Celebrate the Second Anniversary of My Groupon Book

Groupon-worksIt was two Super Bowls ago I published this book, same time Groupon had their infamous Ad featuring Tibetian restaurant. Since their IPO a few months later their stock is hovering around $5 – far below its opening day pop but 150% growth over their 52-week lows.

How do you make informed decision about whether or not a business should run Groupon promotion?  Here is a chance to read this book for free, because you likely spent all the money on iPad and iPad mini. Or worse lost it buying high and selling low Groupon shares.

Fill out this form and the first 50 people will get the book that sells for $9.99 for free.

Even if you are not a small business owner you will find the chapters on demand curve and sales vs. marketing channel a refresher course for you.

Here is the link : Groupon Book

Just because there is a gap in product line

Recently I wrote an analysis on the implications of rumored  iPad mini on Apple’s profits. The best case scenario, one that will result in another billion profit, is the one where Apple successfully positions iPad mini as yet another device we need between iPhone and iPad. This may sound like a recent piece in The Onion,

Any other scenario is fraught with risk of cannibalization, not just to its iPad but to its iPhone and iPod Touch products as well.

Recently there was another article that looked at price points of iPod and iPhone product lines and made a prediction about iPad mini. The premise is based on Apple CEO’s comment about price umbrella,

“one thing we’ll make sure is that we don’t leave a price umbrella for people” in the tablet space.

The chart we see on the left is simply a representation of Apple’s current price points using bar-chart. From the iPhone and iPod examples it asks us to make a leap of faith about iPad.

Strategy is not about nicely completed artificial triangles. Absence of iPad in the lower price points does not point to a gap but Apple’s choice for profit share and not market share.

If filling the gaps in the price points is the driver then you we should have several sub $500 laptops and desktops from Apple. Just open the flyer from Fry’s and count the number of laptops available in the $400-$700 range and compare that to the price of MacBook and Macbook Pro laptops. Shouldn’t Apple be worried about yielding that market to others?

This is not to say there will not be a iPad Mini but pointing out that the case being made for iPad mini lacks any kind of rigor or evidence.

The gaps in the price points says nothing about the segmentation or the demand.  Nor does it say what happens to demand for current products when a newer cheaper one comes along.

If one is going to use charts to make a case for iPad mini, it will look something like this

This is the representation of the demand for iPad and iPad mini. We do not have data on how these demand curves look like. May be Apple has this information. What this chart tells us is the impact of the demand for $499  iPad when there is a $299 iPad mini. As long as the profit from iPad min sales exceeds the lost profit from cannibalization of other products, Apple will introduce iPad mini. Not because they do not like gaps in someone’s bar-chart.



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?

Pricing the Weekend Edition

The Sunday edition of the print version of The Times is priced $6,  3 times the price of daily edition. But the Sunday edition comes packed with many extras. According to Ad it would take someone the whole day to finish it. The Sunday edition is actually a type of bundling that combined many different specialized offerings that are valued differently by different segments. Note that even weekday edition of newspaper pricing follows bundled pricing model (See for more on bundling).

But I saw a different case of weekend edition pricing for business newspapers in India (The Economic Times, Business Standard, The Financial Express).  The weekend editions are actually much thinner and sparser than the weekday editions and priced almost twice the weekday editions. The regular newsstand that I bought the weekday edition did not even carry them. The news vendor said there aren’t many buyers for the weekend edition because it was priced  so high. The vendor at the other newsstand I walked to said he carries fewer copies than the weekday edition.

So why is the weekend edition that carries fewer stories (and fewer Ads) priced higher and sold fewer copies? This is just another case of effective pricing.

Fewer people bought the weekend edition than the weekday edition. Due to fewer readers the advertisers weren’t willing to buy Ads for on the weekend edition and hence the newspapers are also losing Ad revenue. But those who bought the weekend edition valued the paper more and hence were willing to pay more. The price is simply set to sell just to these high value customers and maximize profit.

If we were to dig deeper the Ad prices would also be higher for the weekend edition, despite fewer copies sold because of the targeted reach.

That’s effective pricing.

Price Increase When Demand Shifts – Semi Rigorous Proof

Previously I have written about pricing for recessionary times and how CPGs and other businesses are realizing increase in profits despite drop in revenues. As more and more price sensitive customers switched to private labels and other low cost options, premium brands responded by raising prices. The claim is this price increase delivers higher profit than a price cut to gain back customers because once the price sensitive customers moved out those that continue to prefer the brand are less price sensitive. The claim is just that if it is not formally proved. With the recent changes in bottled water prices I made an attempt at proof. But it was one example based on one data point and is not really a proof.  Here is another attempt.

