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[I arrived late for class this day. I missed his lecture on demand, supply, and equilibrium.]

…those people can afford it, they don’t have a lot of choices, there’s not a lot of new places to build gas stations, and so they get away with it. And, so, basically, they watch each other’s prices every day. What’s really interesting about this gas price thing is that prices are monitored every single day. Now in the milk business, they don’t monitor everyday, they monitor maybe weekly or monthly, maybe even quarterly. Now, that there’s some concern, it probably gets done more often, and the media might come in and do some monitoring as well.

But in the gas business, there’s a company right here in the Twin Cities that has put together a pretty sophisticated program. When they started, they were calling, long distance, every state in the nation by calling on a number of strategically located gas stations in each of these states, and they would survey to find out what’s going on. Then they became electronically savvy with it and they decided to survey more and will just give them a certain dollar amount each week for reporting to us. So, virtually, each day gas stations from all over the country will report their price for that day to this firm in Edina. They, in turn, report it back to the industry.

So that information gets looked at each morning by a gas station manager. And so he’s saying, ok, here’s what’s going on, here’s what other people are doing, here’s what people are doing in my neighborhood, here’s what people are doing in the state of Minnesota and in my county. And so it’s very much a monkey see-monkey do kind of deal. And what will happen, then, is they will post their price outside, and if you’re near an independent, or someone who’s pricing philosophy is to charge less, they will charge a few cents less. So if I’m at Super America, I might be at $1.79, and the Conoco down the road, might be at $1.69. His thing is to always be a dime less. And that’s essentially how it happens.

Now, if one of those local gas stations was lucky and smart enough to buy a futures contract on that product, and deliver that in for a much lower price, for a time, they could have a considerably lower price. And that often brings other people down. And so they’ll reduce their margin so that they can keep their business. Usually, those things don’t last very long, because when that independent goes to buy another futures contract, now he’s going to have to pay a higher price for it. And, so no one can be that low cost provider on a consistent basis. And it’s those contracts that cause those spikes and dips. So all of a sudden, here’s the Holiday Corporation going, “Well, we have 187 Holiday stations, and we’re going to buy this amount of gas.” And everyday they’re buying new gas for the next cycle, right. Well then all of a sudden, that price jumps up. Well, what they do, which I think is wrong, I think their pricing aught to be based on what they paid to get it in, but they jump the price the minute they expect those high prices coming, which is unfair, because they do take advantage of us that way.

It’s a commodity, but if I buy beer, and if I had 28 cases that came in at a dollar a case, I should be able to sell that to you for two and make a profit. Now, if the price of the beer doubles, should I double the pricing of that inventory?

It’s the market price, that’s supply and demand. So people will do that. It’s only human nature. So for someone to say, well that aught to be illegal, that isn’t going to happen. That’s how the game is played.

Do they take advantage of us from time to time, because the market jumps? Yeah. In the long run, what I have found out about the gas business is that the margins aren’t all that good. When I wanted to buy a gas station, I was pretty excited about it. But what I found out back then was that the typical gas station was making about 8.5 cents per gallon. The taxes were more than the profit from the product. And you had to cover all of your expenses out of that. You had to pay property taxes, you had to pay for tank inspections, you had to pay for electricity to pump the product; you had to pay for your employees, etc., etc.

By the way, my father-in-law just came back from the state of Oregon where there are no self-service gas stations. By law, you have to have some one pump gas into your car. It’s a union thing, he was told; they say that it’s a safety thing, but we have proven that that is not a valid argument is it. So it really is a union deal. Have any of you bought gas today? How much are we paying for it right now?

Ok, he was paying $1.96 out there. So it’s about twenty cents higher for the full service deal. I would be very surprised if their ability to produce the product was less than ours. Although, we’re gifted here in that we have two refineries, and Koch is huge, it is very very big. The Ashland facility isn’t nearly as huge. But we’re lucky to have two players here. By the way, have you ever noticed as you drive by there that every gas supplier gets their product from over here.

[Yeah, I think Holiday does… Ashland, though, that’s mostly for Super America stations.]

Yeah, Ashland is Super America, but every now and then, you’ll see Super America trucks at Koch. Well, what’s a Super America truck doing at Koch refinery? Well, what that means is that…

No…well, that could be that they are changing over, but more than likely they are tapped out. They are selling more gas than that plant can produce. And so in order to meet that gas station demand at the retail level out in the real world, they go to Koch and buy. And buy the way, if you send a truck over and buy, today, because you need some today for nine more stations that are running low, because of unanticipated higher demand, are you going to pay a lower price or a higher price?

