Getting Fair Share of Value vs. Offsetting Lost Revenue: Ad Free Hulu #Pricing

hulu-logoQuestion at the outset: Hulu introduced a new commercial free version of its subscription service for $11.99/month. Is the new pricing based on the share of value to customers or the need to offset lost Ad revenue?

For those cutting chords (figuratively speaking) – removing cable TV option and satellite TV – Hulu has been the go to option to catchup on TV shows. For $7.99 a month subscription fee Hulu offers its customers current and full season episodes of most popular TV shows (some network exceptions apply based on their content licensing agreement). Seems better option to customers than paying cable TV bill or struggling with Over The-Air Antenna.

What viewers get for the price is unlimited and on-demand streaming of TV shows. Just like a TV show is interrupted by commercials (even in the pay-Cable ones) viewers see commercials. Sometimes these are the same that aired with the show and other times different ones inserted. But the experience is the same – 30 minute sitcoms and 60 minute murder mysteries filled with 10%-20% commercials.

Some of those paying customers are not too happy to be interrupted by the commercials – limited or not. Clearly demand for such Ad free TV shows exists, Netflix and Amazon are quite successful even though they do not offer current episodes like Hulu does. Seeing this pressing customer need to be not interrupted Hulu is introducing a No Commercials version at a price of $11.99 per month.

hulu-versions

The price difference is $4 for no interruptions. I have always said many times before, “If one price is good, two are better“. So isn’t this better for Hulu and its customers? The answer is a qualified yes.

We need to consider the reasoning and logic behind the $4 price difference for no interruptions. Is that based on customer research and value they assign to for interruption free TV shows (hopefully done using some kind of conjoint analysis)? Or is the pricing done to offset the lost revenue from Ad sales from the premium version?

It is possible Hulu is using one of two revenue metrics

  1. Average Revenue Per User (ARPU)- measured as a sum of subscription fee of $7.99 and Ad revenue from the average user
  2. Total revenue measured as sum of all subscription revenue and sum of all Ad revenue

In case 1 it may see the need to keep ARPU the same and may simply came up with a price point of $11.99 which is likely its ARPU.

In case 2 it may see the erosion in Ad revenue, model possible uptake and come up with per user uplift in pricing needed.

Both cases are wrong as they start with Hulu’s costs over value to customers. In fact there is evidence to point out cost based pricing is how Hulu set its price of $11.99 according to this news article:

Hulu and its owners don’t want to encourage large numbers of existing subscribers to shift to the new ad-free service

That is they are using case 2 above and modeled in small enough uptake of new version and shaping that expected customer behavior with a higher price tag.

universal_express_logoIt is perfectly normal and acceptable effective pricing practice to shape customer behavior with higher price point. For instance amusement parks set a high price for Fast Pass and other similar options to skip lines to reduce uptake. After all if the price is low enough and many take it the lines at FastPass will degrade value to customers.

But using higher price point just to support a model assumption on Ad revenue loss without measuring customer value is simply not effective pricing.

When it comes to pricing your first version or the second version the right place to start is with customers, not your costs and revenue goals. If one price is good, two are better if both are based on customer value and not costs.

How do you set pricing?

Nestle’s Marketing Fallacies

Hi, this is Prithi, the fifth grader writing about a wide span of topics, but today my post is on a marketing error.

There is a common noodle soup snack in India called Maggi, made by Nestle. This new advertisement they made has one main messaging error. Watch it carefully, then speculate.

The big revealment:

Take a look at the nutritional content of Maggi. Why would mothers want to feed their children something with so much sodium and fat?

Furthermore, in the advertisement, it shows a girl wanting to be self-reliant, but she should have learned to cook from scratch and eat healthy . To open a pack of processed food, boil it in water, and call that self-reliance is ludicrous and an insult to women in general.

 

 

Surely you are not surprised by Groupon woes?

Update 11/1/2012: Groupon valuation is back in news because of its rival LivingSocial’s woes.

In Amazon’s 10-Q filing late Friday afternoon, it disclosed that Living Social saw revenue of $372 million for the nine-month period ended Sept. 30. While that is up 120% from the same period last year, it reflects third-quarter revenue of just $124 million – down 10% from the June period.

