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.

 

Pricing Flash Storage in Tablets – Don’t Call This As Markup

The New York Times Bits blog laments about the giant markup Apple and Amazon charge on flash storage. Bits blog not only complains about the price vs. cost difference but also caught on to the price difference between Kindle and iPad for the same storage.

Kindle: 16 gigabytes for $300 and 32GB for $370; to enjoy 16 extra gigabytes of storage, a customer pays $70 more. For its smaller 7-inch tablets, Amazon charges $50 more for an extra 16 gigabytes.

iPad: You can get a 16GB model for $500, a 32GB model for $600 or a 64GB one for $700. That’s $100 extra for that first 16GB bump, then a relatively cheap $100 to get from there to 64GB.

At the outset let me point out I have lamented on the same topic as well but mostly admired it and only lamented it a bit as a consumer. Let me point out how the flash storage prices vary even within Apple’s different product lines,

Yes both Kindle and iPad are able to extract lot more consumer surplus with their flash pricing. That is because they figured out their customers value the additional capacity lot more and are willing to pay the additional $100 (or $70) for doubling capacity. This is not markup and the fact that flash costs 50 cents per gigabyte should not matter.

Using words like markup comes from cost based pricing (add up all the costs then mark it up to get the price, hence markup), as is shown by this text in the same Bits blog post,

Of course, when you buy a new gadget, you’re not just paying for a slab of components. The maker of the product is trying to get you to cover the cost of research and development, manufacturing and advertising, and still rake in some profit.

Note how sure the author is – “Of course, you understand the price you pay is …”.

Let me do my own convincing and point out that – of course  customers are not concerned about your costs. They are not paying the price to defray your costs. Besides R&D, Manufacturing and Advertising costs are sunk and are not attributed on a per unit basis.

Customers pay for what they value and marketers charge for that value. If marketers figured out a way to deliver the value at  the lowest possible price it does not mean they have to pass on the savings as lower prices unless they are forced (by market forces) to do so.

Call this effective pricing and don’t call it as markup.

As a customer do I lament alongside Bits blog? I do. But as a product guy I admire their pricing.

For extra credit see my articles on

1. Nexus 7 flash pricing
2. Second degree price discrimination infographic
3. Why Apple does not include earphones with iPad?

A must read pricing book with ‘Free’ in its title

There are two books on pricing with free in their titles.

One is by Chris Anderson and has the subtitle of, “How Today’s Smart Businesses Profit By Giving Something For Nothing.  I wonder how these companies do that, must be the volume. This is of course the new title for the paperback edition, the original subtitle was “The Future of a Radical Price”. I guess the future is here.

Rest assured I am not recommending you read this book.

The other book with free in its title is by Saul J. Berman, “Not for Free: Revenue Strategies for a New World”.  By new world Saul refers to the current business world that drank the kool-aid of previous book or obsessed with monetization model innovations.

And I recommend this book.

Saul isn’t as popular or a household name as Chris Anderson is, although a WSJ reported asked me, “who is Chris Anderson?”, when she was interviewing me on my GigaOm freemium article. This book has just 4 reviews on Amazon (all 5 stars, likely his colleagues?) compared to Chris’ book that has 170 reviews.

But don’t let what is popular and accepted by your peers let you decide the book to read or your pricing strategy.

Chris Anderson’s book talked about the abundance of computing power, abundance of bandwidth etc and how these forces led to a marginal cost of $0 which naturally means $0 price. Saul starts with those same trends disrupting business models and comes to a different conclusion – how important it is to have a differentiated revenue strategy in order to not let these forces drive your business to dust.

The first step in Saul’s revenue strategy roadmap? Segmentation (chapter 1 in the book):

 traditional segmentation approaches are at best correlative—they take an identifiable characteristic and match it with a likely behavior. Why be so indirect? Why not look directly for the behaviors relevant to your industry? Doing so can reveal when consumers are well served with an existing business model and when consumers would be open to new ways of doing things, especially for incumbents.

In other words start with the customer needs or the jobs they are hiring a product for and not whether they are in 25-35 demographics.

This alone is worth the price of the book. What are you waiting for? Go get now – Not For Free

Waging the right price war – The $65,000 Mistake

I believe “price war” may be a misnomer if both sides do not live to fight many rounds. We only see price battles or skirmishes that go for 1-2 rounds before one side throws in the towel or runs out of cash. There are two kinds of companies when it comes to price wars.

Category 1: There are just handful of companies that can wage incessant price war  by consistently keeping their prices low

Category 2: Even fewer that can withstand such low price attacks by their competitors.

Amazon.com and Walmart fall into the first category. Apple is in the second category.

In fact if the two players know that the other has the will, reserve and wherewithal to keep up the fight without ever letting up they most likely will choose not to enter price war in the first place. This is very much like nuclear deterrent  — mutually assured destruction.