Oh yeah, you’re going to pay a higher price. It’s really kind of interesting. But the guys who do the best are the independents who have their own trucks. And they will buy a contract. It’s much like buying newspaper advertising. If you go in and buy an ad for Saturday’s paper, and you pay for that today, you’re going to pay the maximum price. If you buy a whole year’s worth of contract, and each week you get a certain amount, you’re going to get a lower price, right, you’re going to get a quantity discount. So some of those independents that have gotten smart will buy a considerable amount in advance and then they just over and use that part of their allocation. By the way, if we get to a point where we’re really in a shortage, they will get their trucks filled first, while the other guys will sit there waiting. Because the guy at the facility is going, “Well, wait a minute, I’ve got eighteen contract trucks, I have to fill them first. And since you’re on the daily market, you’ll just have to wait.” I have seen those trucks, out there, sometimes forty long when we’ve had a gas supply crisis. There were forty semis in a row waiting to get in there. And, believe me, they don’t miss their turn, so they don’t venture very far from their truck.

{Well, what I understand is that if I’m buying on a contract, I’m already buying at a set price, right? But you still have that jump. __________}

But, you see, you’re making profit because you’re capitalizing on the fact that everyone else has to pay a lot higher, so you just make more profit. The consumer gets shafted.

{_________________________________________it’s Super America that raises the prices and every time I see this, I go and fill up elsewhere before they in turn follow suit.}

There’s a guy on Rice, up by 694, that has his own truck, and he buys on contract. And I’ve watched him. My friend Jeff who lives up on Lake Owasso, tells me that this guy is always eight or nine cents less than his peers. But he has his own trucks, he goes and picks it up. He’s made a fortune over the years; he’s got more than enough cash. He pays cash in advance for the product, so he gets the best price. Well, one of the reasons he has become so wealthy is because of that. Everyone else has their prices jacked up, but he’s still a couple of cents below Super America, but he’s paying less for it. And Super America essentially has their own refinery, so you would think that they would be in the position of controlling pricing.

Now, Cennex for a long time had their own refinery. Now, the Cennex store in Apple Valley has been made into a _________ store, and I don’t know what’s going on there. They might have decided that it wasn’t profitable to keep their own store anymore. But in South or North Dakota Cennex has a petroleum refinery and they produce their own product. Well, that gives them more margin to work with. And so they’re profits tend to be steady and in the case of Cennex, that money goes back to the farmer. And the farmer is glad to be able to have that option and not be at the mercy of Koch refinery and Ashland.

[You would think that they are using their own fuel for their own facilities up here for their own gas stations, the transportation costs must be really high.]

That’s one of their biggest expenses is the transportation costs. But you have to understand that where they built that facility is based on where their biggest farm customers are. So a guy who is a dairy farmer in Minnesota, he doesn’t use a lot of gas, a dairy farmer in Wisconsin doesn’t use a lot of gas, but a guy who has the big spread out in the western part of the state, where he has 6, 8, or 10,000 acres, he’s going to use a lot of gas. So it was interesting on how they decided on where to locate that refinery. The other thing is that facility is located to be able to draw Canadian product from the north, western product, and southwestern product. So they get crude product from Oklahoma and Texas. And so where that product comes from and the crude level also has to be figured into the distribution package. It’s pretty interesting stuff.

They are actually right on William’s crossroads. If you look at the map, there is a pipeline crossroads, and here in Minnesota, we’re also located at a hub, but if you look at the map, you can see how this makes sense. But if you overlay that with their biggest needs, they are close to that. It’s pretty interesting stuff.

All right, I always give one supply and demand story. And we also talk about marginal analysis. And I’ll try to cut this story short, so we get a chance to look at a couple overheads, but my brother-in-law gave me this story and it’s a true story. He was in the Navy and he managed a commissary store on the island of Formosa, which is now Taiwan, the Nationalist Free China, which by the way, could be the site of future conflict between us and the Chinese. Well, have to see how that plays out over time, but it has a huge American base, and it still is particularly since we’ve been kicked out of the Philippines, which has made this all the more critical. And what he did there was to manage three commissary stores. There were three stores on the island. He had a commanding officer who was responsible for everything dealing with supply via the navy on the island. Gary was down here, and he was responsible for the stores. So his C.O. was responsible for the fuel for the ships, the firing pins for the big shells on the ships, the aviation fuel, the aviation parts, and whatever was stored on the island that had to do with depot operations. Gary was responsible for the three stores. And the three stores were primarily there for the people who live on base, the enlisted men as well as the officers.

The employees, who were locals, can also buy at the base. And they had certain kinds of privileges but they were not to affect the local market place. So, in other words, they’re not supposed to screw up what’s going on in your small store down the road. And so people off the street can’t come in there and buy. By the way, pricing is very good. These guys buy cigarettes, Playboys, lighters and everything for less money than we do, probably because when they military buys, they buy in large quantities.

