We raised prices to preserve our business model

This quote comes to us from Ms. Allie Webb, the Founder and CEO of Drybar a blow dry only salon. A blow dry salon is not like any hair salon. It offers, just as name indicates, blow dry and styling. Drybar is a pioneer in this niche and does $40 million in revenue a year. In an interview with The Wall Street Journal she was asked why  she raised her prices recently. And she offered this answer,

Ms. Webb: We always were $40 in New York. We tried to keep prices $35 [elsewhere] as long as we could, but you know things go up: rent, health insurance, incentives. There’s just a lot of different things that got more expensive. We had to raise the prices to keep the business model as it was.

I am willing to bet that someone as innovative and entrepreneurial like Ms. Webb, one who invented the category getting customers to pay for something they do for free, knows exactly why she raised her prices and is simply saying the best answer one could give to explain price increases. You have seen this done perfectly by Starbucks and repeatedly too.

We are increasing prices because …. ( anything but we found out customers value and charge that price).

Ms. Webb does just that, citing cost reasons, rent and salaries. I don’t have to repeat that a customer could care less about a marketer’s cost. Ms. Webb would be the first to admit that a customer getting their hair blown out does not think about offsetting Drybar’s rent. However using cost reasons to correct your past pricing sins is a perfect tool. It does allay customer concerns and push backs.

However what Ms. Webb added in the end is concerning.

We had to raise prices to keep the business model as it was

Again I believe she does not believe that statement. And no business should. You never raise prices to preserve your business model. Because your business model is nothing more than – how do you get your fair share of value you created for the customer. Pricing is the simplest way to capture the value created. If you are increasing prices without increasing value you are simply getting more than fair share of what you created. Such a business model is unstable and will be disrupted.

 

No one can preserve their model, let alone preserve it by raising prices. Someone else will always find a way to deliver customers more value, do it cheaper than you could and share a greater portion of that value with customers that you do. Your option is to do that before others do it to you.

Free to Fee With Product Positioning Shift

Have you been giving your product away for free and now want to charge for it? Afraid of backlash from your users? Wonder what would make your freeloaders fork over $4.99 a month without complaining about it in twitter?

I have been recommending businesses to focus on the reference price. That is the price customers have  been trained to pay and expect to pay for a product. Any increase from that reference price will be perceived as a pain by the customer and any decrease as a deal.

The reference price problem is severe when the price is frozen at $0, that is you have been giving away your product for free. Changing the price of a pint of ice-cream from $2.99 to $3.49 is difficult but not as difficult as charging $2.99 per week for access to your free online content. The latter is several orders of magnitude more difficult than the former.

Difficult does not mean impossible. You can indeed successfully move reference price in the minds of customers from $0. One such way is using choices, specifically premium priced choices as seen in this research,

Reference price solution alone does not address the free to fee problem says Uri Simonsohn, professor of marketing at Wharton School. According to him the second dimension is – It is the  category problem.

Imagine, for Thanksgiving, you go to your parents’ for dinner and after a nice dinner they say, ‘That’s going to be $10 per person’.

You would be upset.

We expect this category of products to be free like mom’s love is.

If we come to expect a product to be in “forever free” category then reference price is not going to cut it. Moving from free to fee for this category is like charging for mom’s love.

Is there a solution?

Yes – product positioning shift combined with reference price.

Customer Job To Be Done Growth Matrix

Think of your product as something your customers hire to fill a need. You have an active role to play in telling your customers what job you want them to hire your product for. That is product positioning.  When users have come to perceive your product in the forever free category you have a positioning problem. Somehow you have lost control of positioning and let them decide what job they want to hire your product for.

The way to shift that is to change the job – telling your customers what new job you want your product to be hired for. That is serving new jobs of customers (should we call them customers if they are not paying?) you already have.

This may require minor product changes – pivots- but the key is your deliberate action to take complete control of product positioning and telling customers which new jobs your products will serve.

Hopefully you will choose new jobs that they are used to paying for and not yet another mom’s love type jobs.

I, Pencil: My $425 Price Tag

If you have not read the original version of, “I,Pencil“, or the variations as told by many others here is a quick summary

The lesson I have to teach is this: Leave all creative energies uninhibited. Merely organize society to act in harmony with this lesson. Let society’s legal apparatus remove all obstacles the best it can. Permit these creative know-hows freely to flow. Have faith that free men and women will respond to the Invisible Hand.

You likely need no more commentary to see this is about free market economy and the power of invisible hand in setting prices, meeting demands etc.

The famous line from the essay is

Yet, not a single person on the face of this earth knows how to make me.

Be that as it may. It is true no one person can make the pencil on their own. But a subtle point to note is there exist a few who know how to set its price.  Despite what economists say, the pricing is not all left to the market to set. Economists don’t think segmentation, or product positioning. A marketer on the other hand starts with customer segmentation, product positioning and capitalizes on the pricing power that comes with it.

This is back to school season. You likely just bought two dozen pencils for less than $2. If you are willing to shop around you might find even cheaper prices. Price for such commodity pencils are indeed set by the market – by the supply and demand. Add to that retailers cutting prices further to sell pencils as loss leaders.

But those are just commodity pencils that are undifferentiated. More importantly these are pencils that are targeted at a specific segment. You would think  students. True. But think more in terms of needs – Group customers in terms of the common needs they are using a pencil for.

For the segment whose needs are just writing there are many alternatives. The pencil is competing against all those substitutes. And its price is determined by the value of writing to customers and the price of all other substitutes.

