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Pricing is … a Magnifying Glass

Magnifying glassManagers who understand pricing well have a unique view into the health of their company. Here are several examples.

How well do our marketers use Value Based Pricing when setting the initial prices? When we do this well, we truly understand our market. We know what our competition offers and at what price. We know how our customers make their purchase decisions. If we expect our product development teams to build the best products, they must have and utilize this information.

How do our realized prices compare with our competition? If we are lower priced, it’s an indicator that our product development team didn’t build enough value into the product. Earning prices higher than our competition show we intentionally build differentiated products that our customers value.

Can we explain our price dispersion? We want to charge different customers different prices based on their willingness to pay, so price dispersion is good. However, it shouldn’t be random. When we can explain which customers get the best prices (or the highest prices) we show we understand our customers decision processes which will help in future product development decisions.

Are we watching ASP (Average Selling Price) on a product by product basis? Declining ASPs are an indicator that something in the market is changing. New competitors may be entering. Competitors may be lowering their prices. Customers may be changing their preferences. Monitoring ASPs creates an early warning into market dynamics.

Do we monitor our pocket price? This is the price we realize after taking into account all of the costs to serve a customer (e.g. shipping, early payment discounts, damage reserves). Careful scrutiny on pocket price keeps our profitability high.  Decreasing pocket price, especially if ASP is not decreasing, is a strong indicator that we are giving too much away in the sales process.

How well do our salespeople achieve the target prices? The salespeople who sell at higher ASPs for the same product are the ones who are selling value. They are communicating our features and benefits to our customers. The ones who sell at lower ASPs may be relying too much on price. They need to be trained.

As you can see, understanding and monitoring pricing provides a powerful lens into many aspects of your company. What are you watching?

 

Mark Stiving, Ph.D. – Pricing Expert, Speaker, Author

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Photo by  Images_of_Money

What You Don’t Know Does Cost You

HeadacheDo you buy generic aspirin (i.e. the store brand) or Bayer? Do you buy generic acetaminophen or Tylenol? How about generic ibuprofen or Advil. It turns out 70% of us buy generics. Higher than I expected, but still 30% of us pay for the brand name.

For those of us who buy the brand name version, we can pay 2 or 3 times as much for the exact same thing. Why do we do this? There are several possible explanations, consumers just make random mistakes and that brands may be more effective especially considering placebo effects.

Recent research from some University of Chicago professors found evidence for the explanation that we just don’t know better. We are not sure what to do. They compared the purchases of doctors, nurses and pharmacists with the purchases of the rest of us. They found that pharmacists only purchase branded headache medicine 10% of the time (compared to our 30%).

NPR interviewed a lawyer who buys the branded version. He said, “I don’t have time to make the decision, so I’m just going to, you know, pay an extra buck or two and buy the brand name.”

This is fascinating, but what does this have to do with pricing? Here are a couple of pricing lessons we should learn.

Perceived Value – People pay for perceived value, not just for real value. In the case of headache medicines the law dictates the generics have the same effectiveness as the branded versions. There is no difference in real value. But there is a difference in perceived value. You can and should focus on how to create more perceived value. This includes building a brand.

Segmentation – Remember to segment your markets. If you were in the headache drug business with only one product, you would likely go after the 70% of the market. But the branded versions are much more profitable than the generics. The ideal solution is to build both and do your best to keep the markets separate. Do you have different versions of your products so you can capture different segments?

What other lessons are there?

 

Mark Stiving, Ph.D. – Pricing Expert, Speaker, Author

Sign up for the Pricing Perspective, a free monthly summary of my blogs and other publications.

Photo by psyberartist

The Peril of Price Increases – Breaking Brand Loyalty

Price increaseThe absolute BEST thing about our loyal customers is that they don’t even think about which one to buy.  They always choose our product.  Awesome.  No extra marketing effort.  No extra sales effort.  Just keep shipping quality product and life is good.

Until you increase prices.

Don’t get me wrong.  I love price increases … when we can get away with them.  But much of the time we can’t.  The single biggest problem with a price increase is our loyal customers suddenly feel they need to re-think their decision.  That’s the last thing we want.

