Do you need to maintain pricing parity across all channels?

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

1. Those who hire your restaurant as a better (healthier, tastier, fresher …) alternative to greasier and generic options available. This segment includes some members from all travelers.
2. Your loyal locals who are happy to have their favorite option available before they board the plane (without having to make a side trip).
3. Those who hire products simply based on price.
4. Those who hire products based on brand – a local restaurant likely has no brand recognition outside of locals going through the airport
5. Lastly, most ignore this segment, those who work at the airport and need better options for their meals.

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)

1. Price Higher and Use Cost Argument – Recognize it is okay to not serve all customers. Don’t focus on 40 million customers, ficus on who perceive higher value from our offerings. Do a marketing research if need be. You may want to give up on some of your locals buying at airport and choose to target only those with higher willingness to pay.
   Most times you can convince locals of hardships in running your restaurant in airports and charge a premium over your city location prices. You are not doing cost based pricing – you will set prices based on what customers are willing to pay at airports – you are only using cost to justify higher prices.
2. Product Mix – Play with your product mix. Add newer options that are available only in airport locations and charge a premium for them. These could be simple variations of your menu choices. You should do this even if you don’t have pricing pressure.
3. Creative Packaging – Consider different sizes – think smaller for same prices as city locations. A 10-20% decrease in marginal cost can stand in for not raising prices. Apply creative messaging like -ToGo, OnAir etc. You should do this even if you don’t have pricing pressure.

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?

What job do these brands want their product to be hired for?

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?

 

When segmentation fails do you pivot to a new one?

A few months back this is what I wrote about economic value add for business vs. consumer segments while writing about price of LED bulbs,

Here is a case study done by US Department of Energy for LED bulbs. The initial price is almost twice as much as traditional lighting systems. While consumer segments most likely are not willing to pay twice the price for LED, business segments are. That is if you show them the value.

For instance, you and I may not mind changing light-bulbs every year because our opportunity cost is $0. But for businesses there are real costs associated with maintenance. Every bulb change avoided is not only savings in bulb cost but savings in maintenance costs.  If you add these all up, despite the high initial cost, the LED systems  deliver 9% in total cost savings over the lifetime.

Then I went on to show the economic value add from switching to LED bulbs

It seemed no brainer to start with the business segment that had real costs and savings (and budget to spend),  show them value using hard numbers and gain adoption. So did Cree, the maker of LED bulbs, think. Cree based their strategy on a similar analysis that pointed to increased adoption by businesses because of energy and labor cost savings from switching to LED bulbs.

As it turns out their segmentation strategy did not work out and they decided to shift focus from business segment to consumer segment,

the company is making an about-face. Durham, N.C.-based Cree is putting out a new line of bulbs built around light-emitting diodes, or LEDs, for the masses in hopes that greater use by consumers will eventually affect the choices made at their offices

Why did their initial segmentation fail to pan out? There are two main reasons I see,

1. Value Waterfall - As someone who defined value waterfall, even I failed to take this into account while I did the economic value add math for LED bulbs. Despite the real value there are several aggravating factors like cost of doing business, trust discount, switching costs, etc. that knocked down perceived value.
2. Pricing Model – The LED bulbs are priced twice as much as incandescent bulbs and deliver their value over long period of time.  That is the LED pricing captures value upfront while delivering customers value over time. A better model for businesses would have been a subscription pricing model based on usage. Cree needed monetization model innovation to go along with their product innovation.

I do not believe their segmentation failed nor do I believe they need to switch from business to consumers. But Cree believes,

The bet is that light bulbs might follow the same trajectory as touch-screen smartphones, whereby consumers grew comfortable with the technology at home and then insisted on having it available at work.

While that worked for phones that we use everywhere and at work and think of it as part of our self the same logic does not extend to light bulbs what are simply part of the environment.  Besides how can they get consumers to pay twice the price when the economic value add math does not add up and the fact that it does not have aspects of conspicuous consumption like a smartphone does?

I wrote recently how monetization model innovations follow segmentation. Cree’s segmentation was not wrong it is their product positioning and monetization model that need to be realigned to the business segment.

When your well thought out initial segmentation fails it does not mean you chose wrong and you must switch to a completely new one. Segmentation is a strategy and changing it is not like a product pivot. And there is no guarantee you will succeed with the new segment if you commit the same mistakes you committed with targeting, positioning and pricing with the first segment.

How do you choose your segment and what do you do when your product fails to get traction?

