside source of income (such as a spouse’s salary) masking the true performance of the business, or the seller may not have the business knowledge to know there is even a problem. Cottage food laws have not helped the situation since they lower barriers to entry even further. If these laws required even just an hour or two of basic business training on how to market and set prices alongside the required food safety training things might be different.

So, as a seller, what can you do? To fight the aforementioned headwinds you have to be aggressive about demonstrating the value you can add over cheaper alternatives. Highlight your competitive advantage, whether that advantage lies in high quality ingredients, decorating skills, or appealing to a niche, but try to avoid going negative about the competition.

You will also want to make sure the customer knows the level of complexity involved in the designs they choose. You don’t need to be exact, but if they want a design that will take 60 hours to execute but can only pay $3/serving, you’ll need to redirect the conversation to increasing their budget and/or selecting a simpler design.

If you get pushback from customers who want to pay a lower price without compromising, reiterate your price in a polite yet firm manner. Continuing pushback should result in you giving the customer a choice between their desired order at the original price or a simpler order at a lower price. Failure to select either of these options means that they are no longer your customer, and you can wish them the best of luck with their event.

Also think twice before offering coupons or discounts, or signing up with a service like Groupon. If you have a quality product, you should not be competing on price, and discounts tend to attract exactly the type of customer you want to avoid. A similar problem occurs if you set your prices too low to start with because you’re new; when you finally increase your prices to reasonable levels, you will probably lose most of your customers and have to start from scratch, while at the same time trying to erase your reputation as the “cheap” bakery.

It is possible that your local market has already been poisoned by severe undercutting, to the point where pricing at market value for your products will lead to paying yourself below minimum wage with zero profit. This is a tough situation, since you can’t really bring this up directly with your competition. If the undercutting businesses are operating illegally based on local food safety laws, one solution is to contact your health or agriculture dept with the names of the alleged illegal businesses.

If the offending businesses are operating legally, you may be able to work through a third party (such as the SBA or the local Chamber of Commerce) to set up some free business training, which could be offered by the third parties to all the bakeries in the area. Another alternative is to shift your target market to a niche that is not being served in your area, pursue a different channel (e.g. wholesale), or pursue exclusive arrangements with popular venues.

The crux of this issue is that every business that offers products to the general public is responsible for the economic health of the industry they participate in. This includes hobbyists who advertise and sell their works, even if they don’t think they really have a business. If you don’t want to go through the effort of charging what your products are worth, you are better off not selling to the public at all and sticking to providing products for friends and family.

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