Deconstructing the Price Tag

 
 
A new study by Bhavya Mohan, Ryan Buell, and Leslie John has an important conclusion for retailers: Explaining what it costs to produce a product can potentially increase its sales.
 
 
by Dina Gerdeman

When a company sets a price for a product, shoppers typically have no idea what it costs to produce that item. But it turns out that consumers reward efforts to lay out these figures—to deconstruct the price tag.

In fact, new research shows that when a company selling T-shirts, for example, itemizes what it spends on cotton, cutting, sewing, dyeing, finishing, and transporting each shirt, consumers become more attracted to the brand and more likely to purchase.

“By unpacking the costs, you have the opportunity to explain everything you did for the customer in putting that product or service together”

"By unpacking the costs, you have the opportunity to explain everything you did for the customer in putting that product or service together," says Bhavya Mohan, a Harvard Business School doctoral student in marketing. "When firms communicate the effort that went into making a good, consumers tend to value the product more."

Mohan is an author of the paper Lifting the Veil: The Benefits of Cost Transparency, written with HBS assistant professors Ryan W. Buell and Leslie K. John.

Intimate Disclosure

Since cost breakdowns are so often tightly guarded secrets, the researchers say that when a firm does share this information, consumers consider it a form of "intimate disclosure"--and people are often more attracted to brands that disclose intimate information.

Shoppers have greater affinity for brands that advertise how much
it costs to make a product.Photo: iStockPhoto

"If we think about our interpersonal relationships, when people share things with us—as long as they don't overshare—we tend to like them better," Buell says. "We find it interesting that we're seeing evidence of the same thing in our relationships with companies."

To gather data about consumer pricing sentiment, the researchers conducted six lab experiments in which participants answered questions about a simulated website of a fashion retailer selling T-shirts. The research also included a field study of sales figures at a real online retailer, to look at how spelling out a firm's variable costs of production could affect consumer purchase behavior. The researchers found:

  • When a firm voluntarily discloses its costs, the consumer is more attracted to the brand, which increases willingness to buy. "There's this lay intuition that when customers find out that a company is making a profit off of them, they might get upset," John says. "But that's not necessarily the case."
  • Consumers enmeshed in private, longstanding relationships with the brand were just as likely as newcomers to respond favorably to cost transparency.
  • Cost transparency benefits weaken as a company's profit margins grow larger relative to costs. Interestingly, a company that exposes costs still sees a decent level of purchase intent even with a fairly high price markup.

    "We wanted to understand when cost transparency would be harmful," Buell says. "With a T-shirt that cost $6.50 to produce, it seemed reasonable to us that cost transparency would be helpful [in motivating buyers] if the price of the shirt was $10. But even at $35, we still saw an advantage to revealing the cost of production, which is interesting because the markup was five times the cost."
  • Cost transparency fails only when prices become so high that they are way out of whack with the market norm—and when the firm makes it clear that its own markup is much higher than what competitors charge. For instance, if a company charges $30 for a T-shirt, but emphasizes that competitors are charging only $25, that their costs are the same, and that the competitor's markup is lower, the consumer becomes less attracted to the higher-priced brand and less willing to buy the brand's products.

    "It is possible for cost transparency to backfire, but only when a company reveals it is being unfair with customers," Buell says. "It was shocking to us how heavy-handed we had to be." John puts it another way: "Cost transparency doesn't fall apart until we say, 'Hey guys, we're ripping you off.'"

Meanwhile In The Real World

The researchers took the academic experiments into the real world by examining customers interacting with an online retailer. In anticipation of the holiday season, the retailer introduced a $115 leather wallet on its website that came in five colors. In an effort to promote sales after the holiday, the retailer included an infographic graphic on each product pages that presented 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. But the retailer made a fortuitous error, including the costs infographic for only three of the colors—burgundy, black, and gray.

“Companies may truly stand to benefit from being more open”

This discrepancy was overlooked for a five-week period, creating a natural experiment that compared how customers reacted to the three wallets that outlined costs versus the two—bone and tan colors—that did not. The researchers found that the introduction of the cost transparency infographic increased daily unit sales on a per-color basis by 44 percent.

Not All Costs Are The Same

Consumers seem to have varying levels of tolerance for different cost variables. Shoppers seem to appreciate the cost of raw materials, such as cotton, but certain expenses, like the cost of transportation, "seem like a waste of money to people," John says—even though it is indeed a very real cost for the company.