When a loyal customer rethinks their decision we stand to lose because our competitors may have improved their products or prices, we may have new competitors in the market, or our customers’ tastes may have changed.  Considering the lifetime value of a loyal customer, losing can be painful.

What are your options?  Your best option is to increase prices only on new customers if possible.  Your existing customers never see the price increase.  Alternatively, you can create loyalty programs so your truly loyal customers are rewarded and don’t really experience the higher prices.

If you think you have to raise prices on everyone, then try to make it as painless as possible.  One option is to attempt to time it simultaneous with price hikes from your competitors.  Regardless, you must justify it with increased costs.

Some industries are lucky in that their customers expect annual price increases.  In those cases meet the customer expectations, but don’t be too greedy.  The goal is to make as much money as possible but still keep them from revisiting their purchase decision.

No two businesses are alike, but there is one almost universal trait among customers: they hate price increases.  Be sure to take extra special care of your loyal customers during price increases.  They are your most valuable and most vulnerable customers.

 

Mark Stiving, Ph.D. – Pricing Expert, Speaker, Author

Sign up for the Pricing Perspective, a free monthly summary of my blogs and other publications.

Photo by Dave Fayram

Price Segmentation: Justify it or Hide it

Rich-Poor (LQ)Nobody wants to pay more.  They don’t want to feel “ripped off”.  They want to feel special, like they received a good deal.

However, it is in a firm’s best interest to charge different customers different prices based on how much they are Willing To Pay (WTP).  If a customer is WTP more you want to let them.  If a customer is only WTP less, you may still want them as a customer so you charge them less.  We’ve blogged several times about how to execute pricing segmentation (Customer characteristics, transaction characteristics, behaviors, and product portfolio), today we are talking about what your customers should know.

Since your customers don’t want to feel cheated, then you only have two choices on how to communicate price segmentation:  justify it or hide it.

Customers see price segmentation all of the time and have come to accept it.  For example, students pay less at the movie theaters.  Vacationers pay less for flights than business travelers.  These are visibile and “justified”.  Here are several ways to think about justifying pricing segmentation:

  • Publish your highest list price.  Offer discounts to customers who “deserve” them.
  • Volume discounts.
  • Lower cost to serve some customers.
  • Need to sell excess supply.
  • Helping the poor (senior citizens, students, etc.)
  • Don’t change the rules often.  Once your customers know and accept them, leave them alone.

You don’t need to actually justify your price segmentation, but your customers need to able to justify it in their minds.  Nobody at the airlines ever justified why business travelers should pay more, but they can explain why they should fill empty seats with vacation travelers at a lower price.  Nobody ever explained why some people pay full price while people who use coupons pay less, but you can justify that in your mind.  It’s always easier to explain why you give one group a discount.

Many companies hide their price segmentation.  They don’t allow customers to know their complete pricing strategies.  They don’t allow customers to know their best pricing.  Here are several techniques to hide your pricing segmentation:

  • Don’t publish a price list.  Nobody knows what they should pay.
  • Give every customer a unique quote.  Don’t share that information.
  • Put your best prices in contracts.
  • Make pricing so complex it’s difficult to compare.

Warning:  Hiding prices is never perfect.  In the B2B world, buyers change companies and mergers and acquisitions happen.  Price information gets leaked.  In the B2C world, once someone finds hidden price segmentation, they write articles about it.  Remember when Amazon charged different prices to different zip codes?  The lesson, even when hiding prices, you will want to be prepared to justify them if they leak.

Price segmentation is a powerful tool that every company should use.  However, you must use it carefully.  When somebody feels cheated by your company, you may lose them as a customer forever.

In the end, you will likely use a combination of hiding and justifying price segmentation.  Even when price segmentation is justifiable, there is no need to flaunt it.  And even when you hide it, you will someday need to justify it.  The best option for you is likely … hide it AND justify it.

 

Mark Stiving, Ph.D. – Pricing Expert, Speaker, Author

Sign up for the Pricing Perspective, a free monthly summary of my blogs and other publications.