Well, they had been buying lettuce for a long time, and their cost had been about ten cents per head. And one day ensign Nelson gets this call from a guy on the dock and tells him that we have a problem. They had shipped 10,000 head of lettuce. And Gary said, “Well, that’s a problem, I’ll have to figure out how to deal with this.” Obviously, you can’t send them back, right, because they would be trash by the time they sent them back. Lettuce is a very perishable commodity. So he came up with a pricing scheme on how to do this. So he sat down and he thought, ok, we typically sell these at 19 to 29 cents per head, somewhere in that range. And that was pretty much the customary price for that same product here in the states. You could buy a head of lettuce for 23 to 25 per head. Now, I think the price of lettuce has been about a buck a head. And the price stays pretty consistent over time.

Usual order is 1,000 per month

Lettuce @ $ 0.10 per head Retail @ $ 0.19 to $ 0.29

Well, anyway, they had been ordering about 1,000 head per month. And that was their standard order, they used 1,000 head for the number of people that came and went on the base. But the total number stayed pretty much the same, so it became a routine order. Every month the ship would come in with this many head of lettuce. Well, now he realizes that he has a supply problem. He has way more supply than he can handle. So he calls his C.O., and his C.O. says, “Well, this is a pretty big screw up, nobody should be doing that to us.” And Gary said, “Well, sir, that’s not really the issue; the issue is how can I continue to look good in my stores by maintaining a profit?” And the C.O. says, “I don’t care if you make a profit. As a matter of fact, I hope you lose some money. That will give me a good excuse to kick somebody’s butt.” Well, Gary gets performance reviews based on not losing money, right, so he’s vested in wanting to do the right thing, here. But his boss is more interested in kicking somebody’s butt. And, basically, what they found out is that somebody somewhere along the line somebody had played with the order. Whether there was money taken under the table or what was not know. But maybe they were just trying to get rid of a surplus of lettuce. So instead of shipping them 1,000 heads, we’ll ship them 10,000. Now, they can’t play that game every month, but for a one month period they might get away with it. And imagine if they did that for as many as ten major bases around the world. That’s a lot of lettuce that’s not in the California market anymore, right, and all of this stuff gets shipped out of California.

{Well they could have just made a simple mistake by adding an extra zero in there…}

It could have been a simple mistake, and that’s initially what Gary thought, but his boss was convinced that there was money under the table somewhere, and he was going to find who ever was messing with him. This guy didn’t have a whole lot to do, so this was his big deal.

Well, what he said to Gary was that he was going to sell that lettuce at nine cents a head. And Gary said, “No, no, no. I have been trained through the University of Minnesota as an economist. I understand marginal analysis; I understand elasticity. This is a product that is definitely inelastic. If we lower the price, we’re not going to sell more. We can lower the price a little bit, but how much more lettuce can you eat, right. You can’t eat that much, and it’s perishable. And it’s right out of a professor’s lecture that in terms of a demand curve that looks like this. So, no, that’s the wrong thing to do, we’re not going to do that. I’ve got a pricing scenario that I have put together, and I’ll have it on your desk by this afternoon. Well, that’s fine and dandy; you just put your fancy college pricing scenario on my desk, but I’m not going to pay any God damned attention to it. We’re going to sell it at a loss if we have to. And he said, no sir, you can’t do that. Let me show you what’s going on and then let me deal with it.

Usual order is 1,000 per month

Lettuce @ $ 0.10 per head Retail @ $ 0.19 to $ 0.29

Pricing Plan: 1^st week: $ 0.79 per head

2^nd week: $ 0.49 per head

His pricing plan was to start off at 79 cents for one week. He increased the price dramatically, but he gave them really good lettuce. So when he went down and looked at it he was like, “Wow, this was a bumper crop. Obviously there was a supply problem in America. They had way too much lettuce, and they had good stuff.” So he thought he could bump the price up, and sell the typical amount that we usually do per week. But from each of those heads, he gains more sales dollars. So at this price, he’s getting 70 cents per head, which covers, later on, when the lettuce looks bad, the losses because people won’t buy the lettuce in the end. So this is a good strategy. Then on the second week, he drops it down to 49 cents.

[When you said that elasticity wasn’t involved, I never took that to mean that inelasticity was…That’s hard to believe.]

Perishable things like tomatoes, potatoes, and lettuce are classic examples of things that are inelastic. You can lower the price, and people won’t buy a whole lot more. They might buy a little more, but they won’t buy a whole lot more.

