Is Target’s Price Matching Policy a Mistake? Yes, but not for reasons HBR says!

 

Rafi Mohammed, a Harvard Business Review blogger asks, “Is Target’s price matching policy a mistake?”. If you have not been following the price wars, Target stores recently announced that they will match published prices of their competitors.

 

If you buy a qualifying item at a Target store then find the identical item for less in the following week’s Target weekly ad or within seven days at Target.com, Amazon.com, Walmart.com, BestBuy.com, ToysRUs.com, BabiesRUs.com or in a competitor’s local printed ad, we’ll match the price.

Back to Rafi’s question. The answer is yes. But not for the reasons Rafi offers in his HBR blog post.  As I wrote recently, Target’s policy is wrong because they are taking on a competitor who is strategically irrational.

Rafi’s argument, surprisingly (surprising because Rafi is a pricing professional) is centered around the cost to operate brick and mortar stores.

Amazon for example — have significantly lower cost structures than brick and mortar stores? That makes it close to impossible for a chain to set the same product price both on its web site and in physical stores that is competitive with an Internet-only retailer and still yields a profit.

This is confusing cause and effect. Amazon chose low prices and then cut its costs mercilessly to deliver products at such low prices. Target chose to reach customers with higher willingness to pay (and disposable income) and offer them a store experience to buy products. They incurred the cost of operating stores for two reasons, one they needed to do that to deliver customer experience and two they could still make a profit from the higher prices customers were willing to pay.

Prices come before costs. You don’t incur costs and expect your customers to offset that with higher prices.

Rafi’s recommendation for Target is,

Target should instead match prices of online rivals with a comparable “apples to apples” service: order from Target.com. If a customer sees a lower online price, Target will match only if ordered from Target.com.

It does not work that way. What is the differentiation here? What compelling reason does Target.com offer to those who otherwise would choose Amazon (based only on price)? I should note that Rafi is also the proponent of 1% price increase philosophy, and that recommendation does not work here as well.

What are the real recommendations? If prices come before costs, customer segment and their needs come before prices. So any pricing strategy recommendation to Target must start by asking what customer segment does Target want to reach  and what should be their offering (product mix, service and delivery model)? May be it is the equivalent of “same day delivery”, or a unique product mix that isn’t available in other channels, or the ease of returns. Target has to find out what is relevant to its target segment and decide.

In my tweet question to Forrester Retail Analyst Sucharita Mulupuru, she replied

@rags Price matches on commoditized goods will be a cost of doing business. The solutions? Private label or UPP.—
Sucharita Mulpuru (@smulpuru) January 11, 2013

For same products where the channel adds no value, she says, charging higher prices is not going to be possible. Her two recommendations are developing private labels (that can yield price premium as well) and Unilateral Pricing Policy (UPP) where the manufacturer sets a fixed price that all channels have to sell for.

If you take this to the extreme, it is likely we will soon see total vertical integration in retail channels – from the very devices we use to browse and buy,  to products we buy  and even the method of payments we make. Not far fetched if you consider the reasons why Amazon is trying to get Kindle in every hand.

And yes, HBR is right but how it arrived at the answer is wrong.

 

On Pricing Low

Here is a comment on an old article of mine titled, Enough with the marginal cost argument,

Rags, there may be a pony in here somewhere, but I’m having trouble finding it.

In competitive markets with many substitutes, marginal cost is a the key to pricing. You may not like it, but it’s true. The start up costs may impact new players, but if the startup costs are already sunk, they are irrelevant. A rational player will grow market share by cutting prices until marginal cost is met. If you tried to compete with YouTube by charging to make up for your startup costs, you’d lose, right?

Now here is what the same commenter had to say in his own blog about low prices (of course I cannot be sure about the identify of the person who commented on my blog, looking at the phrases it is highly likely the two are the same)

If you build your business around being the lowest-cost provider, that’s all you’ve got. Everything you do has to be a race in that direction, because if you veer toward anything else (service, workforce, impact, design, etc.) then a competitor with a more single-minded focus will sell your commodity cheaper than you.

Cheapest price is the refuge for the marketer with no ideas left or no guts to implement the ideas she has.

I like his second version of the pricing principle. May be he had a change of mind? It is far better to find a segment that values your product and deliver them a version at a price they are willing to pay than try to capture market share with a commodity product at or near marginal cost.

Marginal cost is relevant only to set the floor and not the price you should charge. You don’t have to like it, but it s true.

Answer to Pricing Puzzle – Pricing Lactaid Milk at Trader Joe’s and Target

Lactaid milk is priced at $3.39 at Target but $3.99 at Trader Joe's (a block away) because ______—
Rags Srinivasan (@rags) April 07, 2012

This will be a nice reference price question to test for behavioral economists like the beer on the beach question by Daniel Kahneman. My hypothesis, you will find either no difference or higher price quoted for Target.

