In January the HBR Blog Network had an interview with Jeff Bezos on Leading for the Long-Term at Amazon. During this interview Bezos had a couple of comments on pricing which really made me think. Although I’m a huge fan of Amazon and Jeff Bezos, for 99% of companies this is bad advice. Here is the excerpt:
ADI IGNATIUS: At what point will the goal change from lowering margins, building market share, to making a bigger profit?
JEFF BEZOS: Percentage margins are not one of the things we are seeking to optimize. It’s the absolute dollar-free cash flow per share that you want to maximize, and if you can do that by lowering margins, we would do that. So if you could take the free cash flow, that’s something that investors can spend. Investors can’t spend percentage margins.
ADI IGNATIUS: Amazon has done a great job of self-cannibalizing its revenue streams, going from Amazon Store to Amazon Marketplace, from print to ebooks, and so on. In most companies, moves like those would be hard to execute without organizational turmoil. How have you managed the transitions?
JEFF BEZOS: When things get complicated, we simplify by saying what’s best for the customer? And then we take it as an article of faith if we do that, it’ll work out the long term. So we can never prove that. In fact, sometimes we’ve done a price elasticity studies, and the answer is always we should raise prices. And we don’t do that because we believe– and again, we have to take this as an article of faith– we believe by keeping our prices very, very low, we earn trust with customers over time, and that that actually does maximize free cash flow over the long term.
This is perfect for Amazon. They have built a brand around low prices and if they start to raise prices they could lose their positioning. They could invite in competition. Notice that they’ve also done a great job of adding value, indicated by the fact that they could raise prices. I prefer shopping Amazon rather than other online sites because I don’t want to give my credit card number out too many places. For that I’m willing pay a small premium.
However, this is probably not good advice for your company. Why? Because this strategy only works for low price brands and there are very few examples of successful companies competing on price. Amazon and WalMart come to mind. Maybe Family Dollar and Dollar Tree. Low price brands must alway keep their prices down. They don’t want to ever be caught charging significantly higher prices than their competitors. It would damage their brand.
Most companies build innovative offerings, differentiated from their competition, and charge prices higher or lower than competitors based on the comparable amount of value delivered. In the long run you want to build a brand of value, quality, features … not low price. Pricing for the long term for most companies means making sure customers understand your value, and that only happens when you set your price consistent with the value you deliver. This is not to say you shouldn’t use promotions to gain trial, rather you should know your value and clearly understand why you would sell for less than your customer is willing to pay.
One more thing about the long run, you have to survive the short and medium run to get there. Create value. Capture the value you create. Price pragmatically.
Mark Stiving, Ph.D. – Pricing Expert, Speaker, Author
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Thank you to Roman Malendevich for sending the HBR blog to me.