Perfect Packaging and Pricing – Delighting customers doesn’t mean over-delivering

Think about this pricing puzzle for a moment.

Apple includes a standard, good-enough, headphones with all its iPods. Even the cheapest iPod shuffle, priced at $49, comes with one. But there is none included with iPad. Even the most expensive Wifi version, priced at $699 does not include headphones.

If you consider the marginal cost of iPad, it is safe to say it is less than 50% for 16GB iPad and even lower for 64GB iPad. If the cheapest iPod shuffle can include one, it is highly likely the headphone don’t add too much to marginal costs (may be a $1).

Then why there are none included with iPad?

If your answer included words like – consumer surplus, perfect product packaging, utility and willingness to pay – you can skip the rest of this article and go straight to the bonus puzzle at the end of the article.

While you think about this puzzle let us take a diversion to what has become the conventional wisdom in customer satisfaction. Number one advice from customer satisfaction/loyalty proponents is turn your customers into loyal and raving fans. And how would a business achieve that? By delighting them, by going the extra mile, by delivering remarkable customer service and not by nickel and diming for extras.

Conventional wisdom is neither conventional not wisdom. The basic economic theory about consumer surplus and pricing is you don’t leave too much consumer surplus – in other words you don’t give more than what is absolutely needed with the product at a given price point.  From that perspective, Apple is offering the perfect Goldilocks package – include only the absolute minimum that is needed to sell the product.

Every additional item you include to the product package must deliver incremental value to customers that can be translated into incremental pricing for you. If either the customer does not see value or the value does not translate into higher willingness to pay, you should not be including it. (See also Value Step Function).

A moment’s reflection will convince you, an iPod shuffle  is pretty much useless without the headphones. So the headphones are indispensable. For an iPad, headphones are purely incremental and no way reduces the value from the device. Customers are hiring the iPad for a different job. By better positioning the product for those jobs Apple is able to avoid including headphones and as a result make $60 million a year in pure profits ($1 per headphone and 60 million iPads sold)

May be you buy this economic argument from selling the product perspective. What about driving loyalty? Wouldn’t the customers be even more delighted if Apple were to throw-in headphones with iPads?

In a research I conducted two years ago, I showed that you do not have to beat customer expectations by a mile to gain loyalty. Beating it just enough will do.  There is no statistically significant difference in customer’s propensity to recommend your product whether you just met their expectations or gave away the farm.

On a related note, Kindle Fire priced at $199 does not include headphones as well. That is likely driven by cost given Amazon’s approach to pricing.

How do you decide what to include in your product?  What is your perfect packaging?

Bonus puzzle:

Why didn’t apple offer yet another iPad offering at higher price with premium headphones?

Pricing Beer in Ballparks

Think of the last time you were at a ballpark and paid for beer. You likely remember paying at least twice as much as what you pay in a restaurant and four times as much what you pay in retail stores.

Which ballpark in the country has the most expensive beer? According to the NPR story it is the Marlin’s ballpark.

According to an analysis by TheStreet.com, the most expensive beer of any baseball stadium is sold at the new Marlins Park, where baseball fans pay $8 for a Bud Light draft.

Why do baseball parks charge you a “small fortune” for a beer?

If you asked the Marlin’s officials, their company line is

“Well, when you look at it, the pricing reflects basically the total cost of the operations including our players,”

Well said. Don’t mistake this statement for pricing naiveté of Marlin’ pricing managers. They understand pricing at customer’s willingness to pay and not based on cost. They simply are using cost argument to justify the pricing. Seriously, no pricing manager worth his salt will believe for a moment the cost of ball players is included in the price of beer. So will the price go up when they sign an expensive player or go down when they fire one? (See here for an example)

The cost based argument is to justify the higher prices and nothing more (like we saw with Starbucks story).

If you read my Groupon book, there is a chapter on how different customers are willing to pay different prices for the same product. One of the example I used is the price of beer at ballparks. Some are willing to pay the set price to enjoy the beer and some aren’t. Ballparks, with so much data about their customers in their hands, can easily find the price at which their profit from beer is maximized. They don’t have to sell beer to most number of people, they only have to maximize their profit.

Take for example, one of the baseball fans interviewed for the story,

“I’m used to, like, $3 pitcher nights and, like, dollar beers and stuff. But I have no choice.”

Marinelli works a part-time job at a sporting goods store where an $8 beer is “an hour of work, on average,” he says. “It’s expensive, man!”

This fan may not buy all the time but does a few times. From the ballpark’s perspective people like Marinelli don’t have to buy beer on every visit, because there are lot more fans like him and there are lot others who are willing to pay every time. An additional thing going for the ballparks is there are no alternatives. You cannot bring beer from outside.

This is the reason why even at the peak of recession, beer prices at ballparks went up. See here for a detailed explanation of demand curve shifts.

Still not convinced how Marlins price beer? Here is a clear indication that they get pricing – Marlin’s EVP of operations says,

the Marlins could be charging a lot more — customers in Miami have been trained to expect expensive drinks. You go to a nightclub and the markup on a bottle of vodka might be 4,000 percent. In that sense, the 800 percent markup on Bud Light at Marlins Park could be much worse

They understand reference price of their customers (remember the famous willingness to pay for beer experiment by Richard Thaler). Customers have been trained to expect higher prices in such public venues and Marlins is merely building on it.