Why I Think Google Chrome Pixel Pricing Is Wrong

When Google unveiled its new touchscreen laptop, Chrome Pixel, Chrome executive Mr. Pichai said

the high price tag was justified and argued that the Pixel stands up very well against a MacBook Air

It is usually a bad sign when a brand uses words like, “the pricing is justified”, let alone  comparing against market leader with established track record in the category. Last time we heard the price tag justification it was from then Motorola executive on Xoom pricing. We know how it ended (agreed, one data point does make evidence).

If you are going to justify your price tag the best path is to use cost arguments, signaling to customers that you were doing it only because of your hardship and appealing to their “good will”. Classic example is Starbucks. While you set the prices based on customer value (and definitely not on costs) you do not communicate so explicitly to your customers.

This is how head to head comparison of MacBook Air and Chrome look like (after upgrading MacBook Air to 8GB RAM).

Let us assume, for now, that indeed Chrome Pixel is packed with features, compares favorably against MacBook Air. But does that mean Google can set the price point to match value delivered (or perceived)? No. The reason is the Value Waterfall.

Several factors are at work here that cause value leaks, bringing down the price customers are willing to pay. In case of Chrome Pixel, the value leaks are

Credibility Discount: It is from a brand that isn’t known for making premium hardware. Nor is the Chrome operating system as mature, full-featured or have supporting App ecosystem as Apple’s OS X.

Selection Cost: Customers are told the additional value comes from touch screen feature (which may not be relevant to them) and from the extra 1 TB of Google Drive storage for 3 years. This isn’t as obvious to customers who have to do the math to see value of 1TB of Google Drive.

Cost of Doing Business: Operating System, Apps, buying experience, support, user experience – everything comes into play here knocking down value delivered.

Risk Aversion Discount: This isn’t the first attempt by Google in making hardware but there isn’t much track record for customers to see. For all practical purposes this is version 1.0 from an upstart laptop maker who does not have integrated hardware-software design.

Reference Price Difference: While Google wants the reference price to be that of MacBook Air, customers will most likely use previous Google Chrome models sold at $299 and tablets with same storage ($499 for Nexus 10).  Despite the additional features and the value Google would want customers to focus on, customers will see the price jump from $299 Chrome to $1,299 Chrome Pixel an unpalatable (and even unjustified) price increase.

So it is not a surprise we see several media reports knocking down Google’s pricing. In his review of Chrome Pixel, Om Malik wrote,

Pichai and I argued a bit about the pricing strategy: my belief is that they need to sell a lot more devices so the price has to be much much lower. Pichai argues that one needs to be able to open our mind to the possibilities of a cloud-based machine. He said that one shouldn’t look at the 32 GB of storage, but instead focus on the terabyte of storage space that comes as part of Google Drive.

Google is not only trying to justify its pricing but also its measly 32GB storage by signaling value from its 1TB cloud storage. But the Google Drive cloud storage comes for only three years and costs $50 a month. On the surface it would appear the 1TB space is good value – if you were to get it separately it costs you would pay $50 a month and hence a value of $1,800.

But that depends on a customer segment that values cloud storage over additional flash storage on their laptop. Besides after that three years it is going to cost customers $50 a month because with all their data on Google Drive there will be significant switching costs. This goes back to the value leaks I discussed above.

Finally, is it possible that they uncovered a segment that values this product at the current price point and we are not the target segment? Mr. Pichai replied to Om,

“The device is for a segment committed to living to the cloud, and who really want a good, high-end laptop, and we believe we have built the best laptop for that experience,”

If true then they should have controlled the messaging channel and the messaging to communicate the pricing and value proposition to just that segment with proper product positioning.

They are not clear in their product positioning to that segment – they are positioning Chrome Pixel against MacBook Air, asking customers to hire Pixel for the same job customers hire MacBook Air for and for the same price. That contradicts their segment definition of “committed to living in the cloud”, because that segment may be hiring different cheaper alternatives and not $1,299 MacBook Air.

Furthermore even if such a segment exists, their willingness to pay will probably go down when they see the media reports on Google getting its pricing wrong.

At this point it is safe to drop likelihoods and probabilities and go on record to say, “Google got its segmentation, targeting, positioning, product and pricing wrong”, with its Chrome Pixel.

 

Sure the market seems big but what can you address?

