Pricing Based On Customer End Use

Update 2/15/2011: See how pricing based on customer end use works in my case.

A recent NYTimes article on renting hybrid cars is titled, “The Excessive Rates for Hybrid Rental Cars“. Most pricing articles written by customer advocates take a dim view of pricing based on two aspects:

  1. Reference price: What the customers are used to paying regardless of value they get. In this case, the reference price is set by regular rentals. The Times article looks at the rental prices of comparable non-hybrid cars and states hybrids are priced way higher.
  2. What it costs the marketer to deliver the product: The author does a cost math and says, “Hybrids generally cost more to buy in the first place, in general, but such premiums are often much higher than the difference in price between the models.”

The cost argument is meaningless. Once the rental car company buys the car, the costs are sunk. But the point is, they are very good at determining customer needs  and in revenue management. They would not have bought high priced hybrid rental if it were not possible for them to rent these at higher prices. Rental companies may use the cost argument in their favor to justify the higher price but they are not going to use it for pricing.

Be it pricing the rental car or any other product, price should be based on what the customer segments are hiring the product for and what they are willing to pay for it. In the case of  rental cars (in general), there are three major segments:

  1. Business customers at Airports
  2. Leisure customers at Airports
  3. Other customers at non-Airport locations

Business customers may not get to choose hybrid rentals and if they are allowed by their employers then the price does not matter to them.

The other two segments are different in their end purpose and have different alternatives to renting a car. Why will a leisure customer rent a hybrid at airport? There are two sub-segments:

  1. Green Customer: Who owns a hybrid and always wants to drive green. It is a small segment. This segment clearly has higher WTP.
  2. Experience Segment: Those who cannot commit to buying a hybrid car for rational and emotional reasons but are very eager to experience the product without commitment. These are very similar to those segments that rent luxury products. This segment has higher WTP for hybrid rentals (splurge for the occasion). These customers usually have no knowledge of how much should the hybrid rental cost and hence the reference price argument does not apply.

Together, both the segments are still small but have higher WTP than the rest of the leisure segment. Hence it makes perfect business sense to price the hybrid rentals at much higher rate.

What if there is no demand at such high rates on a given day? It does not matter, they will “delight a customer” with a hybrid upgrade. On the average they will find higher uptake for the hybrid rentals at higher rates.

What about the rental at city locations? If you read the story carefully you will find this quote from Enterprise Rent-A-Car spokesperson that sheds some light on how they price for this segment:

“limited availability of hybrids at the airport can result in a higher pricing” and at city locations “you will see much less price volatility.”

Limited availability argument is a red-herring. Customers who rent at city locations have multiple alternatives and hence have lower WTP. Their purchase occasion is much different from a leisure traveler who is willing to splurge. So what the Enterprise spokesperson is really saying is, at city locations they are pricing the hybrids at prices closer to non-hybrids.

Pricing hybrid rental provides us a great example of segmentation based on end use and pricing at each segment’s willingness to pay.

What  are your customer segments and why are they hiring your products?

When good enough is good enough

The New York Times reviewed a few productivity applications for iPhone. One of their recommendation is reQall. This review says,

My favorite stand-alone organizational app is reQall, which David Pogue has already praised in The Times. ReQall really does turn your iPhone into a personal assistant — you dictate all your to-dos, reminders, appointments and other ephemera, and it translates your commands into actionable tasks.

A great review that clearly conveys value to customers. But the very next line goes on to destroy that value,

(I find the free version good enough, but heavy users might want to invest in the $25-a-year Pro version.)

Clearly the application was a superior option but as the review says their free version is good enough for a vast majority of users. I am not faulting the review but rather the way ReQall versions are designed. By offering a good enough free version most customers end up choosing that version even though they might have chosen the paid version.

I have written several posts on multi-version pricing– which is about offering multiple product/service versions at different price points to serve different customer segments. There are many examples of effective usage of multi-version pricing, from CPG leader (Nestle) to a salon. The important design decision in multi-version pricing is the price-feature mix so that customers self-select themselves to the pricing option that ends up maximizing profit to the business.

Mr. Chris Anderson calls this type of multi-version pricing as “freemium” in his new book, “Free: the future of a radical price”. Please do note that multi-version pricing is not new and has been covered extensively in the economics and practiced effectively by many businesses. The freemium model is just an extreme case of multi-version pricing, when one of the version is made free. While offering a free version helps to drive customers to your business,  if not done correctly and without analysis of your customer segments it ends up serving the needs of most of your customers thereby destroying the value created.