Well, that’s it; if the price is too high, you’ll back off. However, if the value is there, and you see that it’s really nice stuff, and someone is saying to you that this is beautiful stuff, you’ll say, yeah, it does look nice. So you might buy too heads. So he was actually hoping to increase his sales a little bit via good promotion. Having a lot of the product on display, having people talking about it including recipes, etc., was important. When he lived there, he had a person that cooked for them; they had a chef that came in every day. He lived off base. And there was a guy that came in every day to polish his shoes; and there was another guy that came in to clean his car. And there was another gal that came in to clean the house and do the laundry. I mean, they lived like wealthy people. And so the cook that they had was going to give them all of these wonderful Oriental recipes, and they were going to sample throughout the store, all of these kind of Oriental dishes that required lettuce. They actually had a recipe for corned beef and lettuce, instead of corned beef and cabbage. And my sister made it for me once, and it’s actually pretty good. It doesn’t taste quite the same, but if you like corned beef, that flavor kind of rings through and the lettuce flavor isn’t quite as strong tasting as the cabbage, but it was pretty good.

And they also showed people how to freeze the product, and how you can make recipes with frozen lettuce. And in a lot of Oriental dishes, you end up with a this goopy sauce, so it doesn’t matter if its been frozen before. It’s just there as filler, right. That’s what it’s all about. Anyway, he was going to hype this a lot, and he was going to have people pouring ice water over it multiple times during the day to keep it fresh and to keep it looking good.

Usual order is 1,000 per month

Lettuce @ $ 0.10 per head Retail @ $ 0.19 to $ 0.29

Pricing Plan: 1^st week: $ 0.79 per head

2^nd week: $ 0.49 per head

3^rd week: $ 0.29 per head

½ week: $ 0.19 per head

½ week: $ 0.9 per head

And he finally got to the third week, where he charged the normal price. And then he was going to charge even less the next week later. Then for a half of a week, he charged 19 cents. And then for the last half week, he charged 9 cents. So the last little bit, he charged what the commander said he should do for the whole thing. And that was his strategy: promote the hell out of it in the beginning and make as much money off it as you can. Then start lowering the price to a more normal price while continuing the promotion. Now, he was going to be charged approximately 10 cents per head to dump the product. And this is critical in figuring his costs, right. Because if he’s got 10,000 head, and at the end he’s got 8,000 left, he’s got a serious problem on his hands. And, basically, on a military base, they take advantage of you, because you’re on some one else’s property, right. So you have to pay for everything that gets dumped. And, actually, where they haul to dump this stuff, I would love to go back there to see what that is now, because we dumped all kinds of crap there. There is stuff there that we know was toxic. There were things explosive in nature that got brought out to this dump. And he said that he couldn’t imagine that if they put 8,000 head of lettuce out there how many locals would out there picking through it. And he just thought that would be horrible, but his commander really didn’t care about that. He said, I don’t care if we have to pay to dump it, we’re going to nail this guy. Anyway, they ended up dumping about 3,000 heads of lettuce. Gary’s plan would have called for the least amount of dumping. However, he still would have had to dump, because there was no way he could sell all 10,000.

Usual order is 1,000 per month

Lettuce @ $ 0.10 per head Retail @ $ 0.19 to $ 0.29

Pricing Plan: 1^st week: $ 0.79 per head

2^nd week: $ 0.49 per head generates

3^rd week: $ 0.29 per head maximum dollars

½ week: $ 0.19 per head verses

½ week: $ 0.9 per head maximizing losses

But with scenario, he generates the maximum dollars that come in and minimizes his loss. With the other plan, what does he do? He maximizes his loss, right. He absolutely maximizes his loss. And his boss actually knew more about economics than Gary would give him credit for, but his boss knew that if we did this that it would maximize loss. He knew he’d have to pay a dumping fee, and that it is the total dollar amount that he could write in his report to tell Washington about what this idiot in San Diego cost me. And that really upset him.

By the way, that was a bad month for Gary in terms of his total numbers, because he did show a loss, and that was the first time in his history as being in charge of those commissary stores.

You can’t dump in the local market; you can’t sell to the locals. And the funniest part about the whole story is that the commander said, “Look Gary, you can let your local employees carry out what they can physically carry out in a day on their own. And that minimized his dumping fee. He did end up having to pay for some dumping, but the first day, he said, pick out the bad heads, because already on the first day, you can see there were some that didn’t make it in shipping. And by the way, everyone in the Orient has a pig at home. So everyone wants to feed this to their pig. They want to feed grandpa’s pig, uncle Harry’s pig, so these guys were thrilled that they could haul this home. So each one of them was going out with like three bags full of this, and they would walk out with as much as they could. The next day, they showed up with these big long bamboo sticks, and then they could haul fifteen bags at one time. Well, he’s got some great pictures of these guys with huge smiles on their faces walking down the street with their bamboo sticks and their kid would meet them with a truck, right. So they’d go off the base with all of this stuff, and they’d come back for another load. So, ultimately, that’s how he moved much of the product.