But when you take the pencil and position it for other needs, by targeting those segments with those needs and are willing to pay different prices for meeting those needs you have a different game in your hand. You are not any more competing for writing needs or competing against similar writing implements.

That is the story of $425 Pencil,

The Perfect Pencil in brown with sterling silver (925/1000) pencil extender with built-in sharpener and eraser is the perfect adjunct to the pencil. Writes, erases and sharpens

The pencil is not a product. It is simply a value delivery vehicle that you use to position for higher order needs for which customers have higher willingness to pay. Specifically pay $425 for Sterling Silver version or $260 for Platinum.

So what if you do not know how to make a pencil? You only need to know customer needs, specifically those needs that allow you to command a price premium and not be reduced to nameless commodity competing only on price.

Starbucks Price Increase Déjà vu

When it works why mess with it? Be it a product, price increases, or messaging?

I am talking about recent Starbucks price increase. You hardly even noticed that the prices went up – now or the past two times they did it.

Here is what they did four years ago – 8% increase in prices,  two years ago – 10% increase in prices and now –10% increase in prices.

The product mix they chose and the level of price increase, the markets they chose and how they are messaging it are all exactly same as their last time.

There are always other reasons for setting prices or raising prices and it is not about customer selection or pricing at what you can bear to pay.

Effective pricing is not just about understanding customers and demand curves but understanding how best to communicate that pricing to customers. And as an outsider, do not confuse this cost-driven price messaging with how exactly Starbucks sets prices. No company setting prices based on value will explicitly come out and admit that they their prices have no connection whatsoever to costs.

Recently Paul Krugman wrote about this disconnect between costs and prices in The New York Times,

To a large extent, the price you pay for an iWhatever is disconnected from the cost of producing the gadget. Apple simply charges what the traffic will bear, and given the strength of its market position, the traffic will bear a lot.

And as Krugman agreed in his piece, it is perfectly acceptable to have this disconnect (although he had some riders attached).

Let  us look at Starbucks case  of setting prices. Here is a point by point comparison of the last two times. It is déjà vu.

Product Mix Impacted and Level of Price Increase

Then:

the price for 12-ounce “tall” brewed coffees and latte drinks went up 10 cents.

Now:

” the price of a Tall brewed coffee is changing, the biggest rise would be 10 cents, Mr. Olson said, adding that he can’t share specific price increases of specific drinks in different markets for competitive reasons”

The reason they are going after the Tall size is highly likely it is their most popular SKU with little or no demand elasticity.  Increasing price on the lowest priced item will also help make the Grande and Venti attractive due to relative pricing.

Markets where Prices are Going Up

Then:

“Starbucks Corp (SBUX.O) raised prices by an average of about 1 percent in the U.S. Northeast and Sunbelt on Tuesday, making coffee-drinkers spend more in New York, Boston, Washington, Atlanta, Dallas, Albuquerque and other cities.”

Now:

“Starbucks Corp. SBUX -0.81% plans next week to raise prices by an average of 1% on some of its beverages in the U.S. It would mark the first price change in 18 to 24 months for some markets, the company said.”

Once again they are targeting specific markets and not increasing prices across all markets. You can’t make up such identical news items. It is the likely same markets (those that have customers with higher disposable income and fewer competition). It is the same “1% average increase” message.  The 1% average is true but average is meaningless. It is done here to make  specific price increases look smaller.

Messaging

Then:

The Seattle-based chain said its pricing decisions are based on multiple factors, not just the price of coffee, which has eased lately.

Those considerations include “competitive dynamics” in individual markets as well as costs related to distribution, store operations and commodities, including fuel and ingredients for food and beverages, Olson said.

Now:

 Increasing rent, labor and non-coffee commodity costs as well as competitive dynamics are the reasons behind the new pricing, Starbucks spokesman Jim Olson said.

It is same spokesperson too. I had to pause and check I was not reading old news article. The stories are that close. I wonder if Mr. Olson even talked to press this time or the PR team simply used his quote from last time.

When it works why not repeat it? Like the movie sequels I guess.

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

 

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

@rags Price matches on commoditized goods will be a cost of doing business. The solutions? Private label or UPP.

— Sucharita Mulpuru (@smulpuru) January 11, 2013

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.

 

On Pricing Low

Here is a comment on an old article of mine titled, Enough with the marginal cost argument,

Rags, there may be a pony in here somewhere, but I’m having trouble finding it.

In competitive markets with many substitutes, marginal cost is a the key to pricing. You may not like it, but it’s true. The start up costs may impact new players, but if the startup costs are already sunk, they are irrelevant. A rational player will grow market share by cutting prices until marginal cost is met. If you tried to compete with YouTube by charging to make up for your startup costs, you’d lose, right?

Now here is what the same commenter had to say in his own blog about low prices (of course I cannot be sure about the identify of the person who commented on my blog, looking at the phrases it is highly likely the two are the same)

If you build your business around being the lowest-cost provider, that’s all you’ve got. Everything you do has to be a race in that direction, because if you veer toward anything else (service, workforce, impact, design, etc.) then a competitor with a more single-minded focus will sell your commodity cheaper than you.

Cheapest price is the refuge for the marketer with no ideas left or no guts to implement the ideas she has.

I like his second version of the pricing principle. May be he had a change of mind? It is far better to find a segment that values your product and deliver them a version at a price they are willing to pay than try to capture market share with a commodity product at or near marginal cost.

Marginal cost is relevant only to set the floor and not the price you should charge. You don’t have to like it, but it s true.