Thursday, 13 October 2005

Price check

Based on some hazy memories of finance, the value is what something is worth to a particular person whereas price is the actual sum paid for something. Furthermore, factors of demand and supply (and inherently value) will ultimately affect the price paid for a commodity.

For example, a drug which treats a rare disease which only five people in the world contracted. It would be logical to note that:
  • The drug would probably not be valuable to anyone who did not have any connection to those five people.
  • However, the value of this would be very high to those five people (and probably those around them too). But the price of this would definitely vary depending on supply: if there were hundreds of the drug available, then the pricewould be low; if there were only two of the drug in the world, then the price would be naturally be high (as those five people would be bidding furiously for those prized two cures).
Rationally, a "bargain" would be had when the price paid for a particular commodity is less than what it is worth (to that person). Furthermore, a person will not deliberately overpay for an item (especially if there is a direct substitute for that product).

Thinking through this raises a few questions:

1) What is my value to myself? Am I decently priced?

Casting my thoughts back to some obscure finance lectures and exams (*shudder*), a logical and widely accepted model to understand value would be the Discounted Cash Flow (DCF) model. The theory here is to find the present value of future free cash flow for the next couple of years. Unfortunately, unlike a company, my "going-concern" (i.e. my ability to continue operation in the future) is pretty much a concern. My useful life, will probably be closer to the next forty years or so. Based on this I can probably calculate how much I will have in retirement. Furthermore, I can reverse the formulae and derive how much free cash flow I need to generate now, in order to have a fixed amount in future.

This is only as good as the underlying assumptions made, but theoretically, I can probably work out my monetary value to myself. This excludes all other value to myself, e.g. relationships, etc.

Secondly is price. How does one price oneself? Perhaps the jobs market is a reasonably good indicator. If I have rare skills and experience, I will most likely be more expensive than if I had generic skills (all things being equal). If there was demand for the skills I have , I would be paid more. Alas, doing nothing and playing video games doesn't pay that well. Probably, by placing oneself on the market one would realise one's value, which is probably why many people change jobs within five years.

Interestingly enough, I also value my time. What could I be spending my time on to maximise my value? TV. Video games. Ok, so I am not constructive.

2) Do I value and price safety accurately?

Recent history cannot highlight the importance of safety - natural and man-made disasters have certainly changed the landscape of what I would have previously called a safe and comfortable place. Perhaps it is also a function of growing up and becoming more aware of what's been happening in the world, rather than being concerned about what I have been doing. I have to admit, though, that I value safety highly, but I am not sure that I pay a good price. In fact, this should be a time when I shy away from getting a bargain (hey - let's face it, sometimes you don't know what you are getting until you have gotten it), but in fact, I appear to be doing the opposite.

As I was recently booking my air-tickets, I recalled a lecture in Flight and Civilisation. Interestingly enough, many people book air-tickets based on price, rather than the history/mentality of the carrier. Most people will see flights as direct substitutes for one another, but I'm not sure that many people would attempt to understand the cause of the price difference. Sure, the number of major accidents in the airline industry has dropped considerably than that of the 70's and 80's, but I know that when I travel, I appreciate well maintained aircraft (not ones which have bits of exposed metal in the cabin, and are a flying tin shed) and reliable pilots (not ex-military pilots with vendettas).

Also, having recently evaluated the current car I drive as well as a potential cars, I understand the importance of technological and safety enhancements in cars: ABS is preventative, air-bags and crumple zones are damage control. Is it worth getting newer with better safety features? I would have to agree.

I absolutely agree that taking the necessary steps to prevent something happening does not guarantee it doesn't happen, it doesn't hurt to reduce the chances of it happening. I am risk averse and a numbers person, so higher exposure just means greater chance of something happening.

Insurance will have to be the next big example. If an insurance company goes belly up, the premiums and excesses would have been cheap while it lasted, but what if you had a claim? A disability or income protection claim. And didn't get paid. Disgruntled would most definitely be an understatement.

3) How do I value and price lifestyle?

I value lifestyle. Some people enjoy a vibrant, fast lifestyle and aim to be injected in a technological advance country. Different people have different perceptions of lifstryle - and I ultimately believe that it is a choice which someone makes.

Personally, I feel pretty lucky that I can play soccer on grass and not concrete, I can play golf without having to pay an arm and a leg, I can enjoy beautiful beaches (when I have the chance to go to them), enjoy good weather and enjoying all the good company of friends. All these little things really add up and make staying in this place worthwhile.

Assuming a simplistic model (mainly cos I can't think at the moment or am too lazy to do so) I would price this as the money I forgo by working in places which can give me those things. It could also be the comparative price it cost me to do a particular thing (e.g. playing golf here vs in Japan).

If I worked overseas and got paid more, then all those things which I forgo is the compensated through better pay. Previously, I wanted to travel and have fun. However it is also great to appreciate what I have back home.

Perhaps the phrase, "you get what you paid" isn't too far from the truth.