Yet even if the costs don't seem allocated in an ideal way from the customer's point of view, the customer still applauds the company's willingness to share its production expenses. "Even if it isn't exactly what the customer might envision, the customer appreciates the act of disclosure," Mohan says.

It's unclear whether a company might see these benefits on a sustained basis, particularly if a number of retailers selling similar items all started revealing their costs. Presently, only a few retailers practice cost transparency.

For example, Everlane (www.everlane.com), is a San Francisco-based online retailer that reveals the variable costs of production for each of its products, as well as images and descriptions of the factories where products are made. And Honest By (www.honestby.com), a Belgian retailer, augments cost transparency on its website with detailed supply chain information for each component of each garment, right down to the hang tag. "This was a novel thing to do, and the advantage is probably greatest when it's perceived as novel," John says.

The paper also noted certain cost transparency caveats for retailers. A firm may not want to share production costs if the cost structure provides a competitive advantage. In addition, contracts with suppliers may prevent making certain information public. And it just may be that companies don't have the information readily available—for example, in cases where goods are produced by a variety of manufacturers.

For companies with goods and services that depend on high fixed costs, such as research and development and overhead, simply providing variable costs may not accurately reflect to consumers many of the other expenses incurred. For example, R&D expenditures in the pharmaceutical industry involve more than just the cost of producing one particular drug. Many drugs may have to fail before one succeeds, and that one hit drug ends up subsidizing the other busts.

"It would be a lot trickier for an industry that spends millions or even billions in developing a product to reveal its costs," Buell says.

Raw Honesty Appreciated

Yet in the retail industry—and perhaps in other industries where customers may take for granted how much effort and money goes into producing a good—many firms may benefit greatly from sharing cost figures. Perhaps it makes the price a company charges seem more fair and justifiable. Or perhaps it's simply a matter of consumers appreciating a little raw honesty from the corporate world.

"Our evidence suggests you should open yourself up and say, 'Here I am, warts and all,'" John says. "When you make yourself vulnerable, people like you more."

Buell hopes the research findings get company executives thinking about finding ways to engage more openly with consumers in general as a potential way of piquing interest—and even boosting sales. (HBS related research on how consumers view pricing can be found in the article Brain Marketing: Is the Product Worth the Price?.)

"One of the big takeaways from my perspective is that this opens up the door to companies considering engaging their customers in a more meaningful dialogue. Costs are one of those things historically that we might have thought of as taboo in a dialogue between consumers and companies. It's interesting to think how revealing something that is usually hidden can change the nature of the relationship. Companies may truly stand to benefit from being more open."

About the Author

Dina Gerdeman is a senior writer for Harvard Business School Working Knowledge

Post A Comment

    • Amanda
    I was thinking of Everlane as I read through this article, and then it was mentioned specifically as a company that discloses costs. But Everlane is also marketing its production methods: mostly made in the US, fair and monitored factories elsewhere. So I wonder how the perception of ethics factors into these results. Are consumers more or less likely to respond well to the cost disclosures if it seems like workers are being treated well vs badly?
    • Myles Leighton
    • Behavioral Economist, (Independent)
    This is still endowment effect, only in a different context. Recall Dan Ariely's story about the locksmith? The locksmith that finishes the job in 5 minutes and hands you a $100 invoice is valued less than the locksmith that works for half an hour at the same cost. We value things more when we see more effort, or exhibition of effort.
    • Maarten
    • Research Scientist
    Beautiful line of work! It's great to see that transparency can help rather than hurt organizations.

    I also wonder whether the rarity of transparency adds to its value. Hopefully this is not the case.
    • Ryan Buell
    • Assistant Professor, Harvard Business School
    Thanks for these comments! Amanda, you are right that Everlane discloses much more than its costs, and separate research my colleagues and I have conducted shows that other types of transparency, for instance, revealing the process, are also helpful. That dovetails with Myles' great example from Dan Ariely about the locksmith. When companies show the work they're engaging in on behalf of customers, we've found that customers perceive more effort, appreciate that effort, and value the service more. What fascinated us in this case is that the benefits of transparency even extend to topics like costs, which are typically off the table in exchanges between companies and customers, and that they can be beneficial even before a customer has decided to make a purchase. Maarten, I agree with you that it will be interesting to see how novelty affects the benefits of transparency. To the extent customers find transparency valuable, if more companies
    were transparent, it could become a competitive imperative.
    • Mary Welsh Schlueter
    • CEO, Partnership for Innovation in Education www.piemedia.org
    Great article. I find that as a nonprofit CEO, former Bus School professor and Marketing Executive, the more nonproprietary information that you can offer to consumers, the more interested they become in the output (product). However, I agree, as profit allocations significantly outweigh "real" costs, consumers may have a less-than-positive attitude in the product. It's all about the balance of appropriate message delivery and the degree of transparency needed for a positive consumer reaction and buy-in.
    • Ashwin Hurribunce
    I am not convince of the universality of this concept. For starters, i would like to know what shareholder response t this approach would be. I surmise in a largely capitalist world, shareholders generally might not be too happy.
    • bowlweevils
    • attorney/cognitive scientist, home
    I find the selection of apparel, and t-shirts in particular, to be partially the cause of the results rather than evidence for a wider spread mechanism to increase sales.