Run a split test with,

I am going to Target to get some stuff. I will get your Lactaid milk there. How much are you willing to pay?

OR

I am going to Trader Joe’s to get some stuff. I will get your Lactaid milk there. How much are you willing to pay?

But I digress.

For those who are not aware, Lactaid is the brand of lactose reduced milk ( reduced using lactase enzyme). It is generally priced twice at much as regular milk. Instead of buying Lactaid, one could buy regular milk and lactase and mix it themselves. But what Lactaid offers is convenience and for the limited segment that wants milk despite their intolrenance and values convenience. So a higher price makes sense.

Lactaid is a national CPG brand, available in most stores. So why is it priced higher at Trader Joe’s?

Another argument is cost based. Target, a bigger retailer, has pricing power with suppliers. Since it can negotiate a lower price it can charge lower price to its customers. True but the cause and effect are reversed. Target wants to serve lot more customers that have lower willingness to pay. Once they decided the price they work with suppliers to bring the cost down. Not the other way. Think about prices of other products (granted not same brand). Does the cost argument holds?

One line of argument is, it is not just the product, it is the store experience. The price of store experience is built into the milk. Partly true. Then you must run the behavioral experiment I stated in the beginning.

The answer, as in most pricing cases, starts with the customer.

A Trader Joe’s customer goes there for different reasons than they go to Target (likely same customers but they hire the stores for different reasons). They go to Trader Joe’s for its unique product mix, experience etc. but definitely not for getting Lactaid milk.  If I remember correctly that is the only major CPG brand I have seen at Trader Joe’s. Most of the product mix is  made of store brands or smaller regional brands.

Those customers seeking to buy Lactaid at Trader Joe’s is looking for convenience. They are at the milk aisle for the rest of the family and want to complete their milk shopping list by avoiding one more trip to another store or its milk aisle.

There are likely not many such customers (most  likely TJ’s customers are Target customers as well). So for that limited segment that values convenience and needs a specific product, the willingness to pay is higher.

Since they can charge this higher price they are likely willing to pay higher price to suppliers to stock the milk in their shelves.

No customers. No products.

Price always comes first then costs. And for pricing, customers and their needs come first, then everything else.

Explaining why it costs even more at Whole Foods is left as an exercise to the reader.

Answer to Pricing Puzzles – Restaurants Charging Fee for Sharing

I tweeted a series of pricing puzzles. This series is my interpretation of what the answers could be. Do not treat them as absolute answers. Alternative explanations are possible.

A restaurant in Palo Alto charges $2 to split pasta and $3 to split an entree, because _____ (Hint: not costs)—
Rags Srinivasan (@rags) April 07, 2012

There are two parts to this question.

1. Why do restaurants charge a fee for sharing?
2. Why do they charge two different prices based on what is shared?

It is safe to say that those willing to share are most likely couples and they likely pay for it from the same shared budget. For everyone else, those not sharing budgets, the question of sharing does not even come into play.

A restaurant’s goal is to maximize spend per table.  Their wait-staff are essentially the sales team trying to generate more sales per table during the period it was occupied.

So when customers share, it cuts (almost in half) the spend (and hence profit) per table. To discourage customers from doing so, they make the price of the single entree look a little more unattractive by adding the split fee. This is second degree price discrimination. With the split fee, customers may see higher value (consumer surplus) when they order two vs. one.

For those who still want to share for any number of reasons including limiting portions, even with added fee sharing will provide higher consumer surplus and the restaurant gets to recoup profit.

Why charge different split fees? Price discrimination done right. If you charge one split fee, you might as well charge two.

Should they do it? What about customer backlash?

To repeat my earlier point, this is a limited segment that will share food. The rest won’t even notice the split fee.  So by all means do it as this is money that flows straight to bottom line. However they should consider their customer mix and capacity utilization.

What does this mean to you as a Tech Product Manager?

I do not recommend you following in the restaurant’s footsteps. Start with the customers and their needs. Consider how your webapp is being used by your customers.

1. Do they share login?
2. From what budget are they paying for it?
3.  Is there value for them in keeping separate logins?
4. Do they want to keep their Netflix video queue/history or Evernote clip archive separate?
5. Do they consume your limited capacity without adding to revenue?

My recommendation: Instead of trying to tack on split fees, make the price of adding second (or third) user attractive that most will do it.  (Like SurveyGizmo did)

 

Pricing Strategy Vs. Pricing Parlor Tricks

A research paper published in Journal of Consumer Research, Jan 2012, found that how we present pricing affects perception

Presenting item quantity information before price (70 songs for $29) may  make the deal appear much more appealing than if the price were presented first ($29 for  70 songs).

