The Pilot Pricing Puzzle

By now, you almost certainly would have heard about Ian Hedley’s post calling out Pilot for charging higher prices and offering fewer products in the UK than other markets. And hopefully you would have also seen Pilot’s response to Ian, as well as Ian’s reaction. Today, I thought we’d work through the puzzle and see what it tells us about the FP marketplace. 

Assessing the data

When considering Ian’s first article, we need to start by independently checking the data. Ian made his available in a spreadsheet, which was very kind of him, but I’ve gone through and made my own dataset. Instead of looking at a single US and UK retailer, I’ve collated data from half a dozen of each, and compared the price differential based on average retailer prices as well as the cheapest price available each market. (If anyone is keen to look at my data, shoot me an email.)

The first thing I noticed was that the effect (higher prices in the UK) was limited to two of the six Pilot products: the Metropolitan (or MR) and the Falcon. The other six were only slightly more expensive in the UK than the US (less than 15%) when looking at the cheapest possible price, and comparing average prices showed that prices in the UK were sometimes cheaper than the US. 

The second thing I noticed was that the effect is extremely sensitive to changes in the exchange rate. Mark Knibb (Pilot UK’s MD) raised exchange rates in his response to Ian and gave an example of how the pound has appreciated ~7% in the last month. As firms like Pilot don’t have the freedom to frequently change prices based on exchange rate movements, they tend to build a buffer into their prices. This enables them to absorb some degree of volatility without it pushing their business into a loss. If we add a 7% buffer to reflect currency volatility, the price differential of cheapest retail prices between the US and UK narrows considerably. If we increase the buffer to 10%, the price differential disappears entirely for four of the six products (again, the MR and Falcon are the odd ones out).

So on this particular issue, I both agree and disagree with Ian. I agree that a couple of Pilot’s prices are higher in the UK than the US but I disagree about the extent (how many products are affected) and the magnitude (far less than the 70% markup Ian identified). The remaining question is why would the Metro and Falcon be priced differently to the other products?

Pricing strategies

To answer this question, it’s worth considering the nature of pricing strategies. Most people assume that the pricing decision is relatively simple: a firm figures out the cost to produce something, they slap on a margin for business overheads, maybe another margin for their profits, and the sum of these figures constitutes the price. 

Hopefully, it won’t surprise any of you to hear that it’s more complicated than that. There are internal and external factors which make it more complicated: the external factor is that customer behaviour — how much product they will purchase — depends on what price the firm selects and what other products are in the market. The internal factor is that the amount of product you sell influences your production costs: if you sell a lot more than planned, or a lot less, your production costs could increase dramatically and make the whole thing uneconomic.  

Imagine building a factory and hiring staff that can manufacture a million pens a year. If you only produce a half-million pens, your total costs stay the same but they are spread out over half as many products: the average cost of each pen is doubled. If you try to produce two million pens in the same facility, you’ll have problems: lots of bottlenecks and lots of overtime to sort it all out. That’s expensive, so the average cost of each pen will be higher than if you only produced a million units. The insight here is unit costs vary depending on the scale of production; it’s a moving target, and that complicates the pricing decision. 

There’s also a trade-off between the price and how much product will be sold. In a basic sense, setting a high price means that you won’t sell a whole lot of product and setting a low price means that you’ll set a lot. But there’s an additional factor at play here: elasticity. Elasticity is how much buyer behaviour is actually influenced by changes in price. For most products, a big drop in price means a big increase in sales, exactly as we’d expect. But for some products, a big drop in price has very little effect on sales. Imagine the cost of doors dropped by half — heck, by 90% — would you buy more doors and to put on your home? Probably not. The same thing is true for emergency medical care: if the cost of having a heart attack treated fell in half, you probably wouldn’t start having more heart attacks. 

When our buying behaviour isn’t strongly influenced by price, we describe such products as inelastic. The degree of elasticity is influenced by a range of factors, but the most relevant for this discussion would be the proportion of income and substitutability. When products are a smaller proportion of our income, price changes — even large ones — don’t really register. But if purchases are a large proportion of our income — like homes, cars, or expensive fountain pens — they do register. When they become more expensive, we start reconsidering whether the purchase is still worthwhile, and might choose to defer a new car purchase or to find a more reasonably-priced pen.