 

Cost-Plus Conundrum

conundrumWhen you lower your cost of goods sold (COGS), do you make more profit?

Not necessarily if you use cost plus pricing.

Imagine your company prices using cost plus (the horror).  Your formula is simple, your price is 3 times your cost.  You make product A at a cost of $100 so you sell it at $300.  66% margin is not bad if you can get it.  You make profit of $200 on each unit and since you sell 1000 units, you make $200,000 in profit.

A brilliant engineer figures out a way to make product A at half the cost.  Wow!  Your costs go down to $50.  The marketing team gets out their calculators and say, “Hey, 3 times 50 is only 150.  We should lower our prices to $150.”  You’re still making a nice 66% margin, but you’re only making $100 profit per unit.  In order to maintain the same profit dollars, you now need to sell twice as many units.  Is that even possible?  What will your competition do?

You see, cost plus pricing means as you lower your costs, you lower your prices, but more importantly you lower the overall dollars of profit contribution.  In our example, we went from $200 of profit per unit to $100.

What if instead of cost plus pricing, the marketing team used value based pricing and said, “Hey, customers are already paying $300 per unit.  They obviously value our product at least that much.  Let’s not change the price.”  Now your profit goes to $250 per unit, you sell the same 1000 units and you make $250,000 in profit.  In other words, you let the cost savings go to profit, not to lowering prices.

This cost-plus conundrum is simple, elegant, and obvious once you hear it.  I heard it for the first time last week at the Professional Pricing Society’s spring conference.  (I don’t recall who said it, but if anyone has the original source please share it with me and I’ll post it here.)

Your lesson?  Don’t use cost plus pricing.  Use value based pricing.  But of course if you regularly read this blog, you surely already use value based pricing.

 

Mark Stiving, Ph.D. – Pricing Expert, Speaker, Author

Sign up for the Pricing Perspective, a free monthly summary of my blogs and other publications.

Photo courtesy of Villanova University Digital Library.

How to Compete against Free

Software entrepreneurs frequently ask me, “I have a competitor who gives this away.  How much can I charge?”

The answer:  “Nothing”.

If you have the exact same offering, you can’t charge anything.  These entrepreneurs don’t want to hear this, but they need to.  However, that’s not the complete answer.

Entrepreneurs who want to charge for something similar to what others give away need to answer 3 important questions:

  1. How are you different from your competitors?
  2. Who cares?
  3. How much do they care?

First, how are you different?  You can’t charge for something when someone else is giving it away free.  That’s like putting up a corner stand and selling air to breathe.  Nobody will buy from you because they breathe air for free.  However … have you ever walked around Vegas and seen all of the breathing stations?  They are called Oxygen Bars and they charge about $1 per minute, just for air to breathe.  How can they get away with this?  Because what they sell is not just air.  They sell air that has a higher proportion of oxygen (and a scent).  It is different from just air.  If you want to get paid, your product has to be different from what your potential buyers can acquire free.

The next question is who cares?  Back to the oxygen bar.  I’ve never tried one, so I’m not their target market.  Free air is fine with me.  A little research finds the target market is 28-38 year olds who also like energy drinks and herbal drinks.  They found a group of people who care a lot more than most.  Then they target this group.  Your job is to figure out who would rather have your product than the free one.  These people (or a subset) become your target market.

Finally, how much do they care?  This question is really asking, how much is your target market willing to pay?  You can answer this question through market research or possibly by testing different price points.  Remember, stay focused on your target market.   It doesn’t matter what others are willing to pay, just your target market.

How can you compete against free?  You can’t … if you’re not different.  You cannot offer the same thing and expect to get paid.  You must offer something different that somebody cares about.  Then you can get paid.

 

Mark Stiving, Ph.D. – Pricing Expert, Speaker, Author

Sign up for the Pricing Perspective, a free monthly summary of my blogs and other publications.

Photo courtesy of ‘PT Money’ ptmoney.com.

 

Pricing for the Long Term

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:

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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.

