As I connect with and work with many entrepreneurs from my class at Haas, from Boulder, through my blog and as I read more about them, I am compelled to make a generalization about their mindset and how they approach ideas. I see the doublespeak in mine claims basing it purely on anecdotal evidence, after all my writings on the need for evidence based management and calling out those who make such generalizations. For what it is worth, treat these as hypotheses and not as claims.
H1: It is impossible for someone who rationally estimates net present value of all options, stress tests their assumptions, meticulously conduct sensitivity analysis, determines market sizes and customer demands to start a new venture.
Corollary: To start a venture one needs to be risk seeking and at the very lest to be willing to suspend their rational mind to make the leap.
H2: Most ventures start with an entrepreneur seeing a localized problem and deciding that it needs a generic solution.
Here is a case study (which not should be treated as proof but rather as one of many stories that added to my conviction and pushed me to make the hypotheses).
Netflix for Hot Couture: This is a business started by two Harvard MBAs. One of they saw the problem with women buying expensive evening wear and party wear just for single use and decided that this problem is generic enough and needs a bigger solution. They came up with a web based service for renting designer dresses for $50 to $100. For an analyst this idea is a non-started. Look at all the issues:
- The idea is not unique and is easily copyable
- What is the problem is this addressing and what is the unique value add?
- What is the market size? What are the segments? What is each segment willing to pay?
- Fashion by definition is fickle and changes fast and is different across regions – how much inventory does one need and how big is the risk of carrying this inventory?
- For a $1000 dress can we rent it out enough times to not only cover the costs but also turn profit?
These alone are enough reasons to not starting this venture but not to the two people who not only started this but have successfully found funding for it. Will this venture go big? My analytical part says no, but as a fellow human I wish them well and hope they will go big and succeed.
On a side note, whoever described this idea as “Netflix for Hot Coutre” knows how to do marketing and following the advice of Salesforce.com CEO Mr. Marc Benioff. This metaphor helps with explaining the new service but one should not reduce Netflix to just a DVD rental service, you should read the vision of Netflix CEO on what Netflix is about.
A Netflix Model for Haute Couture
You are walking along the dairy aisle, picking up Yoplait yogurts. You prefer the 99% fat free version, so you load up on some strawberry, some raspberry and some vanilla. The price? All of them priced exactly the same, 59 cents. (Let us ignore the one time promotions they run on one flavor to clear out the stock). After picking a dozen or so 99% fat free version you look up and find Yoplait Whips and it also has almost the same line up of flavors. Price? 79 cents.
- Why does the price vary across the types of Yogurt (let us call this vertical product line) but not across the flavors within a product line?
- Does it cost the manufacturer the same to make raspberry and strawberry yogurt? Should the cost difference be reflected in pricing?
- Do customers value the different flavors differently?
- Why does the price vary across product lines?
- Does a marketer stand to gain more profit by doing vertical line extension or by increasing variety within a product line?
- Can the marketer increase market share by increasing variety within product lines?
In their paper published in Marketing Science( Spring 2006, Vol. 25 Issue 2, p164-174) Stanford GSB professor Michaela Draganska and Kelloggs’ Dipak Jain asked just these questions and found the answers for the rest of us marketers.
We find that consumers value line attributes more than flavor attributes. Given that consumers value line attributes more than flavor attributes, firms have a lot to gain by pricing their product lines differently whereas they have little to lose from pricing all flavors within a line the same. We also find that the value of a product line is not merely a function of the number of flavors it includes: The calculated inclusive values indicate that more flavors do not always result in increased utility for consumers and hence higher market shares.
Firms’ profits would not significantly increase if they were to price flavors within a product line differently. Therefore, the current pricing policy of setting different prices for product lines but uniform prices for all flavors within a line appears to be on target.
What does this mean to marketers? This tells what true versioning means, it is not just changing colors or toppings. Do not chase market share by making minor tweaks, this does not result in profit increase. Strategy is about making choices. When in doubt about where to invest your R&D and marketing dollars, instead of expanding variety within a product line consider product line extensions.