But the law will not allow you to dump it in the local community, because that affects the local farmers; that hurts their local economy. And, essentially, that’s what was going on in San Diego. There was too much supply; they wanted to be rid of some of that supply, so the easy solution was to put it on a navy refer ship and get rid of it. It’s an easy way to keep margins up…

Right, and each of the ships that docked also had a demand, and that was already accounted for within the usual 1,000 heads. And every ship that came in for supplies got extra lettuce. But the problem is that on those ships, you have a storage capacity problem. You can only store so much. And when they load those things up, there’s not extra space for anything.

Yeah, and it doesn’t have any shelf life. I mean it goes pretty quickly. Now, they were able to keep this product refrigerated and looking fairly decent, but imagine how crappy it looked at the end of that forth week. I mean it started to look pretty bad.

Probably about a week, so this is product that is actually picked slightly immature, like the way they ship bananas, which ripen during shipping. Anyway, what he wanted to do was to minimize the loss, and not have a maximization of loss, and he did lose that battle somewhat. But he had a good story to tell, and it was a good story to share with me. And I’ve told this to every marketing class I’ve ever had, because it’s an interesting way to think about pricing.

Now, what this is is using the price determinant using marginal analysis, and this shows us the point at which we maximize our profits. And it’s basically the same concept. By the way, my brother-in-law also tells a wonderful story about his military experience. His first assignment was on a ship called the USS Iowa, the big gun ship with the huge guns. And when ever they would shoot those guns, he would jump up and hit his head on these pipes above him. And I was on a ship just like that in the Carolinas and when I pictured him in there, it made the story all the more funny. But they were off the coast of Vietnam where they would fire their guns inland. Then they would turn around and fire the other set of guns while the first set cooled down. And they did this day after day after day. So everyday, he would write a letter: I want off this ship. He finally bugged his officers so much that they let him off. So that’s how he got transferred to Formosa. While he was there, they had a monkey. And one day the monkey decided to be nasty, while my brother-in-law was entertaining all the top brass for dinner that night. So all these guys are there in their beautiful white uniforms. And the monkey became upset, because no one was paying any attention to it. So it would crap in its hand and start throwing it at the dinner table. And every single one of them got hit with it.

The other story about Sasha the monkey was kind of sad. They had a typhoon one year, and he was worried about the monkey and he didn’t want it to be trapped in its cage, and didn’t want it to get hurt. So he put it in the strongest room in the whole house, which was the laundry room. And the laundry room had bars on the window, and it couldn’t get out. Well, they went to wherever they’re supposed to go on base, and here’s this poor monkey. Well, during a typhoon, the pressure changes dramatically and this drove the monkey crazy. And because he couldn’t get away, he just tore round and round inside the laundry room and made a mess of the place. But you can imagine how crazy this monkey went. I mean, his ears were going to hurt regardless, so he probably had done all he could for it. But that was his monkey story.

But anyway, this takes a look at using marginal analysis to figure out at what point we choose to produce. And so at a price of 22, we’re going to sell 7. That’s the maximum that we want to sell, we don’t want to sell less and we don’t want to sell more. If we sell less, here, you can see that the profits aren’t as good as they would be if we sold more. So we take a look at our marginal revenue, our total costs, our marginal costs, our total revenue sold. And, obviously, it’s like the break even analysis, you have to know what your fixed costs are and all of that. But in this case, we produce 7 units at a price of $22, that gives us 154 dollars in total revenue to come in. The marginal revenue for each additional unit, then, becomes $10. Our costs are $84, our marginal costs are $6, and it yields a profit of $70. Does this make sense in light of the lettuce story? Can you see how pricing at 9 cents gets you into the negative figures, right. That was not the best thing to do. So this was the economic theory that Mr. Nelson was using.

All right, this is how we define marginal analysis. Marginal analysis attempts to determine the cost and revenue associated with production and sale of each additional unit of a product. It focuses on a profit maximum as a goal of the firm. What marginal revenue is, then, is the net additional revenue for the whole firm from selling one more unit of product.

So that’s the definition, and what that looks like when you break it down on the chart. And, I don’t know that it would be after break even. I mean, in this case, they’re starting with one and going to two, then from 3 to 4.

All right, let’s take a look at a kinked demand curve. This is, and I assume that this is like a cleaning service that cleans houses or rooms for motels, or within a motel operation, particularly if they contract that out to someone else. But it could be their costs on what they do as well. And if we look, here, and see what happens is that it’s a relatively straight drop in terms of the demand curve until we get to a certain price. And then at that price, it will demand more. And so that’s what our classic kinked demand curve looks like, and if your pricing at $10 they might have you clean the room just that more often. Or, they have people cleaning additional rooms that you might not have cleaned before.

And this is the point at which the intersection of the marginal revenue and the marginal cost come together, the point where marginal costs equals the marginal revenue curve. And that tells us the maximum or the most efficient, the highest level of efficiency from producing x number of units sold.