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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

For more insights on pricing, sign up for the Pricing Perspective, a free monthly summary of my blogs and other publications.

Photo Credit: Jurgen Appelo from www.noop.nl

Thank you to Roman Malendevich for sending the HBR blog to me.

How to Add Value – Learn from a Professional Equestrian

The other day I met someone with a career I hadn’t heard of before, a professional equestrian.

Caitlin Lighthouse does some things you could guess.  She teaches riding lessons and trains horses. However, as an olympic caliber equestrian she does one thing that I found amazing, she adds value to horses.  Below are two examples in her own words.

“My first horse was Limerick Lad. My grandmother bought him for me when I was 12 at $7,000 from Limerick, Ireland. Importing him cost another 1,000. He was only 5 years old, which is equivalent maturity wise to about an 8 year old child. I kept him for about 16 months before we realized he could only compete at the lower levels and I was progressing beyond that. We sold him about 18 months after we bought him for over for $25,000. He was a fantastic horse as long as the jumps were not over 3’3 so we sold him to an amateur woman that had no desire to jump very high. She still has him to this day. You never forget your first horse. Together we achieved our first few wins and I still have those ribbons.”

Wow, a 12 year old girl adding $17,000 of value to a horse by training and showing him.  This next story started when a 3rd party horse owner was unable to sell his horse.  He was asking $25,000 but nobody bought.  He hired Caitlin to ride and compete with him.

“I rode Matador for one week before I took him to a two week horse show. In those two weeks we won two 2nd places, one 3rd, two 4ths and a 6th. He was the most ADD horse I have ever ridden and was more interested in looking at the crowd than where he was going. He was sold the last day of that show. This was the first time Matador had ever placed at a show and the owner was able to sell him for $32K.”

In 3 weeks Caitlin took a horse that couldn’t sell at $25K and added at least $7K of value.

I loved talking with her.  She adds value to horses by riding them and winning with them.  Her added value can be directly measured by the price of the horse.

How do you add value?  How does your company add value?  Often it isn’t as obvious as a professional equestrian, but if you can’t specifically describe the value you add, you probably aren’t being paid as much as possible.

Today’s lesson:  Focus on adding value first.  Then you can use pricing techniques to capture that value.

 

Mark Stiving, Ph.D. – Pricing Expert, Speaker, Author

To gain more insights on pricing sign up for the Pricing Perspective, a free monthly summary of Mark’s blogs and other publications.

Segmentation – Pricing vs. Marketing

Question:  What are the differences between market segmentation and price segmentation?

Answer: The goals and the techniques.

The goals – In market segmentation, the goal is to find similar customers to “market” to.  This typically means develop products for, create marketing messages for, pay to access (e.g. via magazine or web advertising).  Market segmentation is about the whole package, finding large segments of people that tend to behave and respond similarly.

Price segmentation comes after market segmentation.  Once you’ve decided who your target market is, price segmentation further divides that market to find the customers who are willing to pay more than others.  For example, you may be selling BMWs.  Your target market may be driving enthusiasts, who are relatively well off.  Yet within that target market, some people will buy the high end, and some the lower end.  Some people will buy all the options and others not.  Price segmentation is about determining who within the market segment is willing to pay (WTP) how much.

Even with more focused market segments there are still differences in WTP.  For example, let’s further focus our BMW market to men in their mid life crisis who make over $150K per year.  Even within this very narrow market, some men are willing to pay more than others.  Price segmentation deconstructs this.  How about men who make between $150K and $200K who live in Ohio with a wife and two kids?  There are still differences in WTP.  You get the idea.  No matter how narrow the target market, there are differences in WTP you can use.

The techniques – Market and price segmentation use different tools to determine the segments.  Statisticians and marketers use cluster analysis to find their market segments.  Companies conduct surveys on the markets perceptions of the product and combine this with demographics, psychographics and other customer characteristics to produce the data.  Marketers then use cluster analysis on this data to find customers who are similar to each other (segments) and like our product.  Notice in this approach there is no dependent variable.

