Price Discrimination at the altar of God

Note to new readers: Do check out my other articles on versioning and price discrimination. It would help me greatly if readers coming from Rutgers or New Jersey let me know how they found this article.

To my non Hindu readers the words “car puja” may not ring a bell (no pun). Almost every Hindu Temple in your neighborhood offers this service, “car puja” to the devotees  (customers?). What is it exactly? When someone buys a new car they bring it to the temple and a Hindu priest blesses it with ceremonies and chanting. It is a kind of insurance, buying peace of mind or an unselfish act (or call it by any other unsavory label).

The last time I walked past one such event at a East Bay Hindu Temple, I saw two cars parked side by side  waiting to be blessed. One was a BMW X series and the other a Toyota Corolla.  The price the temple charges for the ceremony? A standard fee of $25.

The value to customer is of emotional kind and not economical. We cannot add up cost savings,  incremental revenue or replacement costs and compute the Economic Value Add. The segmentation variables are also not clear, except for propensity to buy luxury vs. utilitarian cars. The perceived value to the customer is of private kind and is different for each customer. For instance, the value of the ceremony to someone who bought Lexus is much more than the value to someone who bought a Corolla. That said, the value of the blessing to a first time car buyer or someone who  bought the maximum they can afford (even if it were a Corolla) is high.

This screams out for practicing price discrimination.

For all these marketing aspects this serves as a case study for other scenarios in which similar conditions apply (from  buying data backup solutions to luxury products).

I understand places of worship are not about profit let alone practicing price discrimination (be it good or bad) but this is a case where the customers may prefer some price discrimination.  This is a perfect case for calling the practice “Price harmonization“. Besides, the additional revenue gained can be put to good use.

What are some of the ways the Temple could match price with value?

The price they charge $25 needs improvement. While it is not worthwhile to do quantitative research (Conjoint analysis) to set price, they should use  “Relative Pricing“. The customer just spent anywhere from $20K to $50K, they already have a high anchor. They also spent $600 for the insurance and most likely spent $50 for filling up in the past few hours.  So the lowest price charged should be at least the price of a tank of gas.

This will be an improvement, but it still leaves considerable consumer surplus.  Here are some ways to practice price discrimination:

1. Pay What You Can: Since the perceived value is different we can expect the customers to pay different prices. But as I have written in the past the value and the right price to pay is not obvious to the customer and hence is not true price discrimination.
2. Pay What You Can with Suggested Price List: Post a price list with caption “Patrons like you typically pay $50, $100 and $200”. This might work with most choosing middle option.
3. Price Based on Car: Most software companies practice this, charging customers based on the type and configuration of servers they run the software on. While this seems logical it is complicated in practice. (This is Third Degree Price Discrimination).
4. Versions: The recommended approach that fixes flaws in (1) and (2). Offer three versions of the service each priced based on three different price points of cars. When customers see the versions they will self-select themselves to the right version. (Second Degree Price Discrimination)

Versioning is also the recommended method for other marketing scenarios where the value to customer segments varies but is not easily measurable. Any versioning you implement for these businesses will be better than a single priced option but I recommend doing quantitative research to find the segments and what is relevant to each segment. (Stay tuned for upcoming article on how to design versions for Software products).

Which brings us back to the theme of most of my posts – “If one price is good, two are better” – even in the altars of God.

What is your pricing strategy?

Yet Another Lemonade-Stand Parable

Update 8/28/2011: I saw a recent article in Times

that was about how we seem to find economic lessons and parables from  children’s literature. The author nicely summed it up as,

“It’s just that once economics is on the brain, it suddenly seems to pop up a lot in children’s literature.”

Here is a pricing lesson I found in one of the books my child read.

Almost an year ago, I wrote about a children book called A Dollar for Penny. This is a step into reading book for early readers that tells the story of a little girl who runs a lemonade stand. A smart little girl, the protagonist in the story, sells the same  product to different customers at different prices. Prices start with 1 cent for some to 50 cent for the one with most willingness to pay.  That is first degree price discrimination (or is it Price Harmonization?).

I would like you to compare this lemonade stand with the two other illustrated by  Mr. Seth Godin:

1. A standard lemonade stand offers fast service and sells at one price $1 per cup.
2. An unconventional lemonade stand that serves hand-crafted lemonade and the little girl talks to you. The surprising part is there is no set price, you pay what you want.

Which one of the three entrepreneurs have a bright future? The one from the book or one of Mr.Godin’s?

I will state the caveat that future success cannot be predicted based on a single event.

Your gut might tell you that  it is that little girl who sells the experience and not the lemonade. This story is heartwarming and the possibility that some customers will pay $5 for the experience may make it look profitable as well.  If you are a marketing romantic you need no further convincing.  But if you are analytically inclined you need to look more carefully at all three cases.

Standard Lemonade Stand: Selling a standard product at one low-price and little or no-service  is not a bad idea as long as you target the right customers with this offering. If this lemonade stand has operational efficiency it can serve a large number of customers and take in considerable profit. For some customers a lemonade is just a lemonade, for quenching thirst and not about the experience.

Custom Lemonade Stand: Selling the experience and not just the product is a splendid idea (like Starbucks) if (once again) you are targeting the right customers and you are able to charge for it. The wrong part is not setting a price and leaving it up to the customers to pay for the lemonade. Customers do not know what to value a product, no one walks around with an internal value meter that tells them what to pay for each product. Customer willingness to pay is shaped by marketing and reference price. Pay what you want may look very much like first degree price discrimination except it is not.

