Walk away, don’t play chicken with Amazon

I do not know why businesses refuse to learn from the past and why they insist they are different from all others who came before them. Admit it now, it is okay, no business can take on Mr. Bezos and Amazon on price leadership at the low end. Don’t get into the ring. Don’t wage a war. It won’t be a war, it will be quick skirmish in which  you will be thoroughly destroyed and forced to issue statements like,

“it was an experiment and we achieved what we set out to achieve”

This time the brave new knight to get into price war with Amazon is OverStock.com. They announced a daring campaign – a promise to sell books 10% below Amazon. Not just match prices, which would have been a signal to Amazon to not drop prices but sell 10% below. And what did Amazon do? GigaOm reports

Amazon is quietly slashing its own prices on print books. In a special report over the weekend, trade publication Shelf Awareness noted that Amazon has begun “discounting many best-selling hardcover titles between 50 percent and 65 percent, levels we’ve never seen in the history of Amazon or in the bricks-and-mortar price wars of the past.”

These are far greater than the usual 40-50% discount Amazon usually does. Where does that leave OverStock.com? Is it ready to sell below the 65% discount Amazon offers?

When it comes to price setting there are two kinds of companies – Price Setters and Price Takers. Apple is a Price Setter at the high end. Amazon is the undisputed Price Setter at the low end. A rational low end Price Setter may look at cost advantages to maintain leadership. But Amazon is no rational player. At least that is what they want all of the market to think.

Amazon has adopted a deliberate irrational strategy, signaling others they are not going to play by someone’s rational expectations.  You should be careful in waging price wars with such irrational players.

if you are playing a game of chicken in cars, if you were to break the steering wheel and toss it out the window in front of your opponent then he knows you are not going to swerve. (source: Art and Science of Negotiation). That is strategic irrationality.

In the game of chicken played in retail prices, Amazon is such a strategically irrational player. Mr.Bezos has signaled to all other players that he has thrown away his steering-wheel and placed a brick on his gas pedal. They are not going to let up on lowering prices and they can keep at it as long as they can because they have the full trust of their shareholders.

Even this morning CNBC’s David Faber was talking about Amazon stock prices and investor behavior. Even after Amazon reported a loss its stock did not suffer much. Faber quipped, “may be Amazon should have reported larger loss so its stock could have gone  higher”.

In 1999 Barron’s magazine warned investors about Amazon. Then its market cap was $19B, now it is $141B.  Amazon practices strategic irrationality while investors seem to be equally irrational, strategic or not.  There is no expectation what so ever from investors on profit.

Let me repeat my advice. Don’t bother. Don’t get into price war with Amazon. Walk away. You are not going to dismantle Amazon as Price Setter at low end. Instead focus on customer segmentation, product mix and differentiation. You have far better chance of succeeding there because your competitors there are far more likely to be rational.

Finally, let me predict something for Google Nexus 7 – the next Kindl Fire is going to force it to slash prices.

Is Target’s Price Matching Policy a Mistake? Yes, but not for reasons HBR says!

English: Logo of Target, US-based retail chain

 

Rafi Mohammed, a Harvard Business Review blogger asks, “Is Target’s price matching policy a mistake?”. If you have not been following the price wars, Target stores recently announced that they will match published prices of their competitors.

 

If you buy a qualifying item at a Target store then find the identical item for less in the following week’s Target weekly ad or within seven days at Target.com, Amazon.com, Walmart.com, BestBuy.com, ToysRUs.com, BabiesRUs.com or in a competitor’s local printed ad, we’ll match the price.

Back to Rafi’s question. The answer is yes. But not for the reasons Rafi offers in his HBR blog post.  As I wrote recently, Target’s policy is wrong because they are taking on a competitor who is strategically irrational.

Rafi’s argument, surprisingly (surprising because Rafi is a pricing professional) is centered around the cost to operate brick and mortar stores.

Amazon for example — have significantly lower cost structures than brick and mortar stores? That makes it close to impossible for a chain to set the same product price both on its web site and in physical stores that is competitive with an Internet-only retailer and still yields a profit.