How do you price your products? And how do you communicate how you price your products to your customers?

Answer to Pricing Puzzles – Restaurants Charging Fee for Sharing

I tweeted a series of pricing puzzles. This series is my interpretation of what the answers could be. Do not treat them as absolute answers. Alternative explanations are possible.

There are two parts to this question.

  1. Why do restaurants charge a fee for sharing?
  2. Why do they charge two different prices based on what is shared?

It is safe to say that those willing to share are most likely couples and they likely pay for it from the same shared budget. For everyone else, those not sharing budgets, the question of sharing does not even come into play.

A restaurant’s goal is to maximize spend per table.  Their wait-staff are essentially the sales team trying to generate more sales per table during the period it was occupied.

So when customers share, it cuts (almost in half) the spend (and hence profit) per table. To discourage customers from doing so, they make the price of the single entree look a little more unattractive by adding the split fee. This is second degree price discrimination. With the split fee, customers may see higher value (consumer surplus) when they order two vs. one.

For those who still want to share for any number of reasons including limiting portions, even with added fee sharing will provide higher consumer surplus and the restaurant gets to recoup profit.

Why charge different split fees? Price discrimination done right. If you charge one split fee, you might as well charge two.

Should they do it? What about customer backlash?

To repeat my earlier point, this is a limited segment that will share food. The rest won’t even notice the split fee.  So by all means do it as this is money that flows straight to bottom line. However they should consider their customer mix and capacity utilization.

What does this mean to you as a Tech Product Manager?

I do not recommend you following in the restaurant’s footsteps. Start with the customers and their needs. Consider how your webapp is being used by your customers.

  1. Do they share login?
  2. From what budget are they paying for it?
  3.  Is there value for them in keeping separate logins?
  4. Do they want to keep their Netflix video queue/history or Evernote clip archive separate?
  5. Do they consume your limited capacity without adding to revenue?

My recommendation: Instead of trying to tack on split fees, make the price of adding second (or third) user attractive that most will do it.  (Like SurveyGizmo did)

 

Will Apple introduce $299 iPad?

There  are rumors in Tech Blogs that Apple might introduce a cheaper iPad – could be a 8GB version or a 7-inch version, priced close to $299. The argument goes, Apple does not want to yield the lower priced tablet market to Amazon. If Amazon took the risk to invest in 7-inch tablet and uncover a market for it, there is likely no risk for Apple to take its share of the market.

So should or will they do it? (Let us not consider here what Mr. Jobs said about 7 inch tablets)
If three to five million people bought 7-inch tablets in the last two quarters, isn’t that an opportunity for Apple? Not to mention, those who are on the sidelines, because they did not like Kindle Fire and could not afford $499 price tag may enter the market, expanding the pie.

All highly likely scenarios. But there is a third scenario of similar likelihood that most ignore when making a case for introducing a new lower priced version of the product. It is those who currently buy their $499 version switching to the $299 version.

Without going into the details of Second Degree Price discrimination here is a brief description. When there is no $299 version of iPad, if the $499 version offers you enough consumer surplus you will buy it. When there is a $299 version as well, you will pick that instead if it delivers more consumer surplus than the $499 version.

The question Apple will ask (but not the Tech Blog savants who are often wrong but never doubt their claims) is,

Is the foregone profit from those trading down made up by profit from new customers we acquired?

You can see their track record of past product versions (iMac versions  and MacBook Air versions)  we can say with high degree of certainty that Apple will ask this question.

If we used the previously published numbers by iSuppli and others on cost of iPad, it costs Apple about $249 to make $499 iPad. Say their gross margin remains the same for $299 iPad (i.e., cost drops to $149). Then for every customer trading down from $499 to $299 version, Apple has to bring in 1.67 new customers.

That is just to break-even the trading down customers. In addition they need to find millions more  to justify their investment.

Can they do it?


Side Note 1: When you uncover a new market or spend your resources to develop a new market, it is not all yours. Others will swoop in and get their share.

Side Note 2: If you run a frozen yogurt chain and want to offer a lower priced plain yogurt version, this is the question you should ask – Am I losing profit from those trading down to plain yogurt because they get better consumer surplus at its price point?

What happens to the sweater from 6AM to 9AM for the price to double?

Sometime during many of the obligatory Thanks Giving conversations, an elderly relative loudly wondered about the mysteries of Black Friday pricing.

The sweater costs  $29.99 at 6AM but  if I buy the same sweater at 9AM it is $59.99. I mean, come on. It is the same sweater! What happens to the sweater  from 6AM to 9AM that makes it double in price.

She likely was just making a conversation. Or a philosophical observation expecting others to simply marvel at her astute comment that everyone else seem to have missed.

The answer is boring (I still have not mastered any party tricks on pricing to entertain people).

Let us limit the answer to the specific question and not mix it with loss-leader pricing.

Simple answer, nothing happens to the sweater. Yes, it is the same sweater. It is the mix of people (customer mix) that changes from 6AM to 9AM (or later).

