Permission to Raise Prices

You read it right. It is permission that you need to raise prices. Raising prices is not a prerogative. Those who thought otherwise and said their products deserved the price tag saw their business run to ground.

It is not permission from your CFO or shareholders. It is permission from the customers you chose to serve. It is important to see the narrow definition here – “customers you chose to serve”. First the word customers clearly indicates they pay you for your product. Second it is your choice of who to serve since you cannot and should not go after every one with a need and willing to pay for filling that need.

The permission is intrinsic. It is in the form of additional value you deliver to your customers above and beyond the price they pay. More precisely it is the perceived value of customers. When you are not mopping up all the value created in the form of higher prices you have three things in your favor

  1. You build a moat against competition from entering with a lower price
  2. You expand the target segment to bring in those with lower willingness to pay
  3. You earn the permission to raise prices in the future

That is exactly what Chipotle has and says it does when it decided to increase prices,

“We believe we’ve got a lot of pricing power,” Ells said. “We’re not going to spend all the pricing power we’ve built up over time, we still have some in the bank.”

How did they get there?

It is by choosing the customers they want to target – those who do not hire a burrito just for utilitarian purposes but also for other higher order reasons. Reasons like green, healthy, fresh and socially responsible.

If the latter factors are not relevant to a set of customers they will not be willing to pay even the current high prices of Chipotle let alone its new higher prices.

The fact that their chosen customer segment believes there is more value than the price they pay for Chipotle can raise prices without losing customers. They continue to signal that value to customers, reminding them why they hire Chipotle, through better branding and content marketing.

And if there is any doubt to any one why they are increasing prices there is always the time tested reason,

The price hikes aim to address pretty much the only problem that roiled Chipotle during what was an otherwise pretty good quarter: Food inflation. The prices of beef, cheese and avocados have all reached elevated levels in recent months and are expected to stay high. As a result, Chipotle executives felt it was time to pass the cost onto customers.

There are always other reasons to raise prices.

Now a word of caution. Before you run to make your product green, socially responsible, ethically made etc. understand the customers you want to serve and whether those are the factors they desire and value. Without that understanding you cannot expect to set premium prices or earn permission to raise prices

If you like Chipotle, go have a burrito. But do not blindly copy their content marketing, product development or pricing without clear understanding of your customers.

Just because you give it away you can’t hit 5 million customers

There is a widely popular post showing up in my LinkedIn and Twitter timelines. It is from Ryan Holmes, CEO of Hootsuite. Ryan calls the post, “How to get 5 million customers zero Ad budget” and goes to give the first tip to get there,

Give it away for free: Freemium users first; monetization later.

In 2008, we offered HootSuite to the world as a freemium product. The overwhelming majority of users—and we very quickly had hundreds of thousands of them—paid absolutely nothing for the service. Companies who wanted beefed up functionality and extra support paid a monthly fee, from as little as $10 to $1,000 and up.

And he goes on to extol the virtues of freemium, how free users are lead generators and finally ends with,

The basic premise is simple, yet deceptively powerful: Put your energies into developing an irresistible product and loyal user base. Worry about making money later. I can’t imagine doing business any other way.

Is it that simple?

LifecycleFirst let us look at the word customers and distinguish the term from users (or even free loaders). I did this a while back in my user mapping. If they are not paying money they are not customers. That distinction is lost in Ryan’s post. The 5 million are just users of which likely 3% are customers (going by base rate).

Second let us not forget the opportunity cost – how many of those free users would have paid for the premium version had there not been a free version. I explain this point in more detail here. Let us not overlook the fact that a business could have uncovered demand in other ways and could have targeted only those with a product they value.

Third, Ryan writes a general advice column for everyone based on the success of his business. It is not that different from your sports fan friend telling you how he picked Connecticut and Kentucky for the NCAA final. Just because Hootsuite succeeded by signing up 5 million users do not think you will too by giving away your product for free. Let us say you and 999 others take his advice at face value, can those 1000 people who retweeted his post start a company and reach 5 million customers users? By the time 10th such startup succeeds will the previous 9 still retain their 5 million?

Fourth, Ryan quotes the same usual suspects of freemium suspect – Dropbox and Evernote. Let us not overlook the fact that Dropbox now makes almost all of its revenue from its business customers.

Ryan says he cannot imagine doing business any other way.  I want to expose you what other CEOs think about freemium.