If that sequential drop reflects an overall weakness in the daily deals business for the third quarter, then it implies potentially disappointing results for Groupon when it posts its own results for the period next week,

When valuing a company’s stock it pays to understand what pressing customer needs it serves and what unique value it adds. That is assuming you are Benjamin Graham, Warren Buffett type investor who takes the time to understand the business before investing.

Business model is value-creation and value share. A business that creates net new value for its customers gets to share in it. A business cannot get its share of value it did not help create, let alone grow exponentially.

If you are such an investor then Groupon’s announcements about lax controls should not come as a surprise to you. I am not referring to the $2 drop in its stock today but the news that led to it.

It is hard to describe Groupon’s business. In fact even Groupon is not clear about what it is.

For starters, it is a two sided market. It essentially brings together small businesses on one side and end consumers on the other side.

In general a two sided market adds value by unlocking value, creating new value or removing inefficiencies. It then gets its fair share of the net new value added. A two sided market must be consistent in its positioning – it must serve as the enabler for the jobs the two sides are seeking to do. There should be no asymmetry.

Take for example, eBay. It positions itself as the market place for buyers and sellers to find each other. No asymmetry here. EBay adds value by enabling transactions that otherwise would not have been possible.

What about Groupon’s role as two sided market?

What is its positioning to deal seekers? It tells them about, “one ridiculously huge coupon everyday” and its tag line is, “Collective Buying Power”. In other words it wants the deal seekers to hire it as a sales channel to buy products at steep discounts.

What about its positioning to small businesses? It tells them about, “guaranteed new customers”, “big exposure”, and “measurable marketing”. The story line goes, “these customers fall in love with your service and visit you again and again, paying full price”. In other words it wants the businesses to hire it as a marketing channel.

That is asymmetry (to put it mildly) in its messaging. Groupon cannot be a sales channel to acquire ridiculously huge discount and a marketing channel to acquire valuable customers at the same time.

What value does it add?

Businesses bring value to the table in the form of 50% off discount. Deal seekers add no value but get 50% off. Groupon gets its share of 25% from the businesses.

 

You bring a full pie.
Give half of it to my email subscribers.
Give half of what is left to me.
Take home the rest and wait.
It will not only grow to become a full pie, it will multiply into many full pies.

To repurpose Omar Khayyam, “the deal seekers having scored a deal, move on. No level of customer service will bring them back to pay full price for your cupcake they can get for 50% with their next coupon in the bakery next door”.

There is no net new value add. Just value distribution – from businesses to deal seekers and Groupon.  Groupon cannot take its share of value it did not help create.

So we have a business that most do not understand, even it does not have clarity on the needs it serves and adds no new value. How can you place a valuation on such a business?

Surely you are not surprised that such a confused business finds itself again in the accounting hot water?

There is a WSJ report that SEC may investigate Groupon. I see no reason for such an investigation at the expense of taxpayers. If irrational investors want to bet their money on a business they do not understand or chose not to understand, why should they be protected?

Losing Control of Customer Mix Through Group Discounting

From the Book:  To Group Coupon Or Not

In one of the small business success stories featured in GroupOn website, Director of Melt Spa and Salon in Boston tells us about her success from running GroupOn promotion.

Her original expectation was 200 people but the promotion brought in 1400.

If you skip ahead in the video, at one point she answers the question,

“What were GroupOn customers like?”

The Spa Director says,

“We have seen a big range of customers come in, from students to business people to grandmas”

When you open a premium Spa and Salon or any similar business that offers premium product at premium prices, your strategy should be to target specific segment of customers who are similar in their profiles. Most importantly you want a customer mix that hires your product for the same set of reasons.

A customer buying  $125 haircut is hiring the product not just for what the product is but for a basket of reasons. There are utilitarian reasons and then there are other (hedonistic) reasons like brand, experience, ambience, social status and most importantly other customers.

Perception of profiles of other customers is a key decision factor because it tells them about their own profile. We all tend to look for social conformity in our choices.

If a  GroupOn promotion brings in 1400 new customers, from students to business people to grandmas who came in only because of the steep discount, what message will it send to your core customers?

