Segmentation, Targeting, Positioning and Pricing As Customer Jobs To Be Done

The Customer Jobs to be done is a powerful metaphor introduced by Clayton Christensen in thinking about demand and new product development. Christensen’s framework requires us to view our product as something customers hire to get a job done. With different customers there are different jobs.

The term ‘job’ really represents the unmet need at hand. It covers both utilitarian as well as hedonistic (and hence needs and wants). It also makes sense to view this as ‘hire’ decision since they can either stick with what they already have or switch when they find better alternative.

He illustrated that with an example of why different customers hired milkshake from a fast food restaurant. Understand the different customers and the different jobs you find what product and what prices.

In some sense this isn’t new if you viewed what Ted Levitt wrote 50 years back – “customers are not buying quarter inch drill, they are buying quarter inch hole” – which speaks about the customer need and not the product and its features.

The other solid strategic marketing framework that came from Levitt is

• (Customer) Segmentation
• Targeting
• Positioning
• Pricing

And the Jobs metaphor fits perfectly well with this tried and tested framework (in strategic marketing there is really nothing new despite what some gurus say). Let me map the STPP to Jobs To Be Done metaphor

Segmentation: I am not talking demographics based indirect segmentation here but the right way of segmenting based on customer needs (or needs based segmentation). You are grouping together customers based on the similar jobs they are trying to get done.

Targeting: Strategy is about making choices. Simply because you mapped out all different segments with their needs does not mean you can serve them all. No one has that level of infinite expertise or resources. You need to find where you will differentiate enough to succeed. There are multiple different customer segments and many different jobs, but which customer and which jobs are you going to target?

Positioning: Positioning is creating a unique, relevant and differentiated positioning in the minds of the customers for your products. From the jobs perspective it is telling them clearly which job you want them to hire for and why your product is the most suited candidate for that job. While your product could be hired for many jobs you want to go after those where you have sufficient differentiation and also pay well. You don’t believe Apple wants customers to hire iPad as a way to display photos on their coffee table, do you?

Pricing: Pricing is your way of getting your fair share of value you create by doing the job. It is what your product gets paid for getting the job done. (I did not run out of things to say on pricing, that has been the main focus of this blog.)

That is it to marketing strategy.

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.

From Effective Pricing to Egregious Pricing – Starbucks

In the past I have only written praiseworthy things about Starbucks pricing. I always admired how they set prices for their drinks, decide to raise prices when everyone else was running price promotions and how they communicated their price increases. This time I think they have crossed over from effective pricing to egregious pricing.

First time I wrote about Starbucks pricing it was on their decision to increase prices when the global economy was going into recession

In the case of Starbucks, how did they arrive at price increase, going against the flow? The simplest calculation here is, when price conscious customers moved out all they are left with are price insensitive customers who prefer their products. Hence it makes sense to charge more for them as long as the loss in profit from further drop in customers is less than the increase in profit from higher price. (Here is an attempt at formal proof on why increasing prices yields better profits).

Later on it was on their price communication,

As you read this multiple times you will find all kinds of reasons except, “We cater to a somewhat higher-income customer and we price our products based on customer willingness to pay. Besides we don’t expect any push back from these high income segment”.

A key attribute of those practicing value based pricing is never explicitly saying that they are practicing value based pricing. There are always other reasons and you never say pricing at customer willingness to pay. A key part of practicing effective pricing is effective pricing communication and managing customer perception.

Even when they announced $7 lattes I only had good things to say. After all they likely have more data on their customers and buying behaviors than any of us do. They likely found a segment willing to pay $7 for lattes and are simply targeting them with a product version at a price those customers are willing to pay (second degree price discrimination).

Even if there is no such segment, a $7 price tag helps to improve the reference price in the minds of rest of their customers and hence will provide Starbucks with a way to increase prices of their other drinks.

All these are effective pricing. No doubt. But now I think they crossed over from effective to egregious, launching a contemptuous attack on their customer’s intelligence.

Starbucks recently introduced its new Steel gift card that is sold only through Gilt.com and costs you $450 but buys you only $400 worth lattes.

If we leave out the last phrase “$400 worth”, everything else about this product is indeed effective.