BestBuy does not fall in either of the categories but was tempted to take on Wal-Mart with its iPhone 5 pricing. The result? BestBuy lost $65,000 in a single day.

Let alone the price war dynamics this is simply the wrong fight to pick. A tactical blunder.

First the product is not yours and the customer has many alternatives. Most are willing to pay full price at Apple stores. Customers do not think where they buy is important when it comes to iPhone (a qualifier is some insist they buy only after standing in line in front of Apple stores).

Second Walmart did not cut the price uniformly across all stores and did not make available unlimited quantities. Agreeing to match the price on such promotional tactic is simply wrong. It appears smart deal-seekers, instead of running from one Walmart store to another, simply walked into to neighborhood BestBuy and asked for the low price match. How convenient.

Finally, the low price was not attached to any other product sales and not designed as a loss leader that would help maximize customer margin.

And the result? Deal-seekers walked in, probably for the first time in many months, bought the $127 iPhone 5 and walked out without buying anything else. That is the $65,000 loss in a day.

Other readings:

See here for Waging Effective Price Wars.

See here for Effective Pricing

 

 

What effective pricing can do for your business

Take a look at this image courtesy of Planet Money

Revenue difference between MegaBloks and Lego

What you see are the annual revenue numbers for MegaBloks and Lego. Since Lego does not have (any more) exclusive rights to make the bricks, anyone can make them. And MegaBloks does. Its bricks are perfect replacement (as for as I know) for Lego bricks only cheaper.

How cheaper? 50% cheaper. Yet Lego makes 9 times more than what MegaBloks does in a year. Not only in revenue numbers Lego also beats MegaBloks on its margins as well

Gross Margin       70.5% Lego to  40% Mega (source below)

Operating Margin  30.1% Lego to 17.6% Mega.

A little bit of math will convince you Lego has no cost advantage. At 30% cost, even if it halved its price to match Mega’s prices, its margin will be 40%. In other words any (percentage) margin advantage Lego has comes purely from its pricing and not because of cost advantage.

What is going on here? In the words of Jeff Bezos, isn’t MegaBloks working hard to charge customers less and Lego working hard to charge more? Why aren’t customers overwhelmingly picking MegaBloks based purely on price?

If lower prices are designed to drive market share how come Mega has just 10% of market share despite being priced at 50% of Lego?

The Planet Money story says it is because of Lego’s attention to detail and because of their licensing deals for Starwars. But they miss the point. The answer, as in all pricing questions, begins with customers.

Think about the loyal customers who already have spent hundreds if not thousands building their Lego bricks collection and bought into the Lego brand and its messaging. Include the newbies who are getting inducted. Toss in those who are buying Lego as gift for someone else. Do you think any of these customers would make buying decisions based on price? What job do you think these customers are buying Lego for? I bet it is just not as a building blocks toy.

If such customers perceive value at its current prices and are willing to pay such prices there is no reason whatsoever for Lego to give its product away at lower prices. Pricing low because of cost, competition or in the hope of gaining market share is simply not effective pricing.

Lego’s effective pricing driven by customer segments helps it achieve 70% gross margin and 90% of the market.

Finally I should not dismiss MegaBloks or call its pricing bad. MegaBloks likely knows its target customers as well -a tiny fraction that is price sensitive but isn’t likely to grow. They likely found the optimal segment size and the price these customers are willing to pay that will help Mega deliver 17.6% operating margin (nothing to be sneezed at).

But if it really wants to put big numbers on the board it needs to get its own customers who are will hire it for its compelling value proposition and not because it is a cheaper substitute.

Price Setters and Price Takers Revisited

Let us recap.

If you can set the price and defend it against competition you are a price setter. Premium price or bargain price does not matter. As long as you can defend it because of your product’s (perceived) differentiation (among your target segment) or because of your cost advantage you are a price setter.

If your pricing is a reaction to an existing competitor then you are a price taker.

In the tablet space, big or mini, Apple and Amazon are price setters but Google is a price taker.

In my September article in GigaOm I analyzed the profit implications of iPad mini for Apple. Making a case against $199 lower-end iPad mini I wrote this about price setting:

If Apple is the price setter in the premium tablet category, Amazon is the price setter in the low end. Entering this segment would mean becoming the price taker or making an effort to become a price setter with a different price point.

By design, Apple has never been a price taker. In any market, the price setter gets to control its  own profit while a price taker is at the mercy of market forces. Trying to become a price setter when there already is one requires Apple to either go low or just a bit higher. Either way, Amazon has set the price anchoring. The most likely scenario is a $299 price point for the iPad Mini.

The real pricing came in at $329. In other words Apple chose not to be player in the low end market because it realized Amazon as the unshakeable price setter in that category and chose a segment where it can be the price setter.

Price Setters will thrive and go on to create significant value over long term.

Price Takers will be relegated to the footnotes of history.