Answer to Pricing Puzzle – Pricing Lactaid Milk at Trader Joe’s and Target

This will be a nice reference price question to test for behavioral economists like the beer on the beach question by Daniel Kahneman. My hypothesis, you will find either no difference or higher price quoted for Target.

Run a split test with,

I am going to Target to get some stuff. I will get your Lactaid milk there. How much are you willing to pay?

OR

I am going to Trader Joe’s to get some stuff. I will get your Lactaid milk there. How much are you willing to pay?

But I digress.

For those who are not aware, Lactaid is the brand of lactose reduced milk ( reduced using lactase enzyme). It is generally priced twice at much as regular milk. Instead of buying Lactaid, one could buy regular milk and lactase and mix it themselves. But what Lactaid offers is convenience and for the limited segment that wants milk despite their intolrenance and values convenience. So a higher price makes sense.

Lactaid is a national CPG brand, available in most stores. So why is it priced higher at Trader Joe’s?

Another argument is cost based. Target, a bigger retailer, has pricing power with suppliers. Since it can negotiate a lower price it can charge lower price to its customers. True but the cause and effect are reversed. Target wants to serve lot more customers that have lower willingness to pay. Once they decided the price they work with suppliers to bring the cost down. Not the other way. Think about prices of other products (granted not same brand). Does the cost argument holds?

One line of argument is, it is not just the product, it is the store experience. The price of store experience is built into the milk. Partly true. Then you must run the behavioral experiment I stated in the beginning.

The answer, as in most pricing cases, starts with the customer.

A Trader Joe’s customer goes there for different reasons than they go to Target (likely same customers but they hire the stores for different reasons). They go to Trader Joe’s for its unique product mix, experience etc. but definitely not for getting Lactaid milk.  If I remember correctly that is the only major CPG brand I have seen at Trader Joe’s. Most of the product mix is  made of store brands or smaller regional brands.

Those customers seeking to buy Lactaid at Trader Joe’s is looking for convenience. They are at the milk aisle for the rest of the family and want to complete their milk shopping list by avoiding one more trip to another store or its milk aisle.

There are likely not many such customers (most  likely TJ’s customers are Target customers as well). So for that limited segment that values convenience and needs a specific product, the willingness to pay is higher.

Since they can charge this higher price they are likely willing to pay higher price to suppliers to stock the milk in their shelves.

No customers. No products.

Price always comes first then costs. And for pricing, customers and their needs come first, then everything else.

Explaining why it costs even more at Whole Foods is left as an exercise to the reader.

Answer to Pricing Puzzles – Restaurants Charging Fee for Sharing

I tweeted a series of pricing puzzles. This series is my interpretation of what the answers could be. Do not treat them as absolute answers. Alternative explanations are possible.

There are two parts to this question.

  1. Why do restaurants charge a fee for sharing?
  2. Why do they charge two different prices based on what is shared?

It is safe to say that those willing to share are most likely couples and they likely pay for it from the same shared budget. For everyone else, those not sharing budgets, the question of sharing does not even come into play.

A restaurant’s goal is to maximize spend per table.  Their wait-staff are essentially the sales team trying to generate more sales per table during the period it was occupied.

So when customers share, it cuts (almost in half) the spend (and hence profit) per table. To discourage customers from doing so, they make the price of the single entree look a little more unattractive by adding the split fee. This is second degree price discrimination. With the split fee, customers may see higher value (consumer surplus) when they order two vs. one.

For those who still want to share for any number of reasons including limiting portions, even with added fee sharing will provide higher consumer surplus and the restaurant gets to recoup profit.

Why charge different split fees? Price discrimination done right. If you charge one split fee, you might as well charge two.

Should they do it? What about customer backlash?

To repeat my earlier point, this is a limited segment that will share food. The rest won’t even notice the split fee.  So by all means do it as this is money that flows straight to bottom line. However they should consider their customer mix and capacity utilization.