First it was the $9.99 (the $8.99, $8.98) hardcover books, now it is $9.99 DVDs. Wal-Mart’s started the price war with a very low price on pre-orders for hardcover books and DVDs. Almost immediately Amazon.com was forced to match Wal-Mart’s price and so did Target. When the three retailers wage this war, customers stand to benefit while shareholders will see value destruction.
The value lost is not uniform for all three retailers. According to WSJ that quotes a JP Morgan analyst, Wal-Mart makes less than 1% of its revenues from its online channel WalMart.com while Amazon.com it is 100%. Online revenue from books and DVDs is even smaller portion of the total revenue. I do not have numbers for Walmart.com but Amazon.com makes 58% of its total revenue from media sales ($11 billion annual, granted that includes music CDs as well).
The all new low price is offered only on 10 new titles, so their share of total online revenue is low but even a fraction of the 58% is a larger share of total revenue than that of 1%. Wal-Mart may not gain much from this price war but stands to hurt Amazon.com a whole lot more. That is an effective price war.
It is effective not because it added to Wal-Mart’s profit but it forced Amazon.com to respond. There really was no reason for them to match the price. Let us do back of the envelop math. Let us assume the low price was offered only for a quarter, the new books and DVDs constitute 10% of the media sales and the margin for Amazon.com is 10%. The price cut is about 30% of their total price, all of which is lost profit. That is a total loss of $82.5 million (11*(1/4)*10%*30%)
Even if we assumed the worst so that Amazon.com’s new book and DVD sales would be completely wiped out had they not matched Wal-Mart’s price cut, their loss would total to just $27.5 million (11*(1/4)*10%*10%). Clearly, retaliating is not a profitable option for Amazon.com and by doing so they only helped make Wal-Mart’s initial attack effective.
Meanwhile Wal-Mart is only happy to reap the benefits of free publicity from its low cost price war that hardly puts a dent on their profits while damaging their competitor’s profits.
Marketing is about segmentation and targeting there is nothing more to it. Segmentation is recognizing that different people buy different products for different reasons and finding those reasons, occasions, usage scenarios and hence what the customer is willing to pay for. Targeting is delivering versions that meets those reasons and customer’s willingness to pay. I started a new series of articles on what I called “Fidelity Trap“. As I said in the introductory post, this is concept I based off of the concept of Fidelity, Convenience and trade-off as used by author Kevin Maney in his book Trade-Off: Why Some Things Catch On, and Others Don’t and on the concept of congruence and traps used in a different context by professor and author Henry Chesbrough (I did one course with him while at Haas School of Business).
If you take Maney’s book, the core of it is not new or groundbreaking – somethings catch on and others fail when the marketer fails to fully understand their segments and/or fail to target them with the right versions. By definition, products fail in the market place because of marketing failure. What Maney’s framework of Fidelity and Convenience does is to frame and group together different reasons, occasions and usage scenarios of the customers.
What about the Traps meme ? It is just another framework or my hope for getting a catchphrase. Traps result when a firm’s marketing strategy is inwardly focused, ignoring market evolution, or due to differences in customer’s stated preferences and behaviors.
In the Trade-off continuum, it is oversimplification to say Fidelity and Convenience are the only two factors involved in customer decision making. It should also be noted that customer utilities from these factors are functions of other variables independent variables. For the analytically inclined there are methods and tools like conjoint analysis that allow the marketer to find how much customers value the different features (be it a fidelity feature or a convenience feature), all other factors and how to define versions and at what prices.
There is absolutely nothing new in marketing – only restatements, new mental shortcuts and of course catchphrases.
Southwest steadfastly refuses to charge for bags (at least the first two bags). Their marketing campaign, “Bags Fly Free”, says it all. In the short run they are missing out on the profit from baggage fees. The total airline industry profit from baggage fee for last year was around $536 million. Southwest is betting on increasing capacity utilization by attracting and keeping customers who are fed up with all the extras while other airlines are training the customers to pay for the extras.
