CHAPTER  |  TWENTY-EIGHT

There Are No Irrational Customers, Only Irrational Marketers

Value is a strong influence on what customers purchase. When you have what the customers value, they buy from you. Price is one, and only one, measurement of value.¹ Yet some marketers wonder why customers would ever buy a more expensive product when a cheaper one of equal or sometimes even greater quality is available. These marketers say that such customers are “irrational.” But Peter Drucker maintained that irrational customers don't exist. However, he thought that the stubborn belief that customers who don't buy when the marketer thinks they should may itself be irrational. So maybe this means that a marketer who believes this may be a little irrational. Let's take a closer look.

The Easy Answers

At times, so-called irrational customers are fairly easy to explain. When there is limited information about a product and the potential customers have no experience with it, it is perfectly rational to assume that the most expensive product is the one of the highest quality and therefore worth more. We have all seen this. For example, we know nothing about headache cures, so we select the most expensive drug on the market.

Or, perhaps through shrewd advertising, we perceive that a higher-priced product may be better or of higher quality than a cheaper brand, when this is not the case. This is one reason that many marketing experts suggest that your pricing be congruent. That is, you should charge a higher price for a product that is of higher quality or has more desirable features, even if you could charge less.

Similarly, if a price reduction fails to increase sales, maybe the price reduction is too small relative to the original price to attract much attention. Or, other factors may be considered far more important at the time, such as a supplier's reputation for reliability or of available delivery times.

In every case, there are logical reasons for the buyer's decision to pay more—even for what the marketer might consider less value. Drucker concluded that customers are never irrational, and when they make surprising decisions in the marketplace, the marketers should examine those purchases from the customer's perspective to uncover the real reasons behind them, so they can be dealt with successfully in the future.

Start with the Customer's Perspective

The marketer must start with what customers want to buy, rather than with what suppliers want to sell. Did you know that for many years foreigners saw more images of one particular American than any other? It was not the image of an American president, a famous general, or one of our Founding Fathers. And I'm not talking about the days when John Wayne represented America to all moviegoers around the world. Rather, this was a man who sold safety razors.

He wasn't the first to sell a safety razor, and he didn't invent the safety razor or their blades. His razor wasn't any better than anyone else's. He did price it very reasonably, and—catch this—it was more expensive to produce than the price he charged. The man in question was King Gillette. His picture was on the package of every razor and every blade that he sold. And he sold them by the millions, all over the world.

Though he lost money on every razor he sold, Gillette more than made up for the loss on the blades he sold afterwards. Every blade cost him less than one cent to make, and he sold each for five cents. That's a nice markup, but it was really a win-win because it benefited his customers, too. Since the blade could be used at least six times, buyers got a shave for less than one cent. That was one-tenth of the going rate for a shave in a barbershop in those days—though, as the old seven-note musical couplet informed, a shave with a haircut was “two bits,” slang for twenty-five cents in the United States around the turn of the twentieth century.

What Customers Really Want

Gillette understood his customers. He priced his razors at about 10 percent of the price of his competitors’ safety razors, and he positioned his buyers to enjoy a tremendous cost savings at the same time. He realized that customers were not buying either razors or blades. That's just what his company manufactured. The customers were buying shaves.²

Recently, I saw another example of this viewpoint in the solar energy business. Solar cells have been around for quite a while, and consumers are well aware that there is money to be saved from both the free energy from the sun and via federal tax rebates for buying energy-saving devices. In some areas of the country, arrays of solar cells sit atop practically every rooftop.

The problem, however, has been the large investment required, which could easily be in the thousands of dollars for the solar cells and their installation. Just as King Gillette realized that people were interested in buying shaves, not razors or blades, at least one company has seen that customers want energy, not solar cells or energy-saving systems. Though money at the time was short, they began offering free installation of the solar cells and the ancillary system. The big difference was that the customers wouldn't own the cells or ancillary equipment; the solar energy company would maintain them and retain ownership. The customer would pay only for the solar energy used, which is significantly less than the amount paid for the use of electrical energy. That's smart marketing, and it follows perfectly Drucker's view of customer rationality.