  • “We are now seeing the end of the freemium model — signing up users for free and trying to upsell,” said Christian Vanek, CEO of the Boulder-basedSurveyGizmo, in a recent phone conversation.
  • “6.5 million unique users is not all that it’s cracked up to be. I don’t want hits. I want revenue. I want a real business,” said Matt Wensing, founder and CEO of Riskpulse, in an interview with Mixergy.
  • “Make a product people want to pay for,” said Marco Arment, founder of Instapaper, in a Planet Money interview.

It is comforting to think all you have to do is build a product, give it away for free, sign up 5 million users and see 3-5% of them converting to paid users. It is not that simple. It is in fact simplistic, like the advice from your friend who picked the NCAA bracket (when millions were filled out).

This is a product centric view that assumes the world is the target market. There is nothing simple about reaching 5 million paid customers. But there is a way that is more likely to get you there – by finding a segment larger than 5 million with a pressing need that is not met by any alternatives and are willing to pay for a product that fills the need.

 

 

What is the product?

In her book about the missing son of French queen Marie Antoinette, Deborah Cadbury (some distant relation to chocolatier) writes about the elaborate dining arrangements and events of the royalty. It was in fact a spectacle or more precisely a spectator event that people paid money20140406-183904.jpg to come watch the royalty dine. The extra money earned was desperately needed by the royalty that had depleted the coffers.

Why would people who are starving and cannot afford anything close to what the royalty was eating would spend scarce money to watch royalty eat? Remember, “let them eat cake” ( Deborah Cadbury tells us Marie Antoinette did not say that).

It is possible the French royalty was forcing people to pay money to watch them eat. Barring that what was the product that was being charged for? Later on the revolutionaries charged  a price for people to come see her getting beheaded.

 

Let us fast forward a century from 1770 France to 1870 New York. In his book Pedestrianism Matthew Algeo writes about the spectator sport of walking.

Huge crowds packed indoor arenas to watch the best walkers walk. Think of it as a six-day NASCAR race … on feet.

Why would people pay good money to watch others walk while they could be walking themselves for free?  What was the product?

Finally let us move to present day and the marvels of social media. If you thought people were bored stiff then to pay money to see people eat and walk let us look at the story from South Korea where we find new hit shows – Eating shows which are live streams of someone eating and the rest watching. People pay subscription and tune in every night to watch some person eat on webcam.

With hindsight in our favor it is easy to see in the first two stories that the spectator events, however boring they may sound now, were forms of entertainment. Algeo says pretty much that about 19th century New Yorkers with gobs of free time  taking to pedestrianism as form of entertainment.

We are not short on entertainment these days. That cannot easily explain our willingness to pay good money to watch someone eat over webcam. You could at least say the French peasants got to visit the royal palace and see them in real life but that is not even the case with live streaming eating shows.

If you think Eating shows are an anomaly, the million or so who pay subscription are an odd minority  and that you would never pay to watch someone do mundane things – think again. Think about your daily social media ritual.

You get to see pictures of food other people are eating or ate. You get to see pictures of other people taking a walk. Other people doing something or more precisely saying they did something. You are just not a spectator you are also star of your own show where you get to tell others about your walks and eats.  Granted you do not pay for the ticket directly but you do pay in other ways.

What is the product that we value so much that we are willing to pay for it? Has the product changed from 18th century French to 21st century Social Media mecca?

What can you learn about business from Tim Cook?

question_road_signI always wanted to write a link bait title and an article to go with it that is based on another article on a popular leader. May be this is that article.  But honestly I do not believe you can learn effectively by imitating the observable traits of any leader let alone from a blog post that is a second or third derivation of the original piece (which itself is filled with biases).

When I was at Haas School, Berkeley I had  a great Pricing professor who was known for sharing practical wisdom with his students. For example,

  1. Shark fin soup in certain San Francisco restaurant is the best
  2. You need a business model where you make money even when you are in the golf course
  3. When you are in business meetings listen for questions, note down the most insightful questions and ask them yourself in the next meeting.

First advice is not relevant to me. Second doesn’t matter as well as I don’t golf (yeah, that’s the problem with that wisdom). Third is a really good actionable advice with immediate results. Asking right questions is important because that shakes out the bugs in your proposal and takes you on to the next step in better shape than you were in before.

In the TV series Vikings, the leading character says this to the soothsayer (Guru?),

Ragnar: You didn’t answer my question.

Soothsayer: May be you didn’t ask the right question.