Before airlines started to unbundle their services customers viewed the service as a monolith as opposed to a “bundle”. My monolith, I mean, a product service that is marketed and perceived as one entity even thought it is made up of different components. A bundle, on the other hand, is put together from several components, is marketed as a sum of its parts and is perceived by customers as such. Unbundling has changed the perception of airline travel from a monolith to a bundle – a bundle consisting of:
- the main component – the ticket
- convenience of paper ticket
- convenience of seat selection
- ease of boarding
- check-in bags
- and in one extreme case - use bathrooms
So what Southwest sells with its “Fees Don’t fly with us” is a bundle in which every component of the bundle except the ticket is marketed as free. What is the danger of throwing in freebies with bundles? According to consumer behavior researchers from three universities, who published their results in Journal of Consumer Research, April 2009, it is the long term erosion in customer willingness to pay for individual components.
Authors Michael A. Kamins (Stony Brook University-SUNY), Valerie S. Folkes (University of Southern California), and Alexander Fedorikhin (Indiana University) found that describing a bundled item as free decreases the amount consumers are willing to pay for each product when sold individually. They call this the “freebie devaluation” effect.
Why does a freebie decrease the price consumers are willing to pay for each individual product? Our research shows that consumers tend to make inferences about why they are getting such a great deal that detract from perceptions of product quality,” the authors explain. “For example, consumers figure the companies can’t sell the product without this marketing gimmick.” [quote Source].
In the case of Southwest’s bundle in which everything but the ticket is free, the research implies that customers will expect lower ticket prices if they want only parts of the bundle. A customer who is not checking in bags, in essence, is purchasing only one component of the bundle but is paying for the entire bundle. The “freebie devaluation” effect will push down customer’s willingness to pay for tickets when they do not need to check in bags.
What does it mean for Southwest? Unless their customer travel indicate that most customers check in bags they run the risk of lower ticket price expectations from their customers, further depressing their profits.
What does it mean to other marketers who throw in freebie? The same research provides the answer – there is no difference in customer willingness to pay for the bundle whether or not one or more of its components are marketed as freebies. So resist the temptation to increase sales by either throwing in freebies. If you are offering a bundle – you might as well price it same as the sum of the prices of the components.
In introducing the concept of Fidelity and Convenience Traps, I wrote that traps are where a firm is stuck in when its strategy and innovation are aligned with one factor while the market as a whole prefers another. These traps are a result of relatively stable preference (stable over a longer period of time) of large segments of the market for fidelity or convenience while the firm’s resources are committed to and tied up with convenience or fidelity.
I also hypothesized that the market’s needs switch between fidelity and convenience over time. This is not a high frequency switch that happens over a very short period time. The switch happens over a relatively long period of time (1 to few years) and in between switches there is a stability. It is the stickiness of the preference and the slowness of change that cause the traps.
These long run trade-offs are much different from the short run trade-offs we make everyday. These short-run trade-offs do not result in traps. Take for example eating pizza. It is a Friday evening, you and your family of four are considering dinner options. Your children decided it is going to be pizza. On a 0 to 100 scale, rate each of the following options (0 – extremely undesirable, 100 – extremely desirable)
- Pizza delivery from local pizza chain for $25, delivered in 30 minutes
- Two frozen pizzas at $5 a piece, that you already have in your freezer, add fresh toppings of your choice. Total time 30 minutes.
- Make pizza from scratch, with all fresh ingredients including fresh buffalo milk mozzarella for a total cost of $12. Total time 2.5 hours.
- Head out to a highly rated pizza place that serves authentic Italian thin crust pizza in a wood fried oven with all fresh ingredients. Total price $55 and drive time 30 minutes, waiting time 30 minutes.
- Head out to local all you can eat pizza buffet place with all standard pizzas made with packaged and frozen ingredients. Total price $28 and drive time 5 minutes with no wait time
You can see that high quality ingredients and special oven make the pizza very high quality – or high fidelity. A frozen pizza or a delivered pizza are not the highest quality but provide great convenience. There is also the price – that pushes people to til either towards the fidelity or convenience end of the pizza spectrum. The score people assign to these options is referred to as its totality utility. Different people get different utilities from the same option and even for the same person the utilities for a given option will vary with context. The choices are not stable, highly unpredictable and vary over short time periods (even within a week).