Alright, this last one looks at the concept of penetration pricing, which we talked about the other day. And this gives us some situations with the different scenarios between one or the other, as far as it is appropriate. So in the first one, the market cannot be segmented on a price basis. So price skimming makes a certain amount of sense. And the example, there, would probably be 3M video recording tape, where they have various qualities, and it’s nicely segmented in terms of how long you want the video tape to last, and what kind of quality you were looking for, and so they can skim those players off at those higher prices, and have additional product, down the road at lower prices to meet the mass market. And eventually, you end up with a product that’s priced competitively to the other players. And then in that industry there is basically a BASF, 3M, and then two Japanese players. So there’s only four producers in the whole world that produce almost all of that product. And when ever they have a new product or a better product, they will continue following that skimming philosophy.

If competitors enter the market quickly, then penetration pricing probably would make more sense.

Or, if demand for a new product is highly priced as elastic, you would probably want a lower price to stimulate demand to increase your quantities and then overtime and gradually you’ll raise your price. So my Signs For Sale business, where I have not the ability to protect myself, if people see that it’s easy to make a lot of money in that business, I’ll have a lot of competition. So until I establish myself and establish my base, and have a pretty good reputation going, I want to keep my price as low as possible. And let supply and demand bid my price up.

If the Firm is concerned that demand will outstrip production capacity, skimming is a good strategy.

Or, if the Firm wants to recoup their R & D costs quickly, or if the R & D costs are real high, then you almost have to do that. And there’s a certain number of people who will want to buy into the market regardless of the cost, they want to be associated with it, they want a part of what they’re doing. And I though about that while I was reading your music reading program thing. That’s exactly the same kind of scenario, where people will go, “Wow, this is really cool; I don’t care how much it costs, I want to do this.” By the way, there’s a possibility of having it turn it’s own pages without your clicking anything or touching anything…

Yeah, based on the beats of the music, where the computer could, itself, be programmed to move at a certain tempo, and when you reach the end of the page it just turns automatically.

Yeah, so that’s a fun product; that’s a pretty cool thing. If there’s a strong patent protection for the new product. So when 3M introduced their ground fault Interrupt, they had spent a lot of money and a lot of time developing the product; they spent a lot of time lobbying states to make it code, and so they had a lot of investment. So they charged a fortune for it. And they were able to get that, because you couldn’t buy the product from anyone else. They had 100 percent of the market for a certain number of years. Once the patent disappeared, then Square D and everyone else started producing them. And then 3M had to meet the competition, price. And so for the electro products division, they were really the profit group for quite some time at 3M. Now, it’s a different group who is generating those products. And the electro product division struggles with a certain amount of competition. But that’s why companies like 3M invest so much money in research, because they always want to have a certain number of new products that generate those kinds of margins.

{On a patent, though, isn’t it true that you can have something really similar to it as long as it doesn’t have the exact same components of the original enough _________________ to produce it. Isn’t that right?}

Well, they had competition from a similar kind of product. But because it was completely inferior, nobody bought many of them. I mean, they bought a few. So there were people who were making something similar, but they couldn’t call it a ground-fault-interrupt circuit, because that was 3M’s deal. But it did essentially the same thing. But because the 3M product was so much better, people didn’t want to take the chance on the other brand, and they didn’t have the same kinds of guarantees as 3M, so that company didn’t sell much. Once the patent was gone, then they can produce the exact same thing or buy from suppliers the same components and then it truly is a more realistic and real comparison. It’s like why should I pay more money for a 3M product when this one is cheaper and does the same thing?

My friend sold packaging tape and shrink wrap, and he competed against 3M. But where 3M had the market on the Post-It Notes, there was nothing he could do. The law prevented him from competing against him. But in his case, every product that he sold was product that had lost its patent. So there who company was basically just about knocking off 3M. And 3M took intense heat on price. They didn’t have to go out and do a lot of expensive demonstrations or do a lot of advertising. They simply said, why would you buy a 3M product, when you can buy the exact same product along with the same guarantees, for this much less.

{Well, that’s what I was saying _________________________ but you see it all the time. Like the DVD player or something. _______________change one little thing or to…}

Well, that’s why you hire good patent attorneys is to fight that. So if it’s too close, you’re going to get nailed. I mean, you have to be really careful about not… But the problem we’ve had for many years was the foreign competitors who knock off will the original product is supposedly patent protected. And they’re like, well, ok,…..

…it still gets down to this. They are producing for their primary market in their country. And they’re knocking us off, but not shipping to the U.S. It’s a similar product, but it’s via a third party distributor where they can ship to the U.S. Well, the manufacturer isn’t liable or responsible for that, but eventually you can shut down, by saying, well, we know that this guy is buying for this ____ and you can’t sell to him. But it gets complicated.