What does this mean to you as a Tech Product Manager?

I do not recommend you following in the restaurant’s footsteps. Start with the customers and their needs. Consider how your webapp is being used by your customers.

  1. Do they share login?
  2. From what budget are they paying for it?
  3.  Is there value for them in keeping separate logins?
  4. Do they want to keep their Netflix video queue/history or Evernote clip archive separate?
  5. Do they consume your limited capacity without adding to revenue?

My recommendation: Instead of trying to tack on split fees, make the price of adding second (or third) user attractive that most will do it.  (Like SurveyGizmo did)

 

Pricing Strategy Vs. Pricing Parlor Tricks

A research paper published in Journal of Consumer Research, Jan 2012, found that how we present pricing affects perception

Presenting item quantity information before price (70 songs for $29) may  make the deal appear much more appealing than if the price were presented first ($29 for  70 songs).

There are many similar peer reviewed research reports that found behaviors like,

Customers are more likely to prefer prices ending with digit 9

Customers are immune to higher prices when you don’t show the $ sign

Customers pay higher prices when you write the price in words instead of numbers

Customers succumb to decoy pricing (present three options but one is asymmetrically dominated by other and hence a decoy)

Through books and TED talks these  academic reports seep into popular media and are presented as pricing lessons for businesses small and large, especially for startups. After all, these are peer reviewed research reports based on controlled experiments that found statistically significant difference, published in reputable journals and hence worthy of our trust?

May be these are true, but what do they tell us about the customers and their needs? What job is your customer hiring your product for when they pay this cleverly presented price?

The problem is these behavioral pricing tactics may just be statistical anomalies. Let me point you to a xkcd  comic that so nicely makes the point I am about to make . After what xkcd has to say, anything I say below is redundant.

Let us take the first research I quoted, “70 songs for $29 vs. $29 for 70 songs”. What could be wrong here?  Well, why specifically 70 and 29?  What other combinations did the researchers test and what are the outcomes? What about 60 for 25, 50 for 20 etc etc.

Is it possible that they had tested 20 different combinations and found that just this one produced statistically significant difference? (Like the green jelly beans in xkcd comic?). Did the researchers stash away all the experiments that produced no results and published  the one that produced this interesting result?

An opinion piece in Business Strategy Review, published by London School of Economics, pretty much says this is the case with most research we read.

The problem is that if you have collected a whole bunch of data and you don’t find anything or at least nothing really interesting and new, no journal is going to publish it.

Because journals will only publish novel, interesting findings – and therefore researchers only bother to write up seemingly intriguing counterintuitive findings – the chance that what they eventually are publishing is BS unwittingly is vast.

Pretty much we cannot trust any of the research we read.

What are likely statistical flukes get published as interesting findings on pricing and find their way into books, TED talks and blogs. The rest don’t even leave researcher’s desk. Let alone academic journal, try writing a blog post that reports, “found no statistically significant difference”. Who will read that?

What we are seeing is publication bias that is worse than any sampling bias or analysis bias and a prevalence of pricing parlor tricks presented as authoritative lessons in pricing for businesses.

When it comes to pricing your product, be it pricing cupcakes or a webapp, you would do well to look past these parlor tricks and start with the basics.

Pricing strategy starts with customer segments and their needs. You cannot serve all segments, you need to make choices. Choose the segments you can target and deliver them a product at a price they are willing to pay.

As boring and dull as it may sound, that is pricing strategy. Your business will do well to start with the most boring and dull than chasing the latest parlor trick based on selective reporting.

Everything else is distraction. May be these fine tunings have some effect but not before strategy. After you get your foundation right, then you can worry about what font to use in the sign board.

How do you set your pricing?

Other Readings:

  1. Segment-Version Fit
  2. Five Ways Startups Get Pricing Wrong
  3. Small Business Pricing
  4. Three Components of Effective Pricing
  5. Approximate Guide to Pricing Webapps  (buy access for 99 cents, pun intended )

Why are @Pinkberry yogurt flavors priced differently?