The other determinant of elasticity is substitutability, which refers to how easy it is for us to find good alternatives. They have to be products which offer us comparable satisfaction for our money. A lifetime supply of Bics might technically be a substitute for a nice Omas, but it’s not a good alternative because it’s not really bringing the same amount of satisfaction. For most products, there are plenty of substitutes available but for some products, particularly those in niche markets, there aren’t so many. If you’re into fountain pens and love hand-painted urushi designs, you’re not going to have a lot of alternatives to Nakaya. 

If there’s a lot of substitutes in a market — that is to say, it’s highly competitive — raising prices probably isn’t the best idea. Buyers have a lot of other choices, and jacking up your price will drive many of them away to your competitors. On the other hand, if there aren’t any substitutes — like the single seller of water in the middle of the desert — then buyers have no choice at all, and will pay whatever price is asked of them (assuming they need the product and their partner isn’t checking the credit card statements). 

Elasticity matters because firms really only have two strategies they can use —  a high price/low volume strategy or low price/high volume — and firms will use whichever generates the most revenue. Moving to a particular strategy is only desirable if it increases revenue: a firm would only adopt a low price strategy if their buyers were highly elastic and cared a lot about price (and assuming production costs would not increase too much). If the buyers were inelastic — if they didn’t care about reductions in price — then a low price strategy would not bring in many more customers but it would reduce the firm’s income. 

Pilot’s pricing strategies

One of the roles for most distributors (not all) is setting the recommended and minimum prices for their market. Pilot has independent distributors for the UK and North America, and they will both be considering their own markets and choosing a strategy appropriate for their customers. They will be doing this for each of their products, and we can use the above framework to think about Pilot’s prices between the two markets. 

Based on my own data from earlier, I would conclude that the price of four products — Custom 74, Justus 95, Prera, and Vanishing Point — is roughly comparable between the two markets. It is only the Metropolitan and the Falcon which varies between the two, but we can’t really say whether the Americans have gone for a low price strategy in this scenario or whether the British have gone for a high price strategy, or both. (Looking to prices in the Japanese market doesn’t necessarily shed any light on the matter either, as they would be pursuing their own strategies.)

I would not be surprised to learn that the North Americans have gone for a low price strategy for both pens. After all, their market is quite large and generally quite elastic: US buyers have higher disposable incomes and there’s a lot more substitutes available in the market. (On that point, I tried to include Sailor with the analysis in the beginning but found there weren’t enough UK retailers who carried the brand to make it worthwhile. Even Platinum’s availability was surprisingly patchy. I certainly didn’t have the same problem with US retailers.) This might explain why the Metro and Falcon are cheap but it doesn’t explain why the Vanishing Point is roughly the same price between the two markets. 

The other explanation is that the British have gone for a high price strategy: perhaps they don’t expect to sell many Metros or Falcons and have concluded that low volume needs to be met with higher prices, to make it worthwhile carrying the products. Parts of this also ring true: the UK market is much smaller and, anecdotally I’ve gathered the impression that vintage pens are more common there. If that’s the case, maybe new users in the UK don’t need to start out by buying a Metro as frequently as their US counterparts — their parents or grandparents might be more likely to have an old FP lying around the house. And there might be less need to buy a Falcon if there’s vintage flex pens readily available. Of course, this is just a general impression I’ve picked up from conversations with Brit pen users and professionals, it may be entirely inaccurate. 

An alternative explanation for the high price strategy in the UK is the revival of the FP market in the last decade has been largely driven by interest in those aged 35 and younger. As they’ve started buying more and more pens, prices have fallen in the more competitive geographies (largely North America) and product categories (pens priced US$200 and below). If the same revival hasn’t bloomed in the UK — or if the UK users are largely making their purchases from abroad — then there would not be the same boom in volume that allowed low price strategies to work in the US. In fact, by buying internationally, those newer enthusiasts would be helping to push down foreign prices while allowing local prices to remain the same.