So you can see why you would want a good and strong patent, if you have a product that you are convinced will sell. The CD business and the whole way that CD products came out…and now it’s DVD and HDTV, it’s the same thing. If you want to buy a DVD player, now, the price has come down from when they first introduced them, right, or, the microwave oven. There comes to a point, you know, they will find that point where it’s a good value for you. In the meantime, they have pulled out all of those other people who were willing to pay a considerably higher price, particularly people who want to be first and who will have a real competitive advantage in terms of the cost of what they produce. If you’re a restaurant, it’s worth it for you to buy a microwave, even though you’ll pay a lot of money for it, because it saves you a lot of money. And so, they could sell those to restaurants. Well, homeowners…they’re not going to pay a thousand dollars. They will just go without. So, ultimately, you have to get the price point down to bring in that mass body of homeowners. And that’s kind of how that works.

There was an example given while I was doing small business training through the SBA. There was a guy in St. Paul who made a valve for stainless steel tanks. And he had a product that was very unique. No one else in the world had this exact product. And he started off with a cost-plus pricing program.

Cost: $29.99

$50.00

$79.99 3 to 8,000 unit potential

And basically what he did was to say, ok, my cost is $29.99, let’s say. I’m going to add $50.00 on to that for my profit, so that I can make some money. And I’m going to sell it for $79.99. And he said, I think that there is somewhere between 3 and 8 thousand potential opportunities to sell this product globally. He sold it to manufacturers who had stainless steel tanks. And so people in the cosmetics business and the chemistry business and the brewery business would have an interest in this product. What this product did was that it allowed you to take a pressure rating, much like you do while cooking with a pressure cooker…. Well, the product, if it should come in contact with a brass spring or other metal component within the body of the valve, it would contaminate the product. And so he figured out a way to make a stainless steel pressure gauge that would work in a stainless steel tank so that everything was all stainless steel. And there would then be no other metals or plastics or anything else touching that product within the vat. So he filed a patent on it and his patent was for, I think, seventeen years, and he had a pretty neat product.

Cost: $29.99

$50.00

$79.99 3 to 8,000 unit potential

Well, he went to the SCORE ACE workshops and he got in touch with those folks, and the ACE counselor that he was assigned to was a 3M person. And 3M often has people doing that, ok. The 3M guy looked at this and said, “Well, why would you price it at $79? And he said, “Well, because that’s a fair price. I’m making plenty of money. I’m making fifty bucks, and this is all it costs me. And the guy said, “Well, no, that’s not how we do it at 3M, that’s stupid. Why don’t you survey what people would pay.” And he’s said, “Well, why would I want to do that?” And he said, “Because you can charge more, and you can have a higher margin, right. You could end up with what we call the 3M margin. And the 3M margin, when they talk so lovingly about this 3M margin, it’s typically 8 to 9 hundred percent, or even a thousand percent, right. 3M has really been good, throughout the years, at generating some pretty strong margins. And the guy is like, “Well, why would I want to do that, that’s just crazy. I don’t want to charge customers more than I need to for the product.” And this guy is going, “ohhhhh! What is wrong with this entrepreneur?” Of course, if you want to grow your business, and grow your product line, you have to charge, and you have to have profits to pay to expand your company.” And this guy is going, “Well, no, but that’s a good value for these people.” And he comes back with, “Yeah, it’s a good value, but as soon as you’ve sold to all of those, you’re out of business.” And the guy went, “Oh, that’s a good point. I guess I really don’t want to quit my job, over here.” He had invented this as a part time project. But he didn’t want to quit his work, and then sell like 3 to 8 thousand of them, and then all of that money is gone within two to three years…and then what does he have to do? He has to look for another job.

So, this guy agreed to conduct a survey. Well, he had sent out 100 brochures to people who had need of this application. And of those 100, quite a few of them came back at $79.00, because they had already been exposed to this price, and it was kind of locked in their minds as to what it was worth, right. But they sent this out to everyone. Now, partly when they created this mailing list, they created a prospect list, right. Who might buy these? So now they have an ability to call these people on the phone, send them some more information, send a salesperson to call, or what ever it takes.

Cost: $29.99 Survey results:

$50.00 $ 1,200

$79.99 3 to 8,000 999

unit potential 799

And when the prices came back, they were pretty surprised. The average price that someone was willing to pay for this valve was $1,200. That’s a lot different than $79, isn’t it. So they called a few of these people and they asked them, “Well, how did you arrive at this $1,200?” And they said, “Well, I arrived at that, because my tank cost me $12,000, and it’s worth this amount to me to protect that tank and its contents. If that tank ruptures or splits, I’m in trouble.” So they made a value analysis as to what the product was worth, right.