For price segmentation companies typically use more of a regression approach.  They gather historical data on who paid how much and combine it with demographic and transaction data.  Note this is similar to market segmentation data with the addition of actual price paid.  Statisticians and marketers make price the dependent variable and all of the other information the independent variables in a regression analysis.  From this, they can deduce which customers are willing to pay more.

Here is one thought you should take away from this blog.  Big data is the future.  If you already have enough purchase data with price variation and information about your customers, you are ready to use statistics to help with your price segmentation.  If you do not, it’s time to start.  Put systems in place that collect information about your customers and the transactions.

However, don’t use a lack of data as an excuse.  You can use more qualitative methods for price segmentation.  At the same time though start collecting the data.  It will prove valuable.

Price segmentation is very profitable when done well.  It is absolutely worth your effort.

 

Mark Stiving, Ph.D. – Pricing Expert, Speaker, Author

Photo by Sensinct

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Sleazy Pricing by WSJ

Companies should be paid handsomely for the value they create.  They should NOT use deceitful pricing tactics in the process.  Earlier this week, the Wall Street Journal caught me in their sleazy pricing practices.  Here is the story.

The WSJ notified me that my WSJ digital subscription would automatically renew.  No problem. I like the WSJ.  I scanned down the email and saw the renewal rate was $5.99/week.  I did the quick math, that’s MORE THAN $300 PER YEAR.  I’m sure I signed up for $99 per year.  What happened?

I searched my email history and saw last year it also auto-renewed at $311.  Wow, I didn’t even notice.  That was my fault.  It was my responsibility to read whatever fine print there was when I originally signed up saying the rate would go up 3 fold after the first year.  (I trust that there was disclosure since I can’t find the original offer.)

So far in the story the WSJ did nothing sleazy as long as it was clear that the $99 rate was for a limited time.

So I went online to cancel my online subscription.  The cancellation link is nowhere to be found.  I searched and searched but couldn’t find it. What could I do? I thought about calling my credit card company to refuse the charge.  I thought about just giving up.  How much time was I going to spend on this?  I even started thinking maybe $311 wasn’t too much for the subscription, surely what the WSJ was hoping for.  My frustration was building.  I finally decided to search their FAQ and found the following:

The Wall Street Journal and Barron’s – Cancellation requests for print and digital subscriptions are only accepted by phone. To cancel your subscription, please call 1-800-975-3913. Our hours of operation are Monday through Friday, 8am – 8pm Eastern Standard Time. For security reasons, your subscriptions cannot be canceled by email or online.

Seriously????  They can securely accept a subscription with credit card information on line but they can’t securely cancel it?

So I called and was put on hold for 8 agonizingly long minutes and 17 seconds.  This was more wasted time for a task that should have taken seconds online.  A nice lady answers the phone and asks for my email address and the answer to my security question.  Then says “Cancellation is not a problem”.  (Was that more secure?)

Then she asked “Can you tell us why you’re canceling? Management wants to know why we are losing readers.”  So I told her that the price was way more than I thought I signed up for.  Her reply, “Oh, you shouldn’t be paying that rate.  We just moved everyone to a monthly rate of $21.99.  I can offer you two free months.”

I declined.

Here is what I now think of the WSJ.  They were always a great company.  Relatively unbiased.  Honest.  Forthcoming.  In this single interaction they went from respectful to sleazy.  They used to be a a company that created value and charged fairly for it.  Now they are a company that relies on tricking their customers to stay.

Maybe in a declining industry that’s the only way they can survive.  Maybe they are desperate.  That’s unfortunate.

What should you learn from this story?  Don’t try to trick your customers.  When you are discovered (not if, when) it will create ill will.  Your customers will begin to dislike you and worse, they will tell others.

The best pricing advice:  Create real value.  Charge for that value. It’s OK to find ways to charge different customers different amounts, but not using deception.  Your customers are willing to pay for value.

Reject deception.  Win with value.

 

Mark Stiving, Ph.D. – Pricing Expert, Speaker, Author

Photo by CarbonNYC

To gain more insights on pricing sign up for the Pricing Perspective for a free monthly summary of Mark’s publications.