Do you know your customer segments and what they value?

Small Business Pricing – 5 Steps To Effective Price Management

Linda runs a sewing business that does works like alterations and hemming.  Unlike most small business owners, Linda writes a blog that is about “Sewing for profit” in which she shares her ideas and practices to help others like her to run an alterations business.

In the down economy when people postpone purchases, alterations should be good business. But the barriers to entry are low, there are many individuals and businesses offering this service and the market alters (pun intended) with the economy. There are also challenges in reaching the right customer segments. All these make this a highly competitive market with challenges in communicating differentiation and price list becomes the main piece of any messaging.

Linda is thinking about pricing and wrote about it recently. A very well written article that considers factors like opportunity cost of the business owner’s time, competitive analysis and a pricing model for someone starting new in this business. Linda recommends a pricing that is based on the time it takes the individual to do the work and based on pricing from other competitors in the area.

If I were to suggest changes, it is avoiding what Mr. James Mason described as the 8 deadly pricing sins and practicing what I described in Effective Price Management. Pricing a product or service based on what it takes to produce and deliver it is cost based pricing. The risk is that in any undifferentiated market there will always be someone willing to price it lower and quickly prices will spiral down.

What can a small business, like an alterations or any such business, can do to practice effective price management in a highly competitive environment? Here are five steps to get there:

  1. Recognize that cost to produce is not relevant to your customers. Your costs are relevant only to see if you can run a profitable business given the addresable market and prices you can charge.
  2. Recognize that price is not differentiation. Competing on price does not let you have a conversation about the value you add.
  3. Identify the different customer segments and the economic value to them from your service.In the case of alterations the segmentation is based on usage scenarios, sometimes a customer would want to get their work pants altered and other times their expensive evening wear. The economic value is different for each case. Practice a pricing model that is based on this value add.
  4. What is “ownable”? When many other competitors are in the same market, what sets you apart from the rest? Is that defensible and unique and no one else can claim the same? In other words is that “ownable”? Identify that and make the marketing conversations about this and not lower prices. On the last point, salons excel in offering multiple prices based for the same service based on who does the work.
  5. Offer multiple versions of your product/service, be it based on material that is worked on, raw materials you use, convenience or based on person who is doing the work in your business.

Multi Price Point Strategy From Nestle’s Playbook

Versioning
Versioning

Update: I learned today from a boom about Cadbury’s that Nestlé sells 1 billion products worldwide. That is at least one billion prices. That is mind boggling. But the number sounds suspect to me considering their total revenue. Can someone fact check?

In the Nestle 2009 roadshow presentation (PDF) there are three slides that read like a lesson on multi-version pricing. One of the slides is shown in this post (advance thanks to Nestle). The numbers are not exact currency numbers but rather a price index showing relative price position. Nestle says in the transcript of the presentation,

You see here an example of PetCare which has shown and proven also to be a very strong resilient and defensive sector in bad times. And you see how we through the brands are allowing the consumer to have different price points. These are all Purina products. You see it in dog food; you see it in cat food how we have spread over different price points the product portfolio and yet using the Purina brands there rightfully.

Nestle is one of the few companies to report profits this quarter. As I wrote in my previous post, one reason is their price increase. Nestle’s multi-price point strategy seems almost so simple and easy that it will not be a surprise if anyone reading this raised the following questions:

  1. If it is this simple why not everyone do just this?
  2. If this works for Nestle why would it disclose this secret to the rest of the world?
  3. If this is so effective why not have more products at different price points, in fact take it to the extreme and have one price per person?

The answer to the first two question is the the same,

  • This works for Nestle only because of the brand equity and the strong brand loyalty of its customers. Neither of these can be build overnight.
  • Pricing and multi version products are aligned perfectly with the core strategy. In the case of Nestle its competitive advantage comes from a tight integration of its R&D, product innovations, comprehensive geographic presence and from its people, culture and values.

Multi-price point may seem easy to copy but without getting every strategic component right simply copying it is not going to help a competitor.

So why not take multi-price point to the extreme? This requires much longer discussion and I will write on it in a later post. But if you have your thoughts on this please share.