Competing On Price

What's The Price?

If you take an economics course, or you go to business school you hear a lot about the concept of “price”. Supply and demand intersect and that intersection is called price. When you figure out consumer surplus and producer surplus in a market, price is the variable that you are figuring out the surplus from.

When analyzing a business or market segment, there is always a section on price competition in the analysis.

Price looms large in debates on income taxes. Isn’t a tax the price a government wants you to pay to engage in some activity? An aside, Joe Biden and the Democrats tax bill to raise capital gains and tax unrealized capital gains won’t fly. However, it shows you how they are thinking. That’s sinister for a free market free enterprise capitalist society. And no, having a lower percentage than what they put in their tax scheme isn’t a good idea or a win either.

I was thinking about this when I saw a story about an upstart business taking on a large entrenched incumbent.

When you hear a startup pitch, you get the high points of the business. Often a founder will go into some detail on how their business is significantly more cost- effective because they can charge a lower price than the incumbent. In commoditized businesses, price can be a deciding factor. Is this pencil really worth more than that pencil? Does it matter if it’s FedEx, UPS or DHL?

Price is a terrible segment to try and compete on. The lowest price is “free” and you try to make margins somewhere else in the business. Google employees will tell you that they make so little money on search. Pennies. It’s a free product they will tell you. Somewhere in their business, they are making some money. It’s not a charity.

When I was a rookie fresh-faced salesperson at 3M Company, the products I sold were consistently the highest-priced ones in the market. If I was selling against a product that had a higher headline price than mine, I knew it was an easy sale. We were taught how to compete on price.

Price isn’t always what you see. If you are doing a startup business and price is the biggest driver for people to use your business you will soon be out of business. When FedEx started, they didn’t compete on price. They competed on service. “When it absolutely has to get there overnight.” The same is true with other commodity services like airlines. Southwest had low prices but they had other things going for them when they started that other airlines couldn’t or wouldn’t match.

I was thinking about this when I read that Howard Lutnick was going after CME Group’s interest rate business. Howard has been on this quest for as long as I can remember going back to 1990. He’s like Gollum with the ring in Lord of the Rings.

CME is a kahuna. It charges pennies for the big boys to trade. In interest rate futures, .19 for front months, .14 for back months per side. Electronic traders are trading millions of contracts a year so it adds up. However, the tick value is between $6.25 per contract up to $12.50 per contract. At the most, it’s 3% cost. The real cost to trade is purchasing the CME data feed. I don’t know what that costs but I am sure it’s expensive. You can’t trade without it.

Data feeds though aren’t cheap to deliver. There are a lot of physical plant costs and operational costs to get them to customers at the speed and quality they want them.

His new effort FMX has signed up some big players. It will be an interesting competition to watch from outside the ring. So far from what I have read, the only thing that’s different about them is lower prices. They do have a component in which the entities that put up the initial capital of $172MM for a 25.75% stake can earn more equity by trading more at FMX. But, is that enough of a wrinkle?