In other words, this is what pricing is all about. Any marketer willing to use his customers as the basis of his pricing can acquire industry leadership almost without risk. Of course, to enable you to do this, you also need to look at cost—but not until you start with the price and determine what it is from the customer's perspective. This was a major issue with Drucker: you determine price first, and only then turn to cost. This, by extension, takes us to such things as chain costing.

The Concept of Chain Costing

Got a favorite gasoline station only five miles across town, where the price is 5 cents a gallon less than the gas station one block away? You may be better off paying the higher cents. But look at the figures.

Let's say your car gets 15 miles a gallon while driving in town. To get there and back to your starting point is 10 miles. If the gasoline costs $3.50 a gallon at the cheaper gas station, this 10-mile drive will use two-thirds of a gallon, or $2.33. If your car holds 15 gallons, you will have saved 75 cents on a tankful. Not bad. However, your drive was a net loss of $1.58 ($2.33 − $0.75). But wait. If your little trip across town took 15 minutes and was made during work hours, you also should factor that time in. How much do you make on an hourly basis? If your salary and benefits total $100,000 annually and you have 2,000 productive work hours in a year, that's another negative $12.50. Now your trip has cost you over $14! And I'm leaving out wear and tear on your tires and engine, insurance, and so on.

In the city where I live, one of the local radio stations announces the cheapest gasoline in town. It's always a few cents cheaper than elsewhere. But, heck, even if the gasoline were a dollar a gallon less, I'd barely break even on a fill-up. This, then, is the importance of chain costing, which implies simply that you need to consider all of the relevant costs in the chain.

The importance of looking at the entire economic chain is hardly a new idea. This concept was first expressed by economist Alfred Marshall in the 1890s.³ Marshall was no slouch. He was the person who brought the basic concepts of supply and demand, marginal utility, and costs of production into one coherent theory. Unfortunately, many practitioners thought his work exactly that—pure theory with no practical application. Drucker thought differently.

The notion of chain costing is easily applied to your total costs for producing a particular product or service, but it may also reflect the costs that your customers are paying. The latter costs may or may not be recognized or understood by the customers (witness the attraction of saving a few cents at the gasoline pump). But as a smart marketer, you should understand the concept when setting prices if you are to take advantage of these factors to present your customers with rational reasons for buying.

Chain costing may also help you understand the advantages, as well as the challenges, of vertical integration of your product's process, from planning and design to post-sales actions—whether or not its results are seen by your consumers. To put it in Drucker's terms, “What matters in the marketplace is the economic reality, the costs of the entire process, regardless of who owns what.”⁴

Costs Will Change Down the Road

We are frequently too quick to assume that present costs will last forever. Drucker liked to point out that smarter marketers and price setters take over our markets by looking at them differently each time. That's why the United States didn't hold on to the market for fax machines, even though the machines were invented here. The Japanese didn't look at the costs of producing the initial numbers of fax machines, they looked at the numbers of machines that would be sold several years in the future. Ironically, the process of using a learning or experience curve to develop future costs and apply them to today was also developed in the United States.

This type of forecasting came about in the late 1930s, owing to Boeing's production of the B-17 bomber, when analysts at Wright-Patterson Air Force Base realized that every time its total aircraft production doubled, its labor decreased by 10 to 15 percent and its costs went down. Subsequent empirical studies from other industries and products yielded other measurable values. Nevertheless, the curve of decline could be determined and used to predict future costs. In fact, the method was good enough to be employed throughout World War II and is still required of those bidding on government defense contracts today.

Drucker's message, thus, was that price should determine cost, rather than the other way around. And once you have the price, it is only prudent to look at the costs to ensure that the product can be sold profitably. But you also need to consider all other aspects of costs, including the fact that as you produce more of anything the costs of that production will decline. His overriding lesson, however, was that customers are not irrational, as pointed out at the beginning of this chapter. If they aren't buying your product, but are buying someone else's product, there is a rational reason that you need to uncover and correct.