There are many similar peer reviewed research reports that found behaviors like,

Customers are more likely to prefer prices ending with digit 9

Customers are immune to higher prices when you don’t show the $ sign

Customers pay higher prices when you write the price in words instead of numbers

Customers succumb to decoy pricing (present three options but one is asymmetrically dominated by other and hence a decoy)

Through books and TED talks these  academic reports seep into popular media and are presented as pricing lessons for businesses small and large, especially for startups. After all, these are peer reviewed research reports based on controlled experiments that found statistically significant difference, published in reputable journals and hence worthy of our trust?

May be these are true, but what do they tell us about the customers and their needs? What job is your customer hiring your product for when they pay this cleverly presented price?

The problem is these behavioral pricing tactics may just be statistical anomalies. Let me point you to a xkcd  comic that so nicely makes the point I am about to make . After what xkcd has to say, anything I say below is redundant.

Let us take the first research I quoted, “70 songs for $29 vs. $29 for 70 songs”. What could be wrong here?  Well, why specifically 70 and 29?  What other combinations did the researchers test and what are the outcomes? What about 60 for 25, 50 for 20 etc etc.

Is it possible that they had tested 20 different combinations and found that just this one produced statistically significant difference? (Like the green jelly beans in xkcd comic?). Did the researchers stash away all the experiments that produced no results and published  the one that produced this interesting result?

An opinion piece in Business Strategy Review, published by London School of Economics, pretty much says this is the case with most research we read.

The problem is that if you have collected a whole bunch of data and you don’t find anything or at least nothing really interesting and new, no journal is going to publish it.

Because journals will only publish novel, interesting findings – and therefore researchers only bother to write up seemingly intriguing counterintuitive findings – the chance that what they eventually are publishing is BS unwittingly is vast.

Pretty much we cannot trust any of the research we read.

What are likely statistical flukes get published as interesting findings on pricing and find their way into books, TED talks and blogs. The rest don’t even leave researcher’s desk. Let alone academic journal, try writing a blog post that reports, “found no statistically significant difference”. Who will read that?

What we are seeing is publication bias that is worse than any sampling bias or analysis bias and a prevalence of pricing parlor tricks presented as authoritative lessons in pricing for businesses.

When it comes to pricing your product, be it pricing cupcakes or a webapp, you would do well to look past these parlor tricks and start with the basics.

Pricing strategy starts with customer segments and their needs. You cannot serve all segments, you need to make choices. Choose the segments you can target and deliver them a product at a price they are willing to pay.

As boring and dull as it may sound, that is pricing strategy. Your business will do well to start with the most boring and dull than chasing the latest parlor trick based on selective reporting.

Everything else is distraction. May be these fine tunings have some effect but not before strategy. After you get your foundation right, then you can worry about what font to use in the sign board.

How do you set your pricing?

Other Readings:

1. Segment-Version Fit
2. Five Ways Startups Get Pricing Wrong
3. Small Business Pricing
4. Three Components of Effective Pricing
5. Approximate Guide to Pricing Webapps  (buy access for 99 cents, pun intended )

Why are @Pinkberry yogurt flavors priced differently?

This is yet another questions only article. Answering the questions is left as an exercise to the reader, which you can do from other articles in this blog.

Take a look at the picture of menus from Pinkberry frozen yogurt chain. The one on the left is the online menu for their New York stores and the one on the right is from one of their stores in California. You may notice the price difference between New York and California for the same flavor and size but that topic is not the question I want to pose here.

Notice the price difference between Original and  Flavored varieties for a given size? (click on the image to enlarge it)

Notice how the price difference varies between the two states?

In New York,

• The smallest size, Mini is priced the same for Original and Flavored varieties
• For the rest of the sizes, the Flavored varieties (all flavors) are priced 50 cents more than the Original

In California the prices are different across all sizes,

• Mini is priced only 50 cents more than the Original
• The rest are priced $1 more than the Original

Why are the Original and Flavored varities priced differently – between the two states and between sizes?

Before you answer this question let me point you to a research that asked a different question.

Why are strawberry and raspberry yogurts priced the same?

The yogurts in this question are the normal kind we find in supermarket aisle. The researchers who studied the question by looking at store sales numbers concluded,

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

Now you can think about the answer.

For extra credit, think about the cognitive cost to customers making purchasing decision from the price differences between Flavored and Original choices.  Do you believe the additional profit is worth the cost to customer and the likely degradation of customer’s buying experience?

Do self-serve yogurt chains like Tutti Frutti that offer same price for all flavors and toppings are at an advantage in both delivering better buying experience and average sale price?