Neil deGrasse Tyson says this on asking questions,

my favorite question is one that we don’t even know to ask yet because it’s a question that would arise upon answering these questions I just delivered to you. … If you’re a scientist and you have to have an answer, even in the absence of data, you’re not going to be a good scientist.

You can easily substitute the word “scientist” in his quote with “decision maker” and not lose any meaning.

It is questions  with intent of finding  the assumptions made, data used and data NOT used that are lot more important in improving decision making. It is those questions that are driven by curiosity and driven by the need to understand and with the admission that you do not know all the answers that are important.

Not the questions  like the one you see on this post title.

If you insist on learning from Tim Cook you sure can learn from his questions,

“Why is that?”

“What do you mean?”

“I don’t understand. Why are you not making it clear?”

Why do you ask questions?

Forget the Price Waterfall

You have read my past posts on Price Waterfall – the framework that shows how different discounts and value inefficiencies result in many different price erosions from the high list price to low pocket price. It is not my framework, it was created and popularized by the book The Price Advantage. I have used everyday examples you run into to explain the intricacies in simple terms. One popular example is JCPenney mattress pricing,

jcp_pricing_waterfall

As you can see the different discounts erode the list price from $1699 to $630 pocket price. You could go on to say this the reason for all the financial woes of JCPenney but that would be far reaching.

Talking of far reaching claims, some have looked at such price waterfall charts and go on to state,
“what if a business can claw back just 1% of the price?”. There is a book called the The 1% Windfall that is based just on this theme. You can see the fallacy of such an argument.

I think we have been approaching this all wrong, looking at this as price leak that can be addressed. A survey of how many businesses price their products indicates that it is not the leaks we need to worry about it is their complete lack of understanding of value created for the customer.

No one seem to bother with customer needs, alternatives available to them, or assign a dollar value to economic value created for the customer. Instead they start with their cost and add on the margin markups. If there are multiple steps in the flow to the customer each stakeholder adds their markup without regard to value they add. While the incumbents are doing it you would expect different behavior from disrupters. But any new entrant -supposedly a disruptor -goes on to follow exactly the same pricing philosophy.

See what CEO of Hint Water says how she does pricing,

WSJ: How did you come up with a price tag for the products?

Ms. Goldin: We looked at what other people were doing in water overall and flavored water. We wanted to be priced competitively with those types of flavors and those types of products. We knew that we really wanted to get to a point of having a good margin, and in the beverage industry, having a 50% margin is sort of what you’re shooting for before you sell to distributors and they sell to groceries.

Since the way businesses arrived at the prices are all wrong it makes no sense to study the price waterfall which is simply an artifact of the underlying wrong pricing. There is no point in charting the waterfall and trying to plug leaks.

Throw away the waterfall chart and instead start with first principles, asking “What job do we want customers to hire the product for? What value it creates? and what should be our fair share of the value created?”.

If you didn’t start with customers, it does not matter whether it not the price points are working now or not. If you didn’t start with customers your pricing is wrong.

From one price to two prices

If one price is good, two are better.

Or written in more rigorous  way, that the tweet worthy catchy way, that statement would read (try tweeting that)

In most situations, when demand is validated with one price, it is highly likely a second price point will yield more profit than just one price.  As a corollary, any demand and value perception is not homogenous.

If one price is good it does not mean it was the profit maximizing price. It can simply be marginally good in delivering profit, enabling a venture to sell a product a price more than it costs them to make and sell. There is likely more room for improvement in either setting the price point or discarding the current iteration of the product and replacing it in its entirety another product (or version) with different feature set and price point.

Introducing the second price does not mean the first price point is the right one to use in the presence of second price. That  is the previous single price point that was good may become bad when it coexists with the second price. To say it is bad means here it drains profit in one of two ways.

  1. If the previous single price is lower than the newer second price, the lower price may not be low enough or too low.
  2. If the previous single price is higher than the newer second price, the higher price may not be high enough or may seem too high.

So two prices are likely going to be better but when yo started with one price and introduced the second you need to revisit the first price in the context of second price.

That is what we see happened with Tide Plus price increase. You can read that in detail in this deck. http://www.haikudeck.com/p/Rd9lNNK61e/price-realization Here is a summary for those who do not click on links.

P&G was selling Tide Plus at premium price. But as economy took downturn and people thought twice about paying the higher prices it saw a fall in demand. So they introduced Tide Basic at lower price (the second lower price). They did not stop at that but revisited the price of Tide Plus and increased its price.

That is effective pricing.

If one price is good, two prices are better (if set right).