Overview – Are Price and Value the Same Things?
You’ve probably heard it said before that “you get what you pay for”. If you want a high-quality product or service, then you’d better prepare yourself to cough up more money to get that desired level of quality. This simple, everyday quote implicitly makes a very bold assumption: that price and value are directly related to one another – if one goes up, then so does the other.
This conflation is so ingrained in most people that they immediately associate a high price tag with a superior level of quality or service, and are just as quick to look down on a low price as something that’s laughable and not even worthy of consideration because of the perceived inferior value it offers.
However, the problem with conflating price and value is that, although they appear to be similar, they represent two different things. These two concepts aren’t mutually exclusive per se, but they certainly don’t have staggering amounts of overlap between them.
Let’s go over what those differences are, and why this matters not only in your day-to-day spending decisions but in your investment decisions as well.
Price and Value: Distinct, but Not Mutually Exclusive
Although price and value are two distinct elements, this doesn’t mean that they have no relation to one another at all – when talking about one, it’s only a matter of time before the other is brought up as well. This unique relationship is why it’s so important to understand the difference between them.
It can be argued that part of the reason why price and value are thought to be the same is that they’re both quantified in monetary terms. This works well when the price is being discussed, but may not be enough when talking about value.
In the following sections, we’ll go over the differences between these two concepts.
Understanding Price
Price is simply the monetary value assigned to a product, asset, or service. Ultimately, it’s an arbitrary figure that can be set at the discretion of the seller.
Although a seller is free to decide the price of the good, service, or asset they wish to sell, the price of something is usually influenced by other factors such as supply and demand, or can even be determined relative to some established benchmark.
For example, prices at a gas station. Do you notice how gas prices around your city/town are almost all the same, regardless of where you go? Some stations may be slightly higher or lower, but usually not by a huge margin.
Gas prices are influenced by a few factors, namely a gas tax and a markup to get the desired profit margin, but another factor that determines gas prices is the price set by other stations – set it too low and your margin is insufficient, set it too high and nobody will want to buy gas from you.
Whether you’re buying gas, groceries, or GICs, at the end of the day price is simply how much money a consumer will need to give up in exchange for a good, service, or asset.
Understanding Value
Value is an aggregate measure of worth based on the inputs that went towards the creation of a product or service. When talking about assets, value can be thought of as an asset’s ability to produce a future financial gain for its owner.
Because of this, value is very difficult to calculate precisely, especially if there are a lot of inputs involved.
An everyday example is your phone. Assuming you have a smartphone, there are countless inputs that go towards creating this sleek device: the myriad raw materials (rare-earth metals, glass, plastic, etc.), electronic parts, software, cellular antennas, gyroscopic sensors, speakers, and of course, the labour to put all these components together.
When all is said and done, the end result is your phone. Given all the inputs that went towards creating it, how do you determine its worth? Do you simply add up the price of all the inputs, or are other factors to be considered as well such as the quality of the craftsmanship, branding, or the type of software being used?
Apple, Samsung, Huawei, Nokia, and OnePlus all produce their own smartphones that more or less use the same materials and similar software. Despite this, people have different perceptions of value between these different brands – most people would rather get the latest iPhone than the latest OnePlus phone, even if the OnePlus phone offers better technology and more features.
Because of all the potential nuances, value is very difficult to accurately quantify. At best, the most we can hope for is to arrive at a reasonable approximation.
Price and Value Are Related, Though Not Linearly
There’s no denying that price and value are related, but it’s far from the simple linear relationship many people believe it to be.
Generally speaking, price isn’t half bad at approximating the value of something. That’s because the value of a good or service is usually determined by the amount of time, effort, and energy that went into creating it. Therefore, the producer of this good or service wants a level of compensation they feel is commensurate to the worth of what they’re selling, hence the tendency for a higher price.
For example, it’s safe to say that a suit made by a bespoke tailor has more value than one you’d find off the rack at a department store – the quality of the materials, the attention to detail, and the level of craftsmanship between the two are night and day. The prices between the two suits may vary significantly, but the difference in value is abundantly clear.
Generally speaking, and this is meant in the broadest way possible, as the price increases, value tends to increase as well, and vice versa. This loose rule of thumb is typically acceptable for most people when it comes to their day-to-day purchases.
Although price can approximately gauge value to an acceptable level for most people, it’s important to remember that these two are loosely related at best and that this relation isn’t set in stone. A classic scenario when this relationship starts to fall apart is during a sale.
Let’s go back to our suit example: imagine you want a bespoke suit from a prestigious tailor, but the hefty price tag of $1,000 causes you to look elsewhere. However, you come back a week later and you discover that the tailor is offering their services on sale: $800 instead of the usual $1,000.
Is the bespoke suit less valuable now that it’s 20% off? Certainly not. If anything, the sale simply lowered the barrier to obtaining this value.
Another way to think about price is that it represents a barrier to obtaining a certain level of value. Sellers establish this barrier based on what they believe the good, service or asset they’re selling is worth, but because the value is very hard to exactly quantify the price is set at what they believe is fair.
If a seller wants to get rid of excess inventory or if they feel that consumers are hesitant to buy because of the high price, then this barrier is lowered. The value of the good, service, or asset remains unchanged, but consumers no longer have to spend as much money as before to get their hands on them.
This is why the saying “you get what you pay for” isn’t always true. If this truly was the case then people would avoid sales because of the supposed decrease in value, yet our real-world experience tells us that this isn’t the case at all.
Price and value are, for the most part, loosely related at best. It’s possible for an expensive item to be of little value, just as it’s possible for a cheap item to be extremely valuable. People who understand this loose relationship and patiently wait for a disparity between price and value can consistently get the most bang for their buck.
Why This Disparity Matters to Investors
When deciding to buy an investment, the last thing an investor wants is to run the risk of overpaying. No sensible investor wants to spend too much money on an average, or worse, underperforming investment. After all, the major tenet behind value investing is to purchase an investment for less than its “intrinsic value”.
Even if an investor doesn’t abide by the principles of value investing, it’s safe to say that their goal when making purchase decisions is to obtain the most value possible while spending the least amount of money doing so.
During a market crash, while many investors are quick to sell, others are toiling away, looking for high-quality investments they can pick up for cheap. These investors understand that price isn’t always an accurate indicator of an investment’s value – just because it experiences a sharp drop in price doesn’t mean value is adversely impacted as well.
Now, this doesn’t mean investing is as simple as buying the cheapest stocks, bonds, or other investment instruments you can afford – there’s much more to it than that. In fact, choosing to “buy the dip” may not always be the best idea.
Rather, it’s important for investors to understand the differences between price and value, and how to use this knowledge to their advantage when an opportunity presents itself.
Wrapping Up
Price and value are two closely related concepts that people subconsciously refer to when making purchase decisions. Although many people view them as being the same things, price and value are two distinct elements with key differences between them.
Price is how much money a consumer needs to give up in order to obtain a product, service, or asset. Value is an aggregate measure of worth based on the inputs needed to create a product or service, or the perceived ability of an asset to provide a future financial gain for its owner.
Another way to think about price is that it represents a barrier to a specific amount of value. It’s entirely possible for one to be affected yet for the other to remain untouched. During a sale, the price of a good is decreased, yet its value largely remains unchanged.
Knowing the difference between the two is something investors should be cognizant of as well. Intelligent investors do their best to gain the most value possible by spending the least amount of money – the last thing an investor wants is to overpay for an investment that provides minimal value in return.