Here is a tried and tested triangulation framework to size your opportunity

Top-down: You can get an estimate of this from several secondary market research reports and analyst reports. Remember reading certain analyst firms predicting cloud spending reaching $xyz billions by 2016? That is  top down estimate. Even if your product is entirely new you can get an estimate of the market spend from related categories (like hand dryer market sizing)

Bottom-up: If top-down is about what others are making in revenues you need to find what exactly are the customers spending. Say if you see analyst report that fitness apparel revenues will reach $70 billion by 2016 you need check who is spending, how much and from what budget to generate that kind of revenue projection. Many sources are available including census.gov. You need to reconcile what you see as revenue with what you see from customer spend checking if the revenue projections are matched with customer spend.

Your Reach: Sure you can stop with the two but can you reach the identified market with your product, channels and limited resources? This is the hard part and requires you to make strategic decisions to define the segment you can successfully serve better than any other competition. For instance, there are indeed 30 million public toilets in USA but can you serve all of them with your $1500 designer hand dryer?

If you need help sizing your startup’s opportunity, let us talk (I have square device don’t worry).

The Simplest of all Business Models

If you want to use Wifi at Pete’s Coffee & Tea you will have to buy something first.  At the counter they give you a code to use, that allows you about an hour of surfing time.

In many local coffee stores you technically have to buy something but once you do, you can stay parked in their tables for hours without buying anything. In Pete’s bigger competitor, Starbucks coffee, it is the similar unlimited free access plus access to premium extras like The Wall Street Journal.

Coffee shops complain about those who occupy tables for hours at a stretch, buy little or nothing and mooch on their bandwidth as well as electricity. Customers who do spend money at coffee shop and need good connectivity for an hour or two complain about the poor speed and difficulty in finding tables near outlets. General customers (who hire the coffee shop for, coffee) complain about the crowd and lack of seats to simply sit and enjoy their brew or have a conversation.

Free Wifi became a popular perk for coffee shops, restaurants and hotels to attract customers and keep them in their shops. If the customers chose your business over others because of free Wifi, you win. If the customers stay because of free wifi and continue to spend during their stay, you win. You have successfully used free wifi as lead generation tactic and customer retention  tool. (Freemium?). For instance, Panera bread saw its sales increase by 15% when they introduced free wifi.

On the other hand, what is free to customers, is not so to businesses. There are costs of operation (making sure there is enough capacity) and opportunity costs (both for the money spent on their big pipe broadband and the moochers). When everyone else offers free wifi it becomes difficult for a business to either stop offering it or start charging for it. Add to this customer dissatisfaction from providing poor internet service.

Look at where we are in the discussion. We are not talking about the compelling value proposition a coffee shop (or a restaurant) offers but talking about a perk. Let us not forget the primary job these businesses wanted customers to hire them for. If customers’ choice is made based on secondary and tertiary factors, the primary value proposition has become irrelevant. If a business fears their customers will walk next door for free wifi they are admitting that their product is an easily replaceable commodity.

That is a bigger problem they ignore while fretting about wifi costs. In focusing on free wifi as lead-gen activity they ignored the core customer segment they started with and the customer jobs they hoped to serve. While some may call free wifi (and Freemium?) as business model innovation, this is essentially losing sight of customer needs and your core competence.

If the customers didn’t hire your coffee shop for coffee, should you tie your business model to selling coffee? That is an incongruence between value creation and value capture.

On the other hand your strategy – to serve the most amazing coffee – need not be fixed. You can see the customer shift and decide your strategy is to serve those customers who have a connectivity need and are not satisfied with existing alternatives. You recognize customer issues with poor speeds in free wifi places and provide reliable speeds as differentiated feature. In such a case you cease being a coffee shop and become a workspace provider. And guess what, you now can charge for that value delivered.

The business model is back in sync with value capture matched to value creation.

That is exactly what is happening in Russia’s Clock Cafe.

“You don’t have to pay for coffee or tea or cookies. You should pay for time, and time costs — I hope — [are] not that expensive.”

And their target segment? Students and business folks who hire them for connectivity and hence pay for the value they get.  Nicely done. However, I think they fixed one mistake but introduced another – making coffee free. There really is no reason for them to offer free coffee, especially the premium kind they claim they deliver,

We have cappuccino, latte, espresso, Americano, and our coffee is not the cheap one

They are committing the flip side of free wifi at coffee shop mistake. Sooner or later they will run into the free wifi problem in reverse. Why bother with coffee or why not charge for it? Especially if the customers didn’t hire you for coffee?

When it comes to business strategy, starting with customer needs and choosing the ones that you can serve better than others remains the best approach. And when it comes to business models, charging for value you deliver remains the simplest of all approaches.

What is your strategy? What is your business model?