Role of Costs in Pricing

Abstract

The above passage from Henry Ford’s autobiography portrays his basic philosophy in regard to pricing. This was to cut prices below the point warranted by existing costs so as to provide an incentive to expand production and sales, which, in turn, forced costs down. He contends that manufacturing improvements, forced by the low price, came about faster than if the normal practice of cost cutting were attempted prior to price cutting. What actually happened was that price cuts did lead to better sales, which, in turn, acted to force costs down and bring about manufacturing improvements, resulting in yet lower costs and prices — a vivid demonstration of a self-fulfilling prophecy.

Our policy is to reduce the price, extend the operations, and improve the product. We first reduce the price to a point where we believe more sales will result. The new price forces costs down. Using costs to determine price may be scientific in the narrow sense, but not in the broad sense, because what earthly use is it to know the cost if it tells you, you cannot manufacture at a price at which the article can be sold? One of the ways of discovering what a cost ought to be is to name a price so low as to force everybody in the place to the highest point of efficiency.

(From My Life and Work by Henry Ford and Samuel Crowther. Copyright © 1922 by Doubleday, a division of Bantam Doubleday Dell Publishing Group, Inc. Used by permission.)