1. They chose the right customer segment and set a price specific to that segment
2. Set a hard limit on number of units they wanted to sell – a result of their understanding of the size of the segment and a tactic to create artificial scarcity
3. Designed the product to be distinctive (Steel over Plastic) – making it a conspicuous consumption. Imagine flashing this card in your local Starbucks, the baristas and the rest of us mere mortals have no option but submit to your opulence (Disclosure: I go to Starbucks only when someone else is buying)
4. Selling it only through luxury goods website Gilt.com and not at every Starbucks outlet – thereby not only reaching customers with high reference price, high willingness to pay and high wherewithal to pay but also not targeting rest of their customers
5. Guaranteeing profit from a high value gift card that locks up future sales and the possibility to add 10-15% of face value as profit from breakage (customers not using full value of the card)

Had they stopped right there, a $450 card worth $450 lattes, that would’ve been effective pricing. Then they took it one step further.  They decided to extract even more profit by setting the value of the gift card to only $450. And as they were wont to do with giving cost reasons they said,

One reason the card is so pricy is because it isn’t made of plastic — but specially etched steel. That guarantees the heavy metal wedge with the familiar Starbucks logo will stand out in your wallet and at the cash register.

The Starbucks card costs $50 to make,

Even if it is true, why should the cost matter in this case? This is not a true product. This is like the US Treasury asking you to pay $550 in change for a $500 bill because it costs them $50 to print that bill.  While it made perfect sense to use cost argument to push through price increases, cost has no relevance to take away value of the gift card.

What they have demonstrated here is utter disregard for the customer. They probably think, if these customers were willing to pay $5000 for a luxury product that costs $50 make why not take $450 cash from them for $400 worth lattes.

The sad part is they may be right and they likely will sell out all 5000 of their limited edition steel gift card. After all don’t we all pay $100 more for 16GB additional flash that only costs pennies? May be the steel gift card is laser etched and designed to fit so perfectly in your palm and that alone is worth $50 for some.

My outrage is probably misplaced and egregious pricing is likely the new effective pricing.

How are you going to react when you see that startup founder flashing the steel card at Starbucks, especially when his product is free?

What job is a customer hiring luxury candles for?

I grew up in a country where long power outages – planned and unplanned – were the norm.  If you had a test or a project report due the next day you worked through the outage with candles.  The job I was hiring candles for is clear – those white long sticks that drip (leach?) were life savors for students. Without electricity, with a major test next day there is no question the candles did add considerable economic value.

But those candles were priced just a few cents for a dozen. I can explain that away with at least three reasons. One there was a supply glut, two we bought the candles well before the emergency and three there were alternatives, kerosene lamps. Nevertheless it is highly unlikely any segment would pay a price that matches the value and definitely not $65-$500 for a purely utilitarian job.

Let us now turn our attention to the case of luxury candles, a story featured in The Wall Street Journal.

These aren’t fine wines, tobaccos or perfumes. They are candles—and with complicated fragrances and prices that can approach $500, they are a long way from your mother’s vanilla

So what makes the customer pay $65-$500 and how can the players get to keep their price premium? This case study serves to showcase some of the proven pricing principles and pricing mistakes.

1. What job is the customer hiring the luxury candles for?

“Some consumers may not be up for splurging on a vacation or new car but many can rationalize the treat of a $65 candle”

“They just smell very classy,” says a customer who lights the candle to create a relaxing ambience

“People are staying home more. Candles are a kind of an antidepressant”, says a candle salesman

“I wanted it to feel expensive, to feel precious,” says a customer

“It’s not to say that a more expensive fragrance makes for a better scent experience, but it makes for a great story” – says a marketing VP for a candle maker.

It is clear by now the jobs are no where near utilitarian and even the mildly utilitarian aspect like fragrance is not the primary job here. When marketers are able to segment the customers and position the product for a job like vacation alternative, experience, image etc they are able to charge a price for that premium value.  The job customer is hiring for affects the price they are willing to pay for it.

2. So what happens when upstarts simply copy the pricing by the leaders? (remember the stories about copying pricing model of 37Signals?)

“Everybody wants to do a candle, and they wind up in a price range from $50 to $80. That’s a tough price point to be in if you’re someone that nobody knows” says Mr. Carro of Candle Delirium
“The loft prices reflect the brand heritage. This is the brand of kings”, says a brand manager

The price premium candle makers charge comes from their investment in building their brands. Not every brand can expect to charge such prices without brand development.  A well known luxury brand not only convinces the buyer (hedonistic consumption) but also others they are trying to impress (conspicuous consumption).

What is left unsaid here is how their overall marketing strategy works – knowing their target segment, the jobs they want to position the candles for, their buying behavior and delivering them a product at a price they are willing to pay. Simply copying the higher price without the strategy is like Mototola setting its tablet prices by copying iPad.

