Can you see the likely value distribution for features and the pricing is aligned to capture that value?
You really don’t believe Wifi is priced about $70 more because of marginal cost, do you?
Do you know how to find how your customer segments value different features and hence how to charge for them?
Note: In the example above observant readers will notice brand is another variable that could influence the price difference.
Why do you think 10oz mini Pita pockets are priced 18% more than 12oz pita pockets?
Don’t just focus on quantity consumed? Value to customers comes from many aspects – from ease of use, convenience, fit, …
To be precise customers value a product that is a better fit for the job at hand and easy to hire for that job. Be it form factor or ease of doing business.
Focusing on just one aspect leads you to not capture your fair share of the value created. What you see is the case of value staircase the flip side of value waterfall.
Plug the value leaks, you get to capture a share of it as better price.
How do you determine what your customers value?
Print version of Fortune poses the question to its readers,
Are you ready for $10,000 smartphone?
Then teases us with a promise to answer
Who buys these phones and why?
Un-Fortun(e)-ately it is asking the wrong question and fails to answer who and why in its article. The digital version does not commit these mistakes opting for a benign informational title.
Asking its readers whether they are ready for $10,000 smartphone is wrong because that’s not whom Vertu is targeting. Opinions of the columnist or the comments of their readers are irrelevant. You should consider the possibility Vertu understands
Fortune quotes McKinsey study (don’t you love those sentences that start with, “McKinsey study states …”),
brand needs to continue building on its heritage — highlighting the skill of its craftsmen
And guess what? Each Vertu phone is assembled by a single craftsman and Vertu shows it off to its customers at its manufacturing site.
You don’t believe $10,000 price tab is due to the labor cost, do you? Or that the craftsmen are more precise and produce better quality smartphone than the automated machinery that can assemble parts with near perfect precision? In this case McKinsey finding is partly correct.
It is true Vertu wants to highlight the skill of craftsmen but not to the target segment buying the watch but to us in the peanut gallery (and Fortune readers) how great the craftsmanship is so our admiration makes it worth it for those buying the $10,000 smartphone.
Finally an IDC analyst interviewed for the story states,
“even capturing 1% of the $295 billion global smartphone business would be an achievement for the firm”
If you followed the real target segment and understand the job they are hiring Vertu for you will see how irrelevant the size of smartphone market is or the share to capture. Vertu is not competing for the job of iPhone/Galaxy and customers are not paying for it from their budget for smartphone (as a utilitarian device).
The real market size should be based on luxury spend and the market share question is how much of that spend on Gucci handbags and Tiffany’s diamonds can Vertu capture.
The moral of the story is, your understanding of business opportunity, market size, market share, competition, pricing and likelihood of success will all be wrong if you do not start with customer segment and what they are trying to get done.
How do you size your business opportunity?
Let us look at this case study:
Airport terminals are not gourmet ghettos. We mostly get a food court with the usual chain restaurants. Wouldn’t it be great to give the travelers – locals, those in transit, and visitors – a taste of the local flair? Phoenix airport is trying to do exactly that. They are giving the local coffee shops, bakeries and restaurants an opportunity to open their shop at the airport terminal.
It does provide the local businesses a new revenue opportunity by adding a new sales channel. Forty million people pass through Phoenix airport every year. That is a large Target Addressable Market (TAM), even a 5% conversion with average tab of $8 means adding another $16 million in new revenue from one location. There is also the positive side effect of marketing exposure.
But it does come with many drawbacks.
First the rent at airport can be up to 10 times what these local restaurants pay in city locations. Second the hassle and costs associated with security and regulations. Third the additional infrastructure cost in equipment and other things to make the place resemble the city location. Lastly, customers want to pay same price they pay at city locations.
There are many questions here. Primarily should a business consider adding airport location given the huge exposure and opportunity. That is a topic for another day or you can hire me to help you with the analysis. Here I want to address just the last drawback
Customers want to pay same price they pay at city locations. One restaurant decided to do just that,
what you pay for a salad at Chelsea’s original Phoenix location is what you’ll pay at the airport.
Is that the right thing to do? Doesn’t it matter that the restaurants incur significant incremental costs when they open a sales channel in airports? Shouldn’t that costs be offset with a price markup on products? How should the pricing be for a new sales channel?