As customers we all have different prices we think is fair to pay for the sweater. Here, by fair I mean the price that we willingly pay without feeling pain.  Let me use a very simple example with hard restrictions to explain why the price doubles from 6AM to 9AM.

Let us say there are only 100 people, numbered from 1 to 100. Each person is willing to pay a price that is less than and up to their number ( person numbered 10 willing to pay up to $10 etc).   Even if it is a penny less, they will buy the sweater at the price.

Let us also assume the sweater costs the store $9.99 to buy.

If the sweater is priced $59.99 all the time, all those numbered from 60 to 100 will buy it, netting a profit of $2050 for the store.

If the sweater is priced $29.99 all the time, all those numbered from 30 to 100 will buy it, netting a profit of $1420 for the store. Note that all those numbered  60 and above will still buy it at this low price (the difference between their number and the price they pay is heir consumer surplus).

(Higher price netting higher profit is just an artifact of choosing these numbers, and not because higher prices drive higher profits)

But what if the store can sell the sweater a $29.99 only to those numbered between 30 and 59 and sell  it at $59.99 to those numbered 60 to 100? They would make a total profit of $2650. (If one price is good, two seem to be better.)

The problem is these 100 people don’t show their numbers to the store and even if they did the store cannot force them to pay based on their number.

But what if there is a way to separate most of those of those in the 30 to 59 range from those in the 60 to 100 range? Conversely what if there is a way to keep most of those in the 60 to 100 range to pass on the  $29.99 deal?

One such way is changing the buying experience. Create enough pain in the buying experience , like asking them to skip sleep, wake up early and schlep to the store at 6AM, such that most (if not all) in the 60 to 100 range will find it not worth it, just for getting additional consumer surplus. That is why there is a 6AM deal.

Most in the 30 to 59 range will likely do that sacrifice to score the sweater at lower price.

It is not ideal. Not all numbered 30 to 59 will come at 6AM and some from 60 to 100 may sacrifice sleep and family time to come at 6AM. As long as there are at least 5 people numbered between 30 and 59 come at 6AM for every 2 people in the 60 to 100 range, the store will do fine.

So there you have it. That is  a simplified definition of price discrimination, customer willingness to pay and price versioning.

Try explaining this to your elderly relative.

Verifying the Obviously True May Show …

You likely have seen such signs. It may not be in IKEA parking lot (picture used here only for illustrative purposes) it could be your local grocer. The stores tell us that it is important for us to do our part, because it helps to keep prices low. Seems obvious and sounds true. We could even come up with an explanation on our own – carts left astray in the parking lot cause collision damage that cause liability to the store which flow back to products as higher prices.

We do not stop to question or analyze whether it true, we do our part (mostly) and move on. Which is a civic thing to do, so please continue doing it, I am not recommending otherwise. But I am questioning their not so subtle hint on pricing and the reason we tell ourself.

First let us look at this from pricing angle. How are merchandises priced? They are priced at what the customers are willing to pay such that it maximizes the business’s profit. A  simple explanation of customer willingness to pay  and price elasticity can be found in my book. Here let us look at IKEA’s published FAQ for the explanation:

The IKEA business idea is: “We shall offer a wide range of well-designed, functional home furnishing products at prices so low that as many people as possible will be able to afford them.”

You cannot find a simpler and clearer explanation on pricing. IKEA has chosen to maximize its profit by appealing to as many people as possible. Note that if the prices are any lower than they are now, even more will  shop, so why not do that? Clearly they have to price the merchandises at least above their marginal cost (ignoring loss leaders here) – the cost for the store to acquire, ship and shelf them. Even at prices above marginal cost, after certain point the increase in number of customers by lowering the prices will not deliver incremental profit. So they find a price point at which the profit is maximized.

On the flip side, if they were to increase pricing on certain merchandise then they will find fewer people willing to buy it. They may find that the loss of profit from lost sales is more than incremental profit from price increase.

Back to shopping cart in parking lots. If you followed the pricing for profit maximization argument you can see why. The store cannot simply increase prices to recoup the losses from shopping cart damage liability or any other such costs without affecting the sales/profit. The prices we see now are optimized to the extreme, to their final cent. A moment’s reflection will convince you that if they can indeed raise prices because we are not stowing shopping carts properly without affecting sales/profit they would have already done that – shopping cart or not.

Second let us look at this from cost and execution angle. Each IKEA store sells 10,960 products. Only the marginal cost of the merchandises matter not the fixed cost of operating the building, the interest payments, employee salary or liability insurance premium. Even if the costs were to be allocated to each merchandise, and somehow they have figured out a weighted average method to do so across all 10,960 of them based on their price and sales volume, the increase will likely be very low that we won’t even notice it. Which brings us back to previous point in bolded text, why wait for the damages to go up?

So what we see is a nudge to improve a store’s operational profit by keeping its costs down – be it liabilities or hiring an additional person. None of these can be easily passed on as higher cost without impact on their sales and profit. Do not worry about prices going up.

Next time you see a sign like this, do not take take the pricing reason for granted. Leave the cart in its allocated space because it is the civic thing to do.