15 Dec 2014 Research & Ideas

Deconstructing the Price Tag

A new study by Bhavya Mohan,
Ryan Buell, and Leslie John has
an important conclusion for
retailers: Companies that explain
what it costs to produce a product
can charge more for it.

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 figuresto 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.
"If we think about our
interpersonal relationships, when
people share things with usas
long as they don't oversharewe
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."

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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
1

HARVARD BUSINESS SCHOOL | WORKING KNOWLEDGE | HBSWK.HBS.EDU

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 normand 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
colorsburgundy, 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 twobone and tan colorsthat
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

COPYRIGHT 2013 PRESIDENT AND FELLOWS OF HARVARD COLLEGE

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
sayseven 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

HARVARD BUSINESS SCHOOL | WORKING KNOWLEDGE | HBSWK.HBS.EDU

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
availablefor 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 industryand
perhaps in other industries where
customers may take for granted
how much effort and money goes
into producing a goodmany
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."

COPYRIGHT 2013 PRESIDENT AND FELLOWS OF HARVARD COLLEGE

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
interestand even boosting sales.
"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 writer based
in Mansfield, Massachusetts.