Sometimes pricing is just wrong

#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.

Customer Job To Be Done Growth Matrix

There is a very simple way to think about how to grow business. It requires us to think in terms of markets and products.

Markets – Current market segment you play in and new markets you do not serve yet
Products – Your existing products and new products you have not built yet (and are outside of your current product line)

That gives us four ways to grow any business

1. Sell more of what you make now in markets you already play
2. Sell something new – not just product extension, something outside your product line – in markets you already play
3. Enter new markets with your current products
4. Enter new markets with something new - not just product extension, something outside your product line

It is more popularly known as Ansoff Growth Matrix.

The matrix tells us it is easier to do 1 and gets progressively difficult to do steps 2, 3 and 4.

Loyalty proponents believe in staying with 1 and may be add a bit of 2. Product proponents get bored with 1 and want to build new and great (facebook phone). Those who believe buying growth spend more time and resources on 2 and 3 by acquiring businesses that sell in new markets or acquiring companies outside their core (eBay/Microsoft acquiring Skype)

There is a problem with this matrix. It is product driven as opposed to being customer needs (jobs to be done)  driven. When you look through the lens of your current products and new products you end up with approaches like unnecessary M&A and Facebook phone that are not aligned with how customer needs and how those needs are changing.

Let us redraw the matrix but now with Customers (customer segments) and Jobs as the two axes. If you are not aware of the “jobs to be done metaphor“, please see here before reading further.

Briefly, the metaphor asks us to think about customer needs as jobs to be done. Customers hire products among many alternatives to fulfill those jobs.

Now it is not anymore the question of how to sell more of same products or build new products but a question of what are the current jobs we are addressing and what new customers and new jobs provide us opportunities for growth with our core competence.

Here is the recommended strategy for each quadrant

1. Existing Customers and Jobs: Continue product evolution that cements your product as the best candidate for the job.  
2. Existing Customers and New Jobs: The new jobs could arise because of trends impacting customers or simply adjacent jobs you never positioned your product for. Remember positioning is telling customers which job your product is applying for. Instead of going after jobs that are outside your core competence you are better off investing your limited resources on evolving customer jobs and related jobs that can be served by product pivots vs. completely new products (facebook phone)
3. New Customers and Jobs you currently address with Existing Customers: Here the invariant is the jobs – two different segments have the same job to be done but you chose one segment over other and now considering serving the second segment. Understand the reasons why you did not choose that segment in the first place – is it the challenges in reaching them?, is it their willingness to pay? etc.
   Understand that different customer segments have different alternatives for the same job and hence different reference price. Choosing to serve lower willingness to pay segment should not come at the expense of price erosion in higher willingness to pay segment.
   My recommendations are to focus on packaging and pricing innovations that help protect current profits and add net new profits from new segments. It is not revenue growth at the expense of overall profit drop.
4. New Customers and New Jobs: You still have the option of better product positioning to help capture new markets. But most times you are looking at completely new jobs that require product innovations and business model innovations.
   But the advantage is your focus on customer jobs and not on products – your innovations are aligned with customer jobs. While this step once again proves to be most resource intensive with most uncertainty, taking the jobs approach helps you ease into this without taking big risks, pie in the sky product innovation or expensive acquisitions.

There you have it, your recipe for growth derived from customer job to be done.

Willingness to Pay and Reference Price

Take a look at this Yelp review

 went through a mess of salons to get some price ideas for mens haircut and I am sorry, I’ve been paying 10-15 dollars for a haircut for 22 years. I cannot and will not pay $80. That’s the price of a new video game! I called the salon and I got a price of $16 for mens! $1 more than my maximum?

What do we see here? An illustration of the fact that,  as customers we do not walk around with a price we are willing to pay for every product and service. To a large extent this number is shaped by experience and what we have seen and trained to pay. That becomes our reference price.

Any price above the reference price – like the $16 vs. $15 – is seen as a pain or price increase that need to be reconciled. And you can see how this reviewer felt after paying $1 over his old reference price.

Reference price is not a fixed number, fortunately for all of us marketers. It is malleable – newer products, cost justifications, options, or extras - can be used to move it. If the customer is convinced they are seeing value for the extras they will happily move to the new higher reference price and will settle there until next movement. The same reviewer ends with,

I can truly say with a tremendous amount of confidence. I have found my PERMANENT salon.

Back to Willingness to Pay – the $80 price limit this reviewer quotes is his absolute reservation price. No amount of benefits, features, brand, customer service etc. can move this user to pay $80 for a haircut. His willingness to pay is somewhere close (tad below ) that number. You should know that this is just one customer and may be there are lot of them like him while there are many others who are more than willing to pay hundreds of dollars for a haircut (or the salon).

What do these two parameters mean to you as a marketer or entrepreneur?

First stop asking questions like,

“Would you pay $3.99 for my product?”

Because customers do not know.

Second do not be afraid of raising prices, as long as you understand the effect of reference price and execute this change correctly.

Finally, if your product used to be free and you are considering pay model do not assume no one will be willing to pay that price. You need to find those who value it enough, target them and move their reference price sufficiently to get the price that is fair share of your value add.