If you know the answers you can skip the rest of the article.
Here is what you need to consider.
Where do you start for pricing? You start with customer segments based on their needs. In airports you have
This is a case of adding top-right and bottom-left quadrants from Customer Jobs Growth Matrix.
The question of price parity does not come into play with (3) and (4) and anyone that is not local in (1). Stated another way you only need to worry about pricing parity if they already have a reference price – what they pay at your city locations.
Your options?
You could maintain pricing parity as long as the profits far outweigh profits from opening other city locations for the same investment. That is consider your opportunity costs. But don’t charge same price because it is the “right” thing to do or your locals demand that. This is as bad as simply adding your airport cost overheads to your local prices.
You have access to a segment (likely large and constantly refreshed) who value the better options at airports and have higher willingness to pay. You should find a way to capture this value with better pricing.
If only you could do third degree price discrimination – say asking for driver’s license – and give a price discount to locals you are good. But that is a hassle and mostly not something you want to do because of overall customer experience.
That leaves you the following options to capture additional value from customers choosing your restaurant in the airport location (that flows from the recommendations in the Growth Matrix)
The cardinal rule however is start with customer segments before you decide on pricing. Be it opening an airport location, adding food cart version of your restaurant or serving down markets with your enterprise products – start with customer segments, their needs and their current alternatives.
How do you set pricing for your different sales channels?
#Pricing Puzzle – All things being equal (brand, cloth, design), should slim-fit shirts be priced same as regular-fit shirts?—
Rags Srinivasan (@rags) March 31, 2013
Take a moment and think about this pricing scenario. What do you think the pricing for slim-fit shirts should be compared to regular-fit shirts of same brand, material and design?
Logical answer would be slim-fit shirts should be priced higher than regular-fit because there exists a smaller set of customers who prefers the look of slim-fit and value it enough to pay more for it. After all, demographically there are not many that would fit (and look) stylish in slim-fit and for those who want to look good with a slim-fit there is value that can be captured as higher price.
This would appear to be a perfect case of second degree price discrimination. Present two different versions at two different price points and let the customers self-select. It is fair too because all customers have the option to choose either one.
Except that is not how shirt makers think about pricing or set pricing. Here is how shirt makers set pricing
First they add up all the costs – including hours spent and fixed cost (overheads) allocation. The use “standard industry markups” to set wholesale price. Finally double it to get retail price. (And mark it down to generate sales)
It is as simple (or simplistic) as that. Cost based pricing with price markups and not based on customer value and willingness to pay.
Hence if you see same pricing for slim-fit and regular-fit it is not just a matter of missing out price discrimination it is a matter of setting the price wrong to begin with.
If you see different pricing it is highly likely that shirt makers chose to allocate different overheads – likely more to slim-fit because of smaller volume – than because they recognized opportunity for price discrimination.
Sometimes things are not as smart as you would like to believe.
The product is wrist watch – one with simple utilitarian job to be done. We sure all need some version of it and there are many versions available at our disposal. And there are non utilitarian jobs – hedonistic and even conspicuous consumption. Not all segments have these second level jobs but some do.
We are willing to pay a price based on the job we hire the product for. It is under brand’s control to choose the segment with certain high paying jobs and positioning the product with a price to go with it.
Let us look at the positioning of luxury watch makers to see what job they want their customers to hire their product for.
Breitling – Instruments for Professionals
Nothing about time here and the other instrument often associated with the watch? Airplane! And a price to match those private jets.
Patek Philippe – You never really own a Patek. You merely look after it for the next generation.
And you don’t buy it to tell time either. It is a investment for generation and hence the price.
Rolex – The Crown of Achievement
No mincing words about conspicuous consumption. Nor are they giving any utilitarian rationalization reasons. It is about targeting those with achievement to flaunt.
Sure these watches tell time and there are billions of customers who have that job. But there are many other candidates for that job and no one is willing to pay much for that job. Hence these brands chose the small segment with the second level jobs and have the wherewithal to pay for the job.
That is some positioning, telling select segment of customers exactly what job the product is applying for and setting a price based on that.
How do you position your product?