In other words different segments of the market, at different times (within a short time frame) switch between fidelity and convenience. This is the short run cycle and does not represent a stable preference by a large part of the market over a relatively long period of time and hence there are no traps.
Short run cycles do not cause traps, only the long run cycles do.
In the coming weeks, I will write more on modeling the short run and long run cycles.
This is favorite pricing case study for the past ten months or so – Sensorielle spa in the city I love, Boulder, went to a Pay-what-you-can pricing model. The spa’s owner, Ms. Petteway made it clear that this is not “pay what you want” but a scheme to allow those loyal customers who were hurt by down economy to come back and pay only what they could afford.
A few months back I wrote about the partial results published by:
Ms.Petteway published results from her experience in the Boulder Net LinkedIn discussion board. She talks about how few customers interpret the pricing plan as “pay what I want” and ask for high-end services even though they pay less than the posted prices. For any rational customer (Homo Economicus) whose goal is to maximize their utility, it makes sense to pay the minimum they can get away with.
I said then Pay-what-you-can scheme despite its close resemblance to first order price discrimination is not really price discrimination. It does not stand on solid data ground or analysis and leaves the future profit uncertain. Better results could be achieved with segmentation and targeting.
Will this pricing scheme help the spa identify willingness to pay of different customers? No, because the reference price is set by the list price and is pushed down by the option for “pay-what-you-can”. There are other ways to get customers to reveal their true willingess to pay (see my article on Pricing for garage sale).
I do not have access to any sales data nor have I had this conversation with Ms.Petteway but I hypothesize that they found this pricing scheme yielded lower profit than previous years. The spa is not standing still and is making more pricing changes for the coming year:
- The Pay-what-you-can is limited to just two days of the week. This is something they should have done to start with and that would have been a great way to sort customers based on their WTP. This would also help reduce cost of operations for those days by staffing with junior staff and not offering their high margin services. I also would recommend offering no reservations or charge for reservation separately (unbundled pricing) for these pay-what-you-can days.
- They are increasing prices of some and decreasing prices of some. If they based it on customer survey then it makes perfect sense. When re-pricing two version of the same service I would have recommended that they don’t reduce the price for both.
- Note how the text reads for price decrease and price increase. They say “price reduced” and “price changed” respectively. That is not a strategy but the right messaging – do not ever say price increase.
Small businesses can blame the economy and be swept by the recessionary wave or they can take control on their marketing strategy to drive higher profits. Lack of specific marketing skills is not an excuse anymore. Kudos to Ms.Petteway for experimenting with pricing and her willingness to adapt as she gained more data about consumer behavior.
iPhone has less than 3% of the market share of the total mobile phone market but is the reason for the higher churn among mobile subscribers. None really lived up to their title. Verizon Wireless saw its new subscribers additions shrink past quarter compared to past year numbers. Customers either chose AT&T for its iPhone 3GS or T-Mobile for it low prices. Verizon is fighting back with two marketing campaigns:
- There is a Map for that! – This is in the same class as their “Can you hear me now?” campaign, highlighting their network coverage, except it also shows the lack of national 3G coverage in AT&T. The veracity of the claims are under debate and is beyond the scope of this article. The core message is – our competitors may have cool phone with thousands of App but it is all useless if the network is bad. Verizon had always claimed it had the best in class network, and yet it was not enough to stop the churn. Will the new message succeed?
- Everything iCan’t Droid Does: This campaign is for the new Droid smart phone positioned against iPhone. Verizon Ad highlights what iPhone cannot do – like taking pictures in the dark of 5 Mega pixel camera. Since Apple introduced iPhone there has been several iPhone killers. Will Droid be able to take on iPhone?
Take the case of Blu-ray players. Sony won the hard fought format battle against HD and yet the winner has not found firm foothold in the market. With the Beta Max memories still fresh in their minds, Sony did everything right this time – building a coalition, marketing, and most significantly lining up content. According to Nielsen, Blu-ray sales remain a small fraction of the market.