How do you manage your pricing?

See also: Multi-version pricing at salons.

Amazon Price Discrimination Done Well

I wrote a while back about price discrimination and its bad rep. It is actually not all bad. My attempt to rebrand it as price harmonization did not catch on. The right kind of price discrimination is offering multiple versions at different price points so customers will self-select themselves to the version they want to pay.

Like you pick retina display with MacBook Pro or SSD disk over HDD. This is second degree price discrimination. With price discrimination, as long as you do not restrict customers from choosing certain versions and let them choose any of your versions then it is perfectly acceptable.

The success of second degree discrimination also depends on packaging and pricing the cheapest version such that it helps bring-in low-end of the market without being attractive to those who would gladly pick the higher priced version had there not been the cheaper version.

Amazon has a product that very nicely executes second degree price discrimination, while also capturing a little bit extra consumer surplus from one of the genders. (Yes, pure gender based price discrimination is bad but I will show you why in this case it is not the case.)

Take a look at the 3 versions of the same model of GPS watch.

The first version

The base model without heart rate monitor costs you $147.35 (at a discount of $52.64). If you want heart rate monitor to go with the black model, it is sold separately for $45, bringing the total to $192.35.

Now the second version

It is the red model with included heart rate monitor, priced at $184.91. That is $7 cheaper than black base model plus heart rate monitor add-on.

Why is the drab base model priced such that its combo price is more than buying bundled red model? Because they are targeting the base model  at low-end customers with lower willingness to pay.  And if some of those insist on heart rate monitor with that color they likely value it more hence have higher willingness to pay and should pay $7 extra over the bundled red model.

Also note the list prices of the base and red models – $199.99 vs. $229.99 – a difference of $30. But how they are discounted is much different from the $30 difference. You would expect discounted price of red model to be just $30 over black base model. Instead it is $37.56 over base model. In other words the amount Amazon has to discount to make the sale goes down as they move up the model.

That is $7.56 in profit from effective pricing.

Finally, the pink one

The pink model, arguably a choice targeted only at women, is $1.22 more than the red model. But still cheaper than black combo.   Nothing prevents men from buying it so the pink model pricing is not at all a gender based price discrimination. But helps to capture additional consumer surplus from women who most likely will buy it. (I am succumbing to stereotype here! Sorry!)

So is $1.22 a big deal? For the razor thin per-product margin Amazon operates at and the volume it does, it most likely does. The $1.22 flows directly to their net-income.

Overall a very fine management of pricing.

But don’t attempt this at your business – most businesses, especially small businesses and startups do not have the volume, data and computational wherewithal to fine tune pricing to this level. Worse, most are not even in the right zipcode to attempt any such fine tuning.

Ask me what your business should do instead!

 

 

 

When customer demand is known, go for multi-version pricing

Market Place reports on the multiple different ways one can watch the new Hobbit movie.

Burbank AMC 16: You have the IMAX 3D which is in the High Frame Rate, regular 2D, ETX 3D which is not High Frame Rate but it is mastered for Dolby Atmos, and then you have regular 3D.

Previously we have seen about movie theater pricing and how they do not have a way to charge different price for different movies nor do they have an easy way to charge more for the rabid fans and less for others. The choice dimension that customers value different seem to be – time, place, or format and not content. Hence we see the different pricing for different show times, different theaters, 3D, IMAX etc.

Hobbit producers are employing the different content dimensions to offer different experience to customers at different price points.  If one price is good, four seems to be better.

Does that mean every movie producer can take advantage of this and offer four different ways to watch their movies?

The answer is in the same Market Place story

in a case like “The Hobbit,” a movie that people are going to watch no matter what, it makes smart business sense to offer a range of viewing experiences at different price points.

That is there exist demand for the content and the producers have validated this and are simply maximizing profit by allowing customers to self-select themselves to the format they want to experience and pay for. If there is no demand, adding versions that differ on a choice dimension won’t cut it.

Now about those pricing pages that list three editions. Without an understanding of your customers and without validating customer demand for the product, simply introducing three or four editions (versions), modeling after some other popular business will not create instant demand for your product.

Where do you start for your pricing?

 

 

What is it you are paying for with different MacBook versions?

Let us normalize on 13″ screen size and 8GB RAM.

Let us configure a 256GB MacBook Air, MacBook Pro with 500GB ATA drive and a MacBook Pro with 256GB SSD.

This is the pricing distribution. Can you see how Apple is pricing based on our willingness to pay and not on their cost to make it.

For instance, if the price of MacBook Pro goes up by $500 for going from 500GB ATA drive to 256GB flash, what is contributing to the $100 (1,299 – (1,699 – 500) = $100)  extra being charged for MacBook Pro?  The faster CPU? Optical drive?

None of the pricing is based on cost to Apple, it is highly likely based on their number crunching – knowing how many customers value what at the respective price point.

The real magic and amazing thing is in the pricing – pricing driven by analytics and segmentation. Focus just on the fact the numbers end in 99, you LOSE.