Differential Pricing Lemonade Stand: Lastly what about the one that priced the lemonade differently for each customer? She should not have started with a low price  of 1 cent. While this may work for this little girl, pricing at each customer’s willingness to pay, it is not possible in practice. But she is  on the right track to profit maximization – defining product versions for different customer segments and offering at prices they are willing to pay.

The moral from all these lemonade stand stories is that – entrepreneurial success depends on strategic marketing,  which is nothing more than segmentation, targeting and positioning.

Pricing Your Multi-Version Product

Note: This article gives basics of price discrimination, product versioning and consumer surplus that will help see the case I make on iPad2 sales.
[tweetmeme source=”pricingright”] How should a marketer set  prices for different versions? I wrote,

Set prices of your versions such that those who are able to and willing to pay higher prices will do so and are not tempted by the low priced version.

A slight variation of this statement was suggested by Chris Hopf,

Assort Value of your versions such that those who are able to and willing to pay higher prices will do so and are not tempted by the low priced version.

The difference is the value allocation but both statements are not only correct but also are complementary. To explain this we have to go to the very beginning of price discrimination – the Pigouvian economics.  For a marketer to adopt versioning strategy the following two conditions are necessary*:

1. Different customers must value the various versions differently. This means customers needs and the value they get by hiring a version must be different.
2. The products must not be commodities -products must add unique value to customers.

Together these two explain the value assortment argument. But it is not enough to just create value, a successful business model is not only about creating value but capturing a fair share of it. Pricing is the lever for value capture. This is what I said about setting prices for the versions.

Let us walk through an extreme case for simplicity. Let us say there are only two customers Bob and Alice. You, the marketer, create and sell shaving gel.

If both Bob and Alice value just the utility of the gel and hence do not value any other benefits there is no point in creating multiple versions, one for Bob and one for Alice. For instance, if Alice finds that she gets more from Barbasol, after all it is the same product as Pure Silk, then she  will pick Barbasol.

If Bob considers the gel just for its utility and has low willingness to pay (WTP) but Alice appreciates the scent and values how it works in the shower and hence has higher WTP then it makes perfect sense to create two version. The version for Bob is the simple Barbasol and the version for Alice is Pure Silk.

How would you price these two (given Bob does not value Pure Silk at all)?  You should price these two such that:

Value of Pure Silk to Alice  less  Price of Pure Silk

>

Value of Barbsol to Alice less Price of Barbasol

In other words, Alice, the high WTP customer, must get higher net value (consumer surplus) from Pure Silk than what she gets from Barbasol.  This means Alice will be nudged to self select herself to the Pure Silk version and not tempted by the Barbasol despite the lower price.

In reality there are lot more Alices, Bobs, Charlies, Davids, …

Some might  choose Pure Silk regardless of the price and at the other extreme some might always choose Barbasol. Some, if they didn’t know about lower priced Barbasol, would choose Pure Silk but when offered side by side would find higher value in Barbasol and choose it.

The general questions become  –

-What are the customer segments?

– What do they value?

-What are they willing to pay for that value?

-What is the size of each segment?

-What are the product versions and their prices that would maximize profits?

That is the core of strategic marketing.

Talk to me.

*Note: There are 3 conditions for practicing price discrimination (price harmonization) but the arbitrage is not relevant to versioning strategy.

Rebranding Price Discrimination – Breaking the Bad Rep

[tweetmeme source="pricingright"]

Economists are not good marketers otherwise they would not have named the greatest profit maximization scheme to date as Price Discrimination. The word discrimination evokes so much negative feelings that it is hard to justify price discrimination is legal, ethical and  fair. If general discrimination is treating different people differently based on demographic or psychographic characteristics, price discrimination is charging different people different prices based on value they get and their willingness to pay.

Since finding each customers’ true willingness to pay is impossible  the next best options are:

1. Equating customer’s wherewithal to pay  to their willingness to pay – for example giving student and senior citizen discounts. It is the same product but based on verifiable external criteria different customers are charged different prices. While this is termed third degree price discrimination, marketers who implement this have a better term for this – “discount” for one class and a “surcharge” for another.
2. Delivering multiple different versions (products that vary in different dimensions) at different price points and letting customers self-select themselves to the right version. This is the second degree price discrimination and after rebranding it is called versioning.

Still the practice of charging different customers different prices still causes considerable outcry in the news media and in the social media. Most price discrimination schemes end up using demographic variables which further aggravates the situation. It is hard to even classify good and bad price discrimination. In fact, price discrimination makes it possible for certain customers to avail themselves of products and services that would not have been possible with a single price. For example, this is a story from NYTimes on pharma companies selling branded generics at lower prices:

As a result, some drug makers are pursuing a two-tiered strategy in developing markets: selling their own lines of more expensive name-brand products to the more affluent, as well as offering midpriced branded generic lines that include prescription and over-the-counter medicines for the broader market.

“We are able to create different tiers of products at prices they haven’t previously seen with our stamp of approval,” said Andrew P. Witty, the chief executive of GlaxoSmithKline.

What we need, I think, is a new brand for Price Discrimination, to move way from its current negative connotation and the negative press around it.

Here is my recommendation:

Price Harmonization: Has a nice positive ring (harmony) to it and is cryptic enough that it conveys nothing about the true intention of the marketer. Harmony does not have to mean homogeneity, it just has to mean “compatible, consistence, coincide in their characteristics”. You can look at it as making price compatible with customer willingness to pay.

Finally, a marketer practicing price harmonization appear to be doing something nobler than one practicing price discrimination.

Do you practice Price Harmonization?

Other similar pricing terms: Price Realization.