Why did Verizon lose subscribers despite their best coverage?
Why did iPhone succeed?
Why do the Blu-Ray makers cur prices drastically or include capability for on-demand video in order to sell the players despite the promise of high quality video playback?
Why some innovations catch on while others fail?
Does the failure or success of a product in the market depend singularly with the firm’s ability to innovate, build and dominate the ecosystem, its quality of products and its marketing prowess?
In the book Trade-Off: Why Some Things Catch On, and Others Don’t, Kevin Maney offers an explanation based on fidelity vs. convenience offered by the products. In their model, there is a Fidelity-convenience frontier (Maney calls it the Fidelity Belly) and customers make trade offs between the two. Fidelity refers to richness of features and quality and convenience is how easy it s to get what you want.
I agree with the trade off argument but I hypothesize this choice is not static. Market preference switches back and forth between the need for fidelity and the need for convenience. 
Over time, as the customer needs evolve and usage scenarios change their preference for fidelity vs convenience changes as well. The reasons for these shifts are exogenous to the product – disruptions and lifestyle changes introduced by other products even from those unrelated to the product in question. Take the case of Blu-Ray, despite the high fidelity, it has not gained firm foothold because of the market’s shift towards on-demand video.
This means whether a product will succeed in the market place or not i
s determined not by the trade off made by the customer but by the congruence between the market needs and the product purpose (fidelity vs. convenience) at the time of product introduction.
Take a look at the 2X2 matrix. Products that fall into the lower left and upper right quadrants are in congruence with market needs and most probably will catch-on. However, on the top left and bottom right are the traps. Fidelity trap is when the firm’s innovation, product strategy and marketing are all aligned with delivering high fidelity products but the market needs convenience. Convenience trap is the opposite.
Products do not stay in Congruence or Traps over their entire life cycle. A firm that found success with a convenience (or fidelity) product may not continue to succeed with its next version if the market shifts. A prime example is Motorola’s RAZR. On the same note, a firm stuck in the traps has the opportunity to achieve congruence in the next cycle.
This is not to say marketing strategy, innovation and product quality are not important but to highlight the need for congruence between the product and the market needs. A failure will lead to unsuccessful products that are are stuck in one of the two traps.
Disclaimer: This is a work in progress. I need to provide you more theoretical framework and data for the Fidelity trap hypothesis. This inspiration for this concept came from Modularity trap theory put forth by Henry Chesbrough, author of Open Innovation. If you peel the layers, the core concept is segmentation and targeting – ultimately there is nothing new under the sun.
Within any given customer segment, however specifically defined it is, are individuals who ultimately are different from everyone else in the same segment. Demographics, psychographics, buying behavior etc all go only so far. Every individual ultimately has unique preferences, interests and willingness to pay – all of which are non-static and highly malleable. The challenge is in finding the exact willingness to pay of each customer at any given point in time but the opportunity for the marketer is to create product versions, promotions and messaging that nudges the customers with higher willingness to pay to step forward or those with lower willingness to pay to step backward. In either case the front row of customers will be those that are the least price sensitive.
Here are three case studies of marketers nudging the higher willingness to pay customers to identify themselves:
- For their new animated movie Frog and the Princess, Disney is holding two and half weeks’ worth of premium-priced screenings at single theaters in New York City and Los Angeles. Ticket prices? $20 to $50. Disney says it brought in $2.8 million in ticket sales from these premium priced tickets.
- Panera bread, a gourmet casual restaurant, introduced a premium priced sandwich for $16.99 while most of the menu items are priced at $10 or less.
- A coffee shop owner used to charge $1.60 for his regular cup of Joe. He introduced premium coffee illy and serves it in white ceramic cup with illy logo (premium product and premium packaging) at a premium price of $3.00. Sales tripled after this move.
The net is, the marketer can either take the prices as exogenous, set by competitors , dictated by costs etc. or take control of their pricing to maximize profit.