Convergence

In a couple of posts published here almost a year ago (see here and here), I argued that large international pricing discrepancies are unlikely to be sustained in the long run. In most developed countries, FP buyers already have the ability to buy pens from the world’s cheapest market, whether that be the US, Japan, Singapore, or — as in my case — the Netherlands. The only real obstacle to this arbitrage behaviour is a lack of information amongst buyers about the processes (understanding international shipping, sales taxes, import duties, currency exchange, etc.) and that obstacle is far from insurmountable. As the community develops, buyers are becoming more educated and more willing to buy where prices are most competitive.

This undermines the regional distribution strategy employed by most major brands, including Pilot. Having different prices for each region only works so long as large numbers of buyers aren’t able (or willing) to access lower prices in other regions. Now, any distributor with a high price/low volume strategy will find itself primarily competing not with disruptive, low price competitors but other distributors of the same company, selling the exact same product. If the high price strategy is not sustainable, and the low price strategy is not profitable, regional distributors simply cannot survive.

There are two solutions to this. The first is for brands to crack down on distributors and retailers selling outside their jurisdiction: for example, Pilot North America telling US retailers that they cannot export to buyers in Australia, Canada, the UK, and elsewhere. However, I’m not convinced that this would actually work: my understanding is that Engeika has been officially shunned by the Japanese brands but its arbitrage business continues unabated. It is hard to imagine the same would not occur in the US. 

The other solution is for brands to abandon the regional strategy and embrace a global strategy: a standard product price for every buyer around the world (with some minor deviation to account for local factors, like sales taxes and import duties). You can read the post on Convergence and Distribution for the details on this, but the upshot is that such a strategy is challenging — but entirely possible.

I get the feeling this is what Ian would like to see. While I believe it is inevitable, I’m not sure it is actually desirable. It is not obvious to me that UK prices would fall to the levels seen in the US or Japan. At the very least, costs in the lowest-price markets would rise — after all, Japanese consumers currently don’t have to pay for products in the UK to undergo UK quality testing, but with a global pricing strategy, they would — and it would force the brand to consider what is the optimal price and volume target for a global market. 

As an example, I would say that most of the Pilot 823s I see online came from Japanese vendors, where they retail for roughly US$215. It is priced for the Japanese market which is fairly elastic: lots of consumers, relatively high incomes, and quite intense competition (much more than that seen in the US, Europe, or elsewhere). If Pilot embraced a global strategy, they might well choose to shift to a higher price strategy, knowing that the customers they lose in Japan could be replaced by wealthier or less elastic buyers elsewhere. If that were true, it would not surprise me if the price rose to the US level (around $300). Maybe even higher if there was a more profitable market for the pens somewhere.  

This specific example may not transpire, but it hopefully shows that global prices don’t necessarily converge around the lowest regional price, a global pricing strategy may well lead to prices converging at a point somewhat higher. Perhaps the shift would mean UK customers end up in the same situation when buying locally, but become unable to access cheaper prices by buying abroad. 

I would personally benefit from global prices as they couldn’t possibly end up as high as they currently are in Australia. But I suspect I’d be part of a relatively small group of winners, and there would be just as many losers. Even aside from the price impact, the loss of local content (such as distributors educating retailers about products, retailers providing valuable — and valued — feedback to brands and distributors, specialist products for local markets which would not be commercial at a global level) would be a significant loss. 

Ultimately, we have two competing accounts for Pilot’s behaviour. Ian suspects the explanation lies in Pilot not caring about the pen market in the UK. I suspect they do care, but it’s a small market and they use a particular pricing strategy which they feel is appropriate. We don’t really have any evidence one way or the other, so we can’t say for sure if one account or the other is correct (or if either of them are correct). It’s unlikely we’ll ever know. But I’m fairly sure that embracing global pricing is not necessarily the panacea that others think (or hope) it will be.

Correction

There was an error in this post regarding one of the price comparisons. See see here for details.