This is confusing cause and effect. Amazon chose low prices and then cut its costs mercilessly to deliver products at such low prices. Target chose to reach customers with higher willingness to pay (and disposable income) and offer them a store experience to buy products. They incurred the cost of operating stores for two reasons, one they needed to do that to deliver customer experience and two they could still make a profit from the higher prices customers were willing to pay.

Prices come before costs. You don’t incur costs and expect your customers to offset that with higher prices.

Rafi’s recommendation for Target is,

Target should instead match prices of online rivals with a comparable “apples to apples” service: order from Target.com. If a customer sees a lower online price, Target will match only if ordered from Target.com.

It does not work that way. What is the differentiation here? What compelling reason does Target.com offer to those who otherwise would choose Amazon (based only on price)? I should note that Rafi is also the proponent of 1% price increase philosophy, and that recommendation does not work here as well.

What are the real recommendations? If prices come before costs, customer segment and their needs come before prices. So any pricing strategy recommendation to Target must start by asking what customer segment does Target want to reach  and what should be their offering (product mix, service and delivery model)? May be it is the equivalent of “same day delivery”, or a unique product mix that isn’t available in other channels, or the ease of returns. Target has to find out what is relevant to its target segment and decide.

In my tweet question to Forrester Retail Analyst Sucharita Mulupuru, she replied

For same products where the channel adds no value, she says, charging higher prices is not going to be possible. Her two recommendations are developing private labels (that can yield price premium as well) and Unilateral Pricing Policy (UPP) where the manufacturer sets a fixed price that all channels have to sell for.

If you take this to the extreme, it is likely we will soon see total vertical integration in retail channels – from the very devices we use to browse and buy,  to products we buy  and even the method of payments we make. Not far fetched if you consider the reasons why Amazon is trying to get Kindle in every hand.

And yes, HBR is right but how it arrived at the answer is wrong.

 

Waging Price Matching War

In game theory they talk about deciding your move based on what rational opponents would react. A variant of that strategy is to convince your opponent that you are no where near rational so they better not expect you to do the rational reaction to your action.

For example if you are playing a game of chicken in cars, if you were to break the steering wheel and toss it out the window in front of your opponent then he knows you are not going to swerve. (source: Art and Science of Negotiation). That is strategic irrationality.

In the game of chicken played in retail prices, Amazon is such a strategically irrational player. A recent BusinessWeek article screams

Amazon’s Jeff Bezos Doesn’t Care About Profit Margins

Mr.Bezos has signaled to all other players that he has thrown away his steering-wheel and placed a brick on his gas pedal. They are not going to let up on lowering prices and they can keep at it as long as they can because they have the full trust of their shareholders.

The right move in this game is not to do exactly the same and agreeing to match prices. But other retailers don’t seem to get it.

Target is the latest retailer who decided to play the price matching game not realizing their opponent’s stated irrationality. Target announced they will match all Amazon prices if customers can show proof.At least, unlike BestBuy’s mistake of making it easy for customers to get the price match, Target has added manual steps for customers. But that isn’t enough to stop the bleeding – either customers will do that additional work or simply go to Amazon.

If one player in a market says they will match any lowest price in the market the rational move for others is not to lower their prices because they get no advantage from it and only erode their margins. But Target is not dealing with rational player.

Fundamentally, by agreeing to match Amazon prices, they are saying their store provides no unique products, no unique value and  is undifferentiated from an online store. The right strategic move would be to ask,

“what unique value the store provides to its target customers and what is the right product mix that makes the customers buy from them”.

Even if this would result in severe revenue reduction – because they end up eliminating many products from their shelves – in the long run it would help make Target a profitable venture.

Instead they chose to play the game of chicken with with an opponent who has given up on steering.

This isn’t going to end well for Target. Circuit City here we come.

Waging the right price war – The $65,000 Mistake

I believe “price war” may be a misnomer if both sides do not live to fight many rounds. We only see price battles or skirmishes that go for 1-2 rounds before one side throws in the towel or runs out of cash. There are two kinds of companies when it comes to price wars.