The Times has cut as much fat as it can. It had cut staff, offered buyouts, cut pays to employees, cut freelance staff, cut discretionary budget and even cut subscription to other magazines and newspapers. It is still difficult to show profit growth because there is no upward movement on the revenue side of the profit equation. Its Ad sales are declining and its weekly circulation has fallen sharply.
There is only so much they can do on the cost side if they want to maintain product integrity and quality. It is easy for outsiders like us, whom Times executive editor Keller calls as “armchair experts”, to call for charging online access to nytimes.com.
Keller said: “It’s a much tougher, more complicated decision than it seems to all the armchair experts. There is no clear consensus on the right way to go.” At stake are millions of dollars from online advertisers who want the largest possible number of readers. Putting up any kind of pay wall has the potential to drive away readers and some of those dollars.
Keller is correct, it is not a easy decision. The revenue equation he is looking at is
R = annual subscription + single copy sales + Print Ad revenue + Online Ad revenue
Online Ad revenues depend on page views which will go down significantly if Times charges for access. It is not a question of will it drop, but how far will it drop? Will the online subscription revenue be enough to compensate for the lost Ad revenue?
In case of WSJ which still charges for online access it was easier to do the math going the other way from fee to free, but is not the case for the Times that never charged for online access. Any attempt to introduce pricing, without carefully managing customer reference price, will fail.
Here is what I recommend for Times :
- Start charging for access to articles older than 30 days (like Factiva of Dow Jones) – if someone wants access to past articles it must be adding unique value to them, something that is not substitutable. The lost Ad revenue from lost page views of past articles must be lower than revenue gained from selling these articles (they must have gobs of data to validate this). They should also set prices similar to Factiva, high prices for individual copies or an annual subscription with lower price per article.
- Increase price of print copies – those who value the print version will stay and the others will switch, either to online version or to other newspapers. Any increase in online move is measurable and will give them more data on what the drop will be if they introduce pricing for online subscription.
Mr. Keller, what do you think?
The book is The Price of Everything: A Parable of Possibility and Prosperity by Russell Roberts. A very well written book with a storyline, set in Berkeley and Bay area. That alone gets stars from me. If you are exposed to economics or a practitioner you will be bored especially with the parables trying to teach you. On the other hand, if you find it hard to explain to your friends and colleagues market economy, price discrimination and dynamic pricing this book will give you pithy stories to tell.
The book starts with what most people and media would call as price gouging. The scene is aftermath of a mild earthquake when there is a sudden spike in demand for flashlights, candles and baby formulas. The story’s protagonist Ramon was shopping for flashlights. The local Home Depot was completely sold out but another retailer had supplies – at twice the regular price. Is this price gouging? How dare a retailer profit from an emergency and squeeze their customers when they most need the supplies?
This leads to a series of events, later on in the book the question is put back to the readers, “Would you rather shop at a store that charges the same price all the time and runs out of stock in emergencies or shop at a store that has differential pricing and does not run out of essentials when demand spikes?”
This I think is a great way of teaching (that is if you are a reader looking for learning from the book) – set up the problem, the context and also toss in conventional wisdom (which not only not wisdom but down right wrong), let the reader toy with the problem and enable them to form their version of solution before giving an alternative explanation.
The question that was not asked by the author is – If what Big Box did was price gouging, would it be okay if someone picked up all the flashlights from the Home Depot and sold them right outside Big Box for a price just below twice the regular price Big Box was charging?
There is also the famous story of the pencil – how no one single person knows how to make a pencil. The core principle is how price and price alone serves as all the information that is needed to orchestrate the complex and distributed ecosystem that has no central authority and no other channels of information. I liked the version described in the book Free to Choose: A Personal Statement by Milton Friedman and Rose Friedman.
Price is Everything does not ask or explain why some are willing to pay $4 per pencil when Target and Walmart sell a box of two dozen pencils for 25 cents. What is missing is that while price alone serves as the signal, it is not something decided purely by supply and demand equilibrium. A marketer has control over the price they charge and improving customer willingness to pay.
The book also touches on several other economics topics like game theoretic thinking and choosing a dominating strategy.