This is yet another questions only article. Answering the questions is left as an exercise to the reader, which you can do from other articles in this blog.

Take a look at the picture of menus from Pinkberry frozen yogurt chain. The one on the left is the online menu for their New York stores and the one on the right is from one of their stores in California. You may notice the price difference between New York and California for the same flavor and size but that topic is not the question I want to pose here.

Notice the price difference between Original and  Flavored varieties for a given size? (click on the image to enlarge it)

Notice how the price difference varies between the two states?

In New York,

  • The smallest size, Mini is priced the same for Original and Flavored varieties
  • For the rest of the sizes, the Flavored varieties (all flavors) are priced 50 cents more than the Original
In California the prices are different across all sizes,
  • Mini is priced only 50 cents more than the Original
  • The rest are priced $1 more than the Original

Why are the Original and Flavored varities priced differently – between the two states and between sizes?

Before you answer this question let me point you to a research that asked a different question.

Why are strawberry and raspberry yogurts priced the same?

The yogurts in this question are the normal kind we find in supermarket aisle. The researchers who studied the question by looking at store sales numbers concluded,

We find that consumers value line attributes more than flavor attributes. Given that consumers value line attributes more than flavor attributes,  firms have a lot to gain by pricing their product lines differently whereas they have little to lose from pricing all flavors within a line the same. We also find that the value of a product line is not merely a function of the number of  flavors it includes

Now you can think about the answer.

For extra credit, think about the cognitive cost to customers making purchasing decision from the price differences between Flavored and Original choices.  Do you believe the additional profit is worth the cost to customer and the likely degradation of customer’s buying experience?

Do self-serve yogurt chains like Tutti Frutti that offer same price for all flavors and toppings are at an advantage in both delivering better buying experience and average sale price?

 

Bye Bye Price Tags, Price Lists, Pricing Pages, Posted Prices

What is the price?  The question almost all of us ask before we make our buying decision.

Is the price right? That we do not know.  But we want to see the price. Hence there are posted prices everywhere you go.

  1. Price tags on the garments
  2. Price labels on store gadget displays
  3. Prices written on chalkboards in cafes and markets
  4. Price lists (or even price books) published by B2B marketers
  5. Pricing pages of  webapps – presented in spectacular designs too

Marketers present prices and let the customers decide. No surprises.

Withhold the price information until after the customer consumed your product you are bound to shock them. We saw this with Uber’s dynamic pricing during New Year’s eve. We also see  this in case of restaurants that charge “market prices” for their daily specials.

So we see published prices for everyone to see. We see several visual clues to tell us that the price is a “steal”.  There are multiple price stickers, sales stickers, discount stickers.  After all these, there is still one price – one price offered to everyone willing to make the purchase.

But charging a single price for a gadget or an entree does not maximize the profit a marketer can make. When you set a price for a gadget, there are

  1. some who are willing to pay that price
  2. some who would not buy at that price but would pay a lower price
  3. some who would have gladly paid more but are happier with the lower price you are charging

It is easier to see that in case 3 you are giving away too much and hence losing out on profit.

In case 2, as long as you can produce the gadget cheaper than the lower price the customer is willing to pay you are missing out on that profit (however small it is).

By showing the same price to all  you give up on these two profit streams.

If only you can show different prices to different individuals. Their own price that others cannot see. That is the holy grail of perfect price discrimination – First Degree Price Discrimination.

But we do not walk around with the prices we are willing to pay pasted on our foreheads, nor can a marketer show the price to one but not to others.

Until now.

What if we are indeed walking around with the prices we are willing to pay pasted on our forehead?

Well not quite but close. We may be doing close to that with our real life and online social media behavior. We saw discounts on our insurance for our real life behaviors. We have seen cases where Capital One was showing different interests rates based on your web browser. The next step is to not quite unimaginable. It is indeed possible to feed your Likes, Status messages, Photos, Locations, Friends etc into an algorithm that can give with reasonable certainty your willingness to pay for different goods.

