In the context of oil, a recent Swaminomics column in the Times of India made a passing reference to the notion that “price controls do not quell inflation, and abolishing price controls won’t accelerate inflation”.
Politicians and the average reader aren’t the only ones who’d disagree, as the author fears. I can easily imagine many marketers and others raised on cost-plus pricing model to find this notion highly counterintuitive. I can imagine them arguing along the following lines: If the cost of oil contributed five rupees to a soap’s selling price of 20 rupees, then a two rupee increase in the purchase price of oil would result in an increase of the oil component’s cost to seven rupees, thereby forcing FMCG manufacturers to hike up the selling price of their soap to 22 rupees.
This argument is valid in a cost-plus pricing regime where price is calculated after toting up all input costs and applying a ‘reasonable’ margin (which somehow people always tend to assume to be in the region of 10, 20 or max. 30%). While cost-plus pricing may have been the only pricing mechanism used in the good-old days, it is not commonplace in today’s marketplace. Value-based pricing is the most widely used model now. Though it has been entrenched in the developed Western markets for a long time, value-based pricing has gained a lot of traction even in emerging markets like India for over two decades.
Adopted for almost all B2B categories and even in bread, soap and other B2C items that are considered as basic necessities, value-based pricing bases the price on a number of external factors like brand value perception, competing prices, value of pain solved or gain delivered to customers using the said product or service, and so on. As a result, you don’t have to look too far to spot product and service categories where the sum total of all input costs is below $10, but average selling prices often exceed $25. While input costs have not (yet) exited the pricing equation, they play a very limited role under the value-based pricing model, which also goes by the alternative name of “what the traffic can bear”.
Therefore, in the modern world where value-based pricing is the norm, an increase in the input cost does not push up the cost of production to anywhere near the prevailing selling price. So marketers in many product and services categories aren’t under any great pressure to increase selling prices, especially if that created the risk of losing customers. Which is why decontrol in prices of basic commodities like oil doesn’t automatically mean an upward tick in wholesale or consumer price indexes.