Let us take the Starbucks as example. I recently made the same claim on price sensitivity of Starbucks customers. Let us assume there are only two types of Starbucks customers one is price sensitive and the other is relatively less price sensitive. Each with linear demand curve:

q1 =  a  – b * p   (demand curve for price sensitive customers)

q2 = c  – d * p  (demand curve for  brand conscious customers)

Mathematically it is easy to show that the latter curve is steeper than the previous. Each demand curve yields a different profit maximizing price p*, the second curve’s is higher than that of the first (again proof exists in textbooks). Any price higher or lower than p* will yield lower profit (hence the name profit maximizing price). Let us call the p* for demand curves 1 and 2 as p1 and p2.

If Starbucks can find out who is who and can separate them then they can charge different prices. This is called Third degree price discrimination. But when a customer walks into one of their stores Starbucks has no way of finding whether she is of type 1 or 2. They are also attracted by the higher volume by combining the customer segments so to them the combined demand curve will be

q = q1 + q2 =  (a+c) -(b+d)p

This has its own profit maximizing price which is between the profit maximizing prices of the two demand curves.  Let us call this p3. For this demand curve any price different from p3 will yield lower profit than p3.

In other words, p1<p3<p2

With the down economy the price sensitive customers simply stopped coming to Starbucks, thereby revealing who the brand conscious customers are. In other words, the demand curve became

q = c – d*p

If Starbucks continued to price at the previous profit maximizing price of p3 (which is lower than  p2), its profit will be ower than what would it have been if it were to price at p2 (the profit maximizing price for the demand curve).

This proof can be extended to account for many different demand curves and non-linear demand curves.

Hence it makes sense for Starbucks to increase its price when the demand curve shifts.

Watered Down Profits – Shifting Demand Curves

I saw a commercial for PUR water purifier that makes a value proposition on savings from bottled water. There was another commercial by Wal Mart that showed people buying their private label bottled water and taking it with their brown bag lunch. There is yet another commercial by Brita that takes a green approach by showcasing the ill effects of plastic bottles. The net is bottled water sales are down due to a variety of reasons.

  1. How should the marketers handle the shift in consumer preference?
  2. Should they drive down prices to keep their customers from switching to tap water?
  3. How much will the sales volume increase with price change? i.e., what is the price elasticity of demand?
  4. Is raising prices an option?

It is almost out of luck there is data on all these (from WSJ) that one can find without searching too hard. It is as if do all of us a favor, one of the biggest brands, Coke, did not change its prices and another biggest brand, Pepsi, lowered its prices. For all practical purposes we can treat that there is no differentiation between these brand for bottled water and they represent the overall market.

Coke, kept its prices stead and saw its sales drop by 26%. Note that this is sales in dollars not units, but at constant prices we can assume that this represents volume drop. I am no Greg Mankiw or Andy Rose, but to me this drop in demand at constant prices seems like  a shift in the demand curve. So let us treat this as the shift in the demand curve due to income effect (people switching to tap water or store brands as part of their cost cutting). See Figure 1 and 2 for the shift in demand curve.

Figure-1 Demand Curve
Figure-2 Demand Curve Shift

Figure-1 were the demand curve before recession, Figure-2 shows the shift. It is an approximation and not an accurate drawing.

Next, Pepsi cut its prices by 5%, and its sales (dollars) fell only by 13.8%. This is shown in Figure-3. But that is based on the previous demand curve. Since we assumed the demand shifted down, the 13.8% drop is actually 12.2% (26% – 13.8% = 12.2%) increase in volume. That is the price elasticity of demand on the new curve at the same price point before the price cut is 12.2/5 = 2.44.

Figure-3 Price drop results in sales increase (along shifted demand curve)

Not all of this 12.2% sales increase translate into profit. Pepsi and Coke do not break out their earnings to show revenues and profit from bottled water. Luckily, Nestle does. If use their numbers EBDITA numbers, the margin as a percentage of sales is 7.3%. This seems on the lower side. In 2003, MorganStanley reported that the margin is around 20% for US bottlers. So we can take the margin to be in-between these two estimates, say 15%. So Pepsi earned a gross profit of  12.2%*15% = 1.83% of the total sales.

Not a bad move, better than Coke which did not change its prices. But could they have done better? What if they had raised priced by 5%? That is a 5% of sales added to profit.  But their sales volume would fall. If we take the price elasticity of demand to be the same (2.44) in the other direction, then their volume would have fallen 12.2% with a profit loss of 12.2% * 15% = 1.83%. This translates  to a incremental gross profit of 2.6% from price increase despite a 12.2% drop in sales. If Coke or Pepsi were to reduce capacity and operational expenses to account for this 38.2% (26%+12.2%) drop in volume, the cost savings will add to the gross profit from price increase for a higher operational profit.

This leads us to conclude, that  price increase at lower volume would have delivered higher profits than sales increase from lower prices. But recommending price increase when the sales just fell 26% is going against the “conventional wisdom” – one needs data, conviction to act on it and limitless courage to go against “conventional wisdom”.