The second part of the puzzle is how can that price be shown only to you?

The disruptions that are happening in the form of mobile payments and app based purchases are addressing that. You can see how easy it is to do that for online purchases. It is not a stretch to extend that to offline brick and mortar store purchases. Your price is shown only when you scan the barcode or read the RFID with your mobile wallet.

Everyone sees their price, that no one else can see. Taking us closer to perfect price discrimination.

It does not end there. Customers’ willingness to pay is not a fixed number. It is malleable. Once customers open their mind a little through their social media behavior, they are are also opening a control channel to the marketers. A channel that will help the marketers nudge customers to pay a higher price than what they would have otherwise would have paid.

It is a brave new world. World with NO price tags, price lists, pricing pages and posted prices of any kind.

As a marketer, rejoice. As a customer, be worried.

Fixing Past Pricing Sins by Price Unbundling

Price unbundling is back in the news after its big splash during the recessionary times of 2008.  Most people do not use the phrase “price unbundling” or “unbundled pricing” in their everyday vernacular nor do they use it label the trend. Customers and newsmedia call it, “nickel and diming” or “squeezing the customer for extras”. Before we go further definitions are in order.

Unbundling is not the opposite of Bundling nor as the name implies undoing a bundle. Marketers deliberately introduce bundles for several reasons, I discussed a few of them here. Primary reason is customer perception of value. Take a sample case of two products A and B and two customers P1 and P2. Bundling of A and B delivers better profit when P1 and P2’s value perception of A and B are reversed. Before the bundling A and B were valued albeit differently by customers. Unbundling is not the case of reversing the decision the previous decision to bundle A and B.

Unbundling is breaking down a product or service that was perceived as a monolith and charging for parts that used to be included. Marketers did not start with two or more products that each had a customer demand, value and price.

A required condition for unbundling is the component that is being unbundled must be truly optional – selling left and right shoe separately is not unbundling.

So why didn’t the marketers start out by pricing separately for the included components?

  1. Either the components were not separately consumed. Likely no one wants to eat airline food without traveling in one as well.
  2. Even if they could be, the marketer had a different source of revenue that delivered higher profit than charging for the extra.This is the case of bank debit cards, banks were able to charge the merchants an interchange fee. It was easier for banks to drive up debit card  adoption and usage by including it for free as part of the “whole” because each transaction  brought revenue from the merchants.

All is well with these free extras if their current cost, market, demand and ecosystem dynamics remain unchanged. But what if

  1. The product price is inflexible due to regulations, competition or other reasons. For instance they can’t increase the price without drop in demand that will adversely affect profit.
  2. The other source of revenue dried up as in the case of debit cards. The new regulations severely cut the merchant fee and banks are stuck with a service they adds value to customers but nothing to the banks.
We should not lose sight of the fact that these extras do add value to customers and are truly optional (as I stated above). Since the marketers chose not to do value signal and not to charge for it, the reference price for these extras are stuck at $0 in the minds of customers.
It was their past sins – giving away more than what the customer wanted or rewarding one side with value gained through other sources – that leads marketers to unbundling.
When the marketers, airlines and banks, try to charge for this value-add without focusing on the customer reference price they face extreme backlash. Any price higher than the reference price will be seen the customer as unfair. It is especially hard when the reference price is $0.
So how can a marketer roll out unbundling without customer backlash?
  1. Maintain reference price of components even when they are included with the whole. Take the case of amazon free shipping for purchases over $25. Amazon always lists the shipping cost and then subtracts it.
  2. If they neglected to do this step the next best option is to improve the reference price before charging for it. There are many ways, one of them is to use options and another is to use cost signaling.
It is easier to not commit the original sin of including lot more than the customer wants and even if you did maintain the reference price.