Increasing spend per customer while keeping near linear pricing (can you say iPod Touch, iPad, iPad mini)

Nest launched the “After Midnight” collection, three different scents meant to be burned successively into the wee hours. One O’Clock is an Oriental Orchid scent, Two O’Clock is Italian Leather and Three O’Clock is Exotic Woods. (at $32 a candle)

Go for the wallet share and employ effective positioning to create emotional want when no real need exist. Notice also that they do not give bundling discount for three candles. (See here how to price bundles). There is no reason to give bundling discount when the customers are not looking for one. Besides there is a risk that the bundling discount can erode brand value.

Effectively use utilitarian features to justify premium prices for a hedonistic consumption

Its candles are made of a “vegetal wax” blend, including soy and copra (the dried kernel of coconut), which leads to a “clean burn,” free of black smoke

Wax and fragrance have to be compatible and correctly blended, or the perfume oils will “leach” unattractively at the sides, says Karen Solari, vice president of marketing at Symrise.

candles, which are said to be “hand poured” into shiny black-glass vessels

The brands are effectively using their cost and complexity of manufacturing to justify their prices. But more likely they are giving customers utilitarian reasons they can use to rationalize their splurge (irrational purchase?), assuage guilt and tell a story to others.

And about setting high price anchors, offering entry level products, showing a upgrade path

Los Angeles “luxury lifestyle” store sells a $6,400 black patent-leather wingback chair and $575 sets of Antique French Washed linens, has a collection of 10 candles priced at $85 each. The candles, are a strategic offering in the store, Ms. Tobin says. They allow customers to “buy into the brand” with a less expensive product.

For those who are willing to spend $6,400 on leather chair, $85 on a candle is likely a trivial add-on purchase (Relative price). For those who visit the store just for the experience, the $85 candle is positioned as “affordable” luxury they can buy into. Either way the store comes out ahead.

Overall great example of effective pricing.

How do you set your pricing? I take it you start with customers and not decide to simply copy this pricing by candle makers.

Don’t touch that pricing dial

Until a few months ago this is how JCPenney’s prices looked like. I show actual numbers in this chart for one product but you can take that model and apply to all their SKUs. Lots of red bars.

Starting with a high price with many discounts applied to it, leading to a low pocket price. Sales, coupons and free cash were the only way they were bringing shoppers into the store. All these meant signficant price leaks. When the entire marketing strategy is based on discounting and coupons the word waterfall assumes literal meaning.

When their CEO, Mr. Ron Johnson, of Target and Apple fame, took over he decided to plug all those pricing leaks.  Within a few weeks of taking over he put an abrupt end to this practice by going to what they branded as “Fair and Square” pricing.  No more markdowns, sales, coupons to clip or cash backs – one price.

As I have written before, effective pricing requires effective pricing communication. By branding the new pricing strategy (Fair and Square), changing the JCPenney logo to square and by running social media and Ad campaigns (some of which made it look like coupon clipping is a pain-point for customers) JCPenney did all the right things with their change.

All is well in the retail land? Did the Apple retail store magic rub-off on JCPenney?

JCPenney’s stock has taken a beating, dropping 20%, since it announced its last quarter earnings. Its revenue dropped 19%. Just for this quarter it reported a loss of $160 million.

Was it a bad decision to give up on discounting and move to Fair and Square pricing? Are the pundits right about pricing, that lower prices and greater service are the ways to profitability? Before the knives come out against the pricing move, ask this key question.

Where do you start for addressing your pricing problems?

This is not new to you if you have been reading my blog. I posed this question and answered it some time back. To set or change pricing you start with your target customers and understand why they are hiring your product. In the case of JCPenney, they had a perfect execution of pricing change skipping this first step.

Johnson hasn’t clearly defined who his target customers are and how he can get them to shop at J.C. Penney, says Craig Johnson, an industry consultant.

If you do not know your target segment (they likely are not Target’s or Apple’s segment and likely are not hiring JCPenney for reasons they were hiring Target or Apple) you cannot change your pricing strategy. You can apply pricing tactics or tweak it but not set your entire strategy.

The most important question in marketing comes from Clayton Christensen, “What job is your customer hiring your product for?”

“The problem with J.C. Penney is that people aren’t sure what it stands for anymore.  Even the new brands that Johnson has brought into the stores lack both a wow factor and a cohesiveness that would define who should be shopping there.”

Hence the results.

What does this mean to you as a marketer or a startup founder? I see several popular articles extolling the virtues of increasing prices and starting with higher prices. After all, “more money from fewer customers“, seems to make sense. Before you go  down this path, take a lesson from JCPenney.

Don’t touch the pricing dial before you understand your customers and their needs.

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 )