Category 1: There are just handful of companies that can wage incessant price war  by consistently keeping their prices low

Category 2: Even fewer that can withstand such low price attacks by their competitors.

Amazon.com and Walmart fall into the first category. Apple is in the second category.

In fact if the two players know that the other has the will, reserve and wherewithal to keep up the fight without ever letting up they most likely will choose not to enter price war in the first place. This is very much like nuclear deterrent  — mutually assured destruction.

BestBuy does not fall in either of the categories but was tempted to take on Wal-Mart with its iPhone 5 pricing. The result? BestBuy lost $65,000 in a single day.

Let alone the price war dynamics this is simply the wrong fight to pick. A tactical blunder.

First the product is not yours and the customer has many alternatives. Most are willing to pay full price at Apple stores. Customers do not think where they buy is important when it comes to iPhone (a qualifier is some insist they buy only after standing in line in front of Apple stores).

Second Walmart did not cut the price uniformly across all stores and did not make available unlimited quantities. Agreeing to match the price on such promotional tactic is simply wrong. It appears smart deal-seekers, instead of running from one Walmart store to another, simply walked into to neighborhood BestBuy and asked for the low price match. How convenient.

Finally, the low price was not attached to any other product sales and not designed as a loss leader that would help maximize customer margin.

And the result? Deal-seekers walked in, probably for the first time in many months, bought the $127 iPhone 5 and walked out without buying anything else. That is the $65,000 loss in a day.

Other readings:

See here for Waging Effective Price Wars.

See here for Effective Pricing

 

 

What if Customers don’t Want to Hire Your Products at Any Price?

Lot will be said and written about the nook and Kindle price war. Success of iPad will be quoted as the reason for the price cuts. Comparisons will be made to razor and blades and why the reader should be free. Will the price cut increase footprint and convince customers who would have bought iPad to buy nook or Kindle instead?

Let us ask the key question on product positioning for nook and Kindle:

What job will the customer hire the product for?

Kindle is applying for the job of, “Easy to read, even in sunlight.  Carry all your books with you.”.   nook is applying for the same job as well. In other words nook and Kindle are paper book replacements. Yes there are social features, and free books in stores (nook) but these are add-ons.

To some segments this is the job they are hiring for. As Mr.Bezos said, this is for serious readers to read without distractions. He also said that less than 10% of reading population are serious readers. For this segment that has decided on the job, they will choose on cost to hire for that job. So the price cut by nook threatened to take away customers who would have bought Kindle hence Amazon had to respond with its own price cut.

Will the price cut make the product attractive to segments that are not looking to hire for the job of easy reading? The answer is mostly likely no.

What job is your customer hiring your product for?

Buying Loyalty – Does Drop In Defection Make Up For Lost Profit From Price Cuts?

In my previous post on MetroPCS $10 price drop I overlooked a key aspect – increase in profits from customers staying longer because of the price cut.  Thanks to Gerardo Dada for pointing out the scenario of increased customer retention. In my previous model I accounted only for new subscribers and said they needed an additional 1.65 million subscribers (to their current 6.6 million sbscribers). The correct model for break even profit should look like

Lost profit per month =  Incremental % customers retained * 6.6 * $40 +

Incremental new customers * $40

units are $ million, and $40 is revenue per customer and marginal cost is $0.

The two extremes are

(1) No change in churn rate (currently 1.77%), which means MetroPCS must add 1.65 million new subscribers (add 25%)

(2)No new subscribers added, which means they must retain an additional 25% of customers. Since their current churn is 1.77% per month, this case is impossible.

The best churn rate in the industry is 1.1% (AT&T). That is for its subscribers under 2 year contract and driven by iPhone. Even if MetroPCS can reach this level, that is a savings ofonly $1.77 million, it still needs 1.6 million new subscribers to make up for the lost profit.

The net is, while price cuts  help stop customer defection they resulting increased profits are not enough to make up for total profit lost. Brands need to find considerably large number of new customers to make up for lost profit from price cuts.

I stand by my previous claim, price wars lead to value destruction!