Overall I recommend this book, even if the concepts are not new to you there is value in learning from Russell Roberts how to tell a good story and how to create teachable moments.
Nintendo on Thursday scaled back its estimate for Wii sales by 23% to 20 million units. That means a loss of 5.96 million units.
A few months back, when Nintendo decided to cut the price of its Wii unit by $50, to match Sony and Microsoft, I wrote
Sony’s decision to cut prices by $100 means it needs to generate 23% incremental sales, above and beyond what it would it have achieved without the price cut. The 23% number was based on gross margin and customer margin assumptions I made. Now the third game console maker and the market leader in the next generation game consoles, Nintendo announced a $50 price cut on its Wii.
Let us assume Nintendo’s models show Sony selling 23% more units than they would have normally sold due to $100 price cut. Let us also assume Microsoft gains the same – both PS3 and XBox gaining at the expense of Wii. This means Wii stands to lose 5.86 million units sales (email me for numbers).
Coincidence? Or good data modeling?
I heard on NPR a story on the cost to send a soldier to Afghanistan. The price tag is $1 million. So to send the 40,000 soldiers the total cost will be $40 Billion. Correct?
Not quite. The actual total cost could be way more or less this number. The mistake lies in computing the true marginal cost – that is the incremental cost in sending one additional soldier. The $1 million number is misleading because it includes a fraction of the fixed costs allocated to each soldier:
“So, it’s the cost of some allocation of the cost of the plane, some allocation of the cost of the fuel, some allocation of the cost of the pilots, the maintenance folks,” Zakheim explains. “If you focus just on the soldier, it seems outrageous. But if you focus on the support for the soldier — that’s not all that outrageous at all.”
But what if planes are already flying to Afghanistan and have spare capacity? What if the infrastructure is already there? What if the army already have soldiers on the payroll? What if the army has to build new infrastructure for housing 40,000 soldiers at a new cost of $20 billion?
A moment’s reflection on these questions will convince you that the true marginal cost does not include fixed cost allocation and the total cost could be less or more than the $40 billion number.
Do you know your marginal costs?
- Market Segmentation Based On Consumer Behavior
Richistan is the name of the book by The Wall Street Journal columnist Robert Frank. The book is about the lives of the wealthy and high propensity to consume. Frank says in that book,
Pricing for Richistan is like pushing an unlocked door – no pressure
Through @pricingclub I saw the USA Today news on $4000 sunglasses by Oakley.
“I could have seen something like this selling three years ago,” says John Horan, publisher of Sporting Goods Intelligence newsletter. “But conspicuous consumption is out.”
Conspicuous consumption is not all out. While marketers (like LVMH) targeted Richistan there were a few other segments which self selected themselves. They had high willingness to pay but not the wherewithal to pay. Only these segments are now out. Since the economic downturn we do not know the population of Richistan. Their ranks may have shrunk but as it does I hypothesize that those who are left in it have increasingly low price sensitivity and are willing to splurge lot more than. So it makes sense to introduce super and ultra premium products like the $4000 sunglasses.
Oakley is producing just 200 pairs, thus making it exclusive and its stated target segment is “the guy who doesn’t blink at spending $300,000 on a car”. This is super narrow targeting, males of Richistan that can buy expensive cars without a thought. Compared to $300K price tag the $4K is going to look relatively small.
Another reason why this will help Oakley is the presence of $4K per pair sunglasses helps to improve customer reference price and make their $200-$500 prices look like a great deal.
Great marketing strategy. But, what is surprising to me from that story is not the price but the argument for the high price based on the cost.
About 80 layers of costly carbon fiber — a material more common to the aerospace and motor sports industries — are pressed into the frame. The ultracostly material and design make the frames more flexible and comfortable for athletes, says Neil Ferrier, Oakley’s advanced product development chief.
Another reason for the high price tag, Ferrier says, is the number of worker hours devoted to them. About 90 hours of machine time go into crafting each pair, he estimates.
Costs do not matter to customers and making a cost based justification makes sense only if a marketer expects push back. So why bother even mentioning cost to produce?
