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PRICING THEORY 101

Thinking back to my days in business school, I remember a fascinating class designed around a then “brand new” computer enhanced game. The class was divided into four teams, each producing a widget at the same cost, and each having a home market and three foreign markets to sell into. The home market gave each widget manufacturer some price advantage due to a lower transportation cost in one’s own market. The only variables available to each team were the pricing of our widgets and the advertising expense we prescribed for each market. The winning team was the team that accumulated the highest profits by the end of the semester. Clearly, the class was designed to teach us the value of pricing in the equation of maximizing profit. We were hunting for the optimum price that would create the optimum volume of sales and the highest level of profits.

As George W. Bush left law school to enroll as a business student, it stands to reason that he also took some form of curriculum built on pricing theory. It is this simple assumption on our part that gives us an interpretation of his speeches, comments, and retorts in the public arena. When the President refers to taxes and the tax code, he is viewing taxes as the price of government. The overall rate of taxation represents the simple price of government in an otherwise “free market”. Given this analogy, one would logically hunt for the optimum tax rate (price) that will produce the greatest revenue for the IRS. By definition, if government revenue is optimized, so will the income and investment returns of the remaining private sector. It has long been our belief that the price of government is too high, thereby limiting the revenues available to government, as well as the income and returns to the private sector. We believe the President views the world in the same way and will make every effort to optimize the price of the U.S. economy in his second term. The degree of his success will have a corresponding effect on the returns that we receive as investors in our economy. Yardsticks of value and other determinants will need to be revised if the President is successful. Herein lies the explanation for our current bullishness.

Most policymakers in Washington, as well as the media that follows them, are largely products of law schools, journalism schools and liberal arts curricula. While we have great respect for these learning institutions, the vast majority of them do not offer a class on pricing theory and profitability. Accordingly, their graduates are dealing with a subject that is far afield of their background and training.

While the Administration organizes its efforts to lower the price (tax rate) of government, we expect objections and arguments to come forth from sources that either don’t comprehend the subject or are aligned against a free market economy. There is apt to be much noise over this issue and with each argument, we expect the investment markets to weaken, fearing a failure to optimize the price of government. We feel that periods of weakness represent buying opportunities and, in the foreseeable future, we will move closer to an optimum tax rate. Investors must simply exhibit patience and endure the process.

Meanwhile, there are other risks to the market place which we will be watching. Federal Reserve (Fed.) policy is becoming critical as Alan Greenspan tinkers with his own pricing…the price of money. Interest rates are the price of money and any misjudgment by the Fed. in its pricing policy could affect the supply of money available to fuel a strong economy. He’s done it to us before; consequently, we’re not convinced that he won’t put us into another ditch with poor pricing policy.

Lastly, OPEC is playing with the price of oil, trying to optimize their own revenues, and the terrorists are desperately trying to raise the price of security within western societies.

Achieving good returns requires risk taking in an uncertain world. We think this is a good time to assume this risk as we have an excellent chance of moving our society toward an optimum price for government. There were two other Presidents that understood the need to optimize tax rates: John F. Kennedy and Ronald Reagan. Their administrations gave us several years of subsequent economic growth and prosperity. We believe we are on the verge of another such period. Anyone for requiring Pricing Theory 101 in all institutions of higher education?

About the Author


Harlan J. Cadinha
Founder, Chairman and Chief Strategist
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