Will the big change in customer mix negate a key reason your pre-GroupOn customers hired your product for?

I have nothing against grandmas; the point is your loyal customers may take away a different message about the product when they see a sudden change in customer mix.

Acquiring 1400 new customers who paid $50 for $125 services is not all bad  but you lose control of your customer mix.

Instead of targeting all its 25 million email subscribers, can a Group Coupon site enable you to specify the exact customer profile that you want to reach?

Reversal of Irrational Consumption

Have we been buying things that are worth less to us that the price we paid for them? If we all are rational we should not pay more than our willingness to pay which is a function of  what the product is worth and our reference price.  A recent Financial Times article on changing consumer preferences in recessionary times had quotes from several marketing professionals and academics. One of the quote was from Mr. Seth Godin, author of several marketing books,

Seth Godin, a marketing trendspotter, calls this the “affordable premium” product, which, like a McDonald’s coffee, is deemed to be worth more than it costs.

If we are rational (left image) we should only be buying products that leaves us a positive consumer surplus. What Mr.Godin suggests (or to be specific the FT’s quote states) is that we have been behaving like the right image.consumption

Does that mean we have been buying goods that are not worth the price  we paid for them? Perhaps. There are two possible explanations:

  1. Our consumptions were hedonistic and we convinced ourselves that the products are really worth more than the price we paid for them.
  2. Our consumptions were conspicuous – that is we have been doing them for keeping up with appearances and with the Joneses.

Availability of easy credit and high home prices drove us to behave like the right image and buy things that we were not getting the value for the price we paid. Now with bad economy we see the reversal to the expected rational behavior.

The bigger question is how do consumers value the products they buy? Even consumers do not know the exact dollar figure of value. A marketer can tease out this value and make a reasonable estimate of the relative weights we assign to the components of a product like is utility, hedonistic value, brand and luxury. Next up I will discuss the factors that go into the valuation and the current shift in consumer valuation.

Is the end of free online newspaper nigh?

I love reading NYTimes online version and  love the fact it is free. Every time I read it I feel like I should  click on the Google Ads on its news pages. Rationally it makes no sense for me to do that, and I don’t click, because it is not enough that I click on the Ads if not many are going to. If NYTimes wants to give their content to me for free, I am only happy to consume like any other reader.

Unlike Financial Times and Wall Street Journal many online newspapers like The New York Times are free. They exclusively rely on page views to  drive Ad revenues. As the Ad revenue shrinks, the free model is proving to be  a bad one.

This week’s big news was the end of Rocky Mountain News, print and online version. Closely on the heels, Newsday a Long Island daily owned by Cablevision announced that they will move to pay to read model. Cablevision’s COO says he wants to:

end distribution of free Web content and make our news-gathering capabilities a service for our customers.

He is absolutely correct, the line of thinking that news has value and hence customers should be charged for this regardless of the distribution medium is slowly taking hold. If the online version of a newspaper has been free all along, can it successfully convert the readers into paying subscribers? If the newspaper can gain more incremental revenue from subscription than it receives from Ad revenue today, it is the right decision. But how can it convince readers to pay for something they always received for free?

ZDNet’s Tom Steinert-Threlkeld wrote a blog post on whether on not Newsday’s pay model is an Optimum one.  He says,

It’s not like I don’t value it. I just don’t have to pay for it, on screen.

Of course the question is not whether we value are not, we all value the service we get from Newsday or NYTimes despite the $0.00 price. It is also not the question of communicating this value. Like Tom, most readers will not accept the transition from fee to free model because of their reference price frozen at $0.00.  So if the NYTimes or Newsday  want to charge for what used to be free they need to focus first on impriving this reference price.

To answer the question, will Newsday succeed? Without any move to improve customer reference price, they are not going to find it easy to convert customers from free to fee. Take the case from airline industry. US Airways started charging for coffee and soft drinks in their flights but after seven months they decided to rollback their unbundled pricing. My recent consumer behavior experiment shows that such a move would have been successful if they had considered improving customer’s reference price.

Reference price rule applies to valuing any service and especially with valuing free.  WSJ and FT.com has it easy because they never made their online version free. For everyone else who want to move to fee model, “it is the reference price, stupid”.