    People in most developed countries have been wearing t-shirts for years, literally since since before they can remember. They also frequently wear them, and they see them for sale everywhere from drugstores, to guys out in the street, to sporting events. They know the prices vary widely, and most are smart enough to know that the cost of production for a t-shirt must be closer to the cost at the drugstore or the Walmart than at Yankee Stadium or the Taylor Swift concert.

    What this means is that people know approximately what common articles of clothing cost. What we also know, however, from hundreds of years of examples and mountains of corporate sales records, is that clothing, including t-shirts, is a mechanism for displaying your wealth.

    The person who pays $40 for a t-shirt at a Taylor Swift concert when a similar shirt could be bought at the mall for $20 is paying that premium in part to advertise to other people that they were there.

    The person who will pay $35 for a t-shirt that costs $6.50 to make is willing to do that because the person understands that the ability to pay such a huge mark-up for a shirt is a sign of their wealth. A person who does this is the kind of person who has friends who do this. In your peer group, bragging about the expense of something, rather than the bargain, is the common activity.

    The fact is that we already knew that a $35 t-shirt was being sold at a huge mark-up before the experiment. Providing the exact amount actually gives the person will to pay $35 for a t-shirt more ammunition for their conspicuous consumption - now they can say "that t-shirt cost $35, totally like 5 times how much it cost to make it! but I had to have it!"

    Or price may be a proxy as evidence of quality: "How good are those new golf clubs Bob?" "They better be good, they cost me [whatever premium golf clubs cost]!"

    There is also a phenomenon amount the youth in many cities in the US of buying hats and sneakers and leaving the price tags on so that others can visually see how much you have to spend on these things. Part of the signaling behavior is also to keep these articles in as immaculate condition as possible, preferably by having enough of them to wear to change them from day to day or even for different events within a day.

    So providing production costs at both ends of the price spectrum helps, for different reasons. I'm going to guess that the experimental subjects who responded favorably to the cost disclosure for the $35 shirt were not the same subjects who responded favorably to the $10 shirt. The subjects differed going into the experiment, those who like bargains appreciating information that allows them to see the mark-up over costs so they reduce their concerns about paying for things they don't value. Those who like costly clothing appreciated the information because it let them know how much more they were paying than they (or their parents) had to.

    I think that retailers and producers of luxury goods already know that their target market is made of people who want to spend more than they have to because they want other people to see that they spend more than they have to. Production cost transparency gives them extra ammo.
    • Keiko Matsumoto
    • General Manager, Life Insurance Co.
    I think this study is really true for mass-produced goods like $20 t-shirts. But how about luxury brands? The major motivations to acquire luxury brands are self-assertion, differentiation and genuine appreciation for product excellence, according to the paper of Rohit Arora (8 P's of Luxury Brand Marketing). Will deconstructing the price tag increase the sales of luxury brands?
    • Kapil Kumar Sopory
    • Company Secretary, SMEC(India) Private Limited
    It is tricky to announce costs and more so for the consumer to believe these without any sort of verification. Hence, while the conclusion drawn by this researcher may have some impact on the velocity of sale, to me it does not appear to be a universal phenomenon relevant to all types of goods
    Costing of products is generally a closely guarded exercise and is done by management groups which maintain secrecy. Many times even most insiders are not kept aware. Therefore making disclosures can be difficult by the sales team and the members may not be able to express themselves uniformly - different statements can create doubts in the mind of customers leading to the entire endeavour becoming unproductive.
    Hence, a cautionary approach is called for. And, the decision to resort to such transparency needs go-ahead of promoters and shareholders who must be a party to allowing such actions.
    • Demola Odeyemi
    • Executive Director, Guaranty Trust Bank Plc
    Transparency and Honesty are two key variables in the equation for long term success of a firm in all economic sectors. A very good work