Cost: $29.99 Survey results: Intro offer:

$50.00 $ 1,200 $ 599.00

$79.99 3 to 8,000 999

unit potential 799

So what they did, then was to say that this was an introductory offer, a one-time only. And if you missed it, you missed it. Because, you don’t want people going, “Well, wait a minute, he bought one for $79…. But now the new price came out at $1,200. And they sold to whoever thought that was a good value. So they did a skimming policy, right.

[But was the $599. more in line with penetration? I get those confused within this context…]

This is the introductory offer [$79.00] that really the 3M guy wished he had never put out there…

Clearly it was penetration, yeah, and this 3M guy must have been thinking, “This entrepreneur doesn’t understand just what penetration is; he just didn’t understand…” But when they lined it up this way, it was then when he could understand. And he said,

Cost: $29.99 Survey results: Intro offer:

$50.00 $ 1,200 $ 599.00

$79.99 3 to 8,000 999

unit potential 799

“Well, ok, once we pull those people out, who are willing to pay that, well, then what do we charge?” Well, then we’re going to charge $ 999.00. And at that point, you’re going to expand your product line by having cleaning supplies and other things. Because by then, you’ll be sending a catalog out. So this guy in St. Paul, now, has a business that sells other things than this one valve, ok. He’s got cleaning supplies and brushes to get into the lines, and suits.

The 3M guy never told us the name of the firm, but it could be. But anyway, they specialized in stainless steel tank accessories and stainless steel tank cleaning equipment and supplies. Well, then they dropped the price to $799 and then they dropped the price to $499. And each of those layers pulled out a certain number of people who said, “Oh, well, yeah, I wanted one of these valves, and now I can afford to install one.”

Cost: $29.99 Survey results: Intro offer: Model # 2

$50.00 $ 1,200 $ 599.00 $ 1,799.99

$79.99 999

(3 to 8,000 799

unit potential)

When they got to $499, they came up with model number two. Model number II was a much better model in that it would print out what the readings were for that day. So it had a little electronic attachment to it, and there would be a printer that would say, “At 3:00 there was this pressure, or at 4:00…” But that’s pretty cool. Now, the new model II, they came out with a price of $1,799.99. And it didn’t cost them that much more to augment their existing product, it just them cost them very little, actually. So, now, people that had the original model, wanted to upgrade to the better model. And they sold even more.

Cost: $29.99 Survey results: Intro offer: Model # 2

$50.00 $ 1,200 $ 599.00 $ 1,799.99

$79.99 999

(3 to 8,000 799 $ 299.00 Model # 3

unit potential) $ 199.00

So does it pay to think things through intelligently? Absolutely. So there original model goes down to $299, and then it bottoms out at $199.99. And that’s probably what an original model, today, still sells for. And so, at some point, you find people who are going, “Well, I can’t justify three or four hundred dollars, but I can justify $200. And, virtually, everyone in America, and the world, has one of his valves in their tanks, who really need it. But they didn’t stop with model two…they came up with model # 3. And model #3 will tell you the pressure in any tank that you have anywhere around the world, and it works on GPS, the same thing that Cennex uses in replenishing their fuel tanks. It works on a radio signal that goes to a receiver. And it’s actually a satellite signal, I’m sure. So, now, you can be sitting in your office in Revlon Corporate headquarters, and see what’s going on in your tanks all over the world. [I’m not so sure that Revlon has “tanks all over the world.] And each one of them has a built in safety thing, and it’s got a couple of built in safety warning systems, etc., etc.

Cost: $29.99 Survey results: Intro offer: Model # 2

$50.00 $ 1,200 $ 599.00 $ 1,799.99

$79.99 999

(3 to 8,000 799 $ 299.00 Model # 3

unit potential) $ 199.00 3,799.99

Well, that one ended up selling for something like $3,799.99 when it first came out. Now, weather since this story had been told, they have come up with another model or not, I don’t know. But the 3M guy had worked with this company for a period of three years, off and on. And he had seen this guy grow from an entrepreneur that had one product and one idea, which might be similar to, maybe, your product and your idea… You know, it’s cool, it’s unique, it’s special, and watch that grow into a company that hires multiple employees and ships all over the world, and probably has a nice web page today, and a nice catalog. Isn’t that what the government is after in terms of growth in business and in growth of jobs?

Yeah…so the point of this, though, is to never be ashamed or never be afraid to charge what the market will bear. Never be afraid to charge a price that the customer sees as ____, because you can always lower your price, right. Over time, you can lower your price.

Now, when my wife started her business, she said, “What do I do if I have too many attorneys trying to book me? How do I deal with this?” And I said, “You simply raise your price…” So price is the way that you control the flow of product through your organization, and through your facility. So if you have more business than you can handle, you raise the price. What’s the matter? You guys want get out of here?

Oh, gees…I’ll see ya later. If you don’t give me these little hints, I just don’t pick up on them.