Dan Brown had the opportunity to decide how his new book, The Lost Symbol, must be priced (or more precisely when it should be released if it were to be priced at the standard $9.99 price). He decided that it would be better to reach as many readers as possible. Here is what he said to WSJ,
“As an author, you want your book to be available in as many formats as possible,” Mr. Brown says. “I know that some of my readers have e-book readers, and I wanted my book available for them.” He says it was ultimately a group decision.
From the author’s point of view the cost and efforts he invested on writing the book are sunk. There is also the risk associated with delaying the Kindle version, if for any reason the book turned out to be a flop then the expected Kindle sales could be much lower than what it would be if released at the same time as hardcover format.
But why would he not want to price it at the same level as the hardcover books or at a higher price point that the standard $9.99? People who prefer reading on Kindle know the trade-offs and prefer the Kindle version over the hardcover version. If the Kindle owners wanted to read the book at the same time as it was released then it should not matter to them that it is priced at the same level as the hardcover books.
Let us do some numbers. The lowest price one could pay for the hardcover version was $14.50 at Wal Mart (I am not sure if the price is still good). By choosing $9.99 price, the lost profit per book is $4.51 per Kindle version sold. To make up for the lost profit, the number of Kindle versions sold at $9.99 must be 45% more than it would have been at $14.5 price. Conversely, the sales at $14.50 must be at least 31% lower than it would have been at $9.99 to warrant a $9.99 price.
Either way you look at it, that is large sales increase (or drop) for the lower price to be more profitable. This leads me to believe that there was lost value (pun intended) by offering The Lost Symbol at the lower price.
In my work on unbundled pricing, I wrote about how restaurants can manage drop in customers and their willingness to pay by unbundling their pricing and charging separately for the many extras they provide. There were instances of restaurants charging separately for salad dressings and restaurants accepting cash only to save on credit card interchange they pay to banks.
Of course the other options I left out are more about maintaining price premium which include multi version pricing, price increases, better marketing to convey value and applying consumer behavior principles to drive profit. One restaurant that is successfully applying all these is Panera bread which delivered 28% increase in profit. The net is Panera bread is practicing the three components of effective price management to drive profit without resorting to unbundled pricing.
- Value-add to Segments: On the macro level they are targeting those who are employed and eat lunch outside. Specifically they are targeting those with spending power and making a relevant value proposition.
Panera’s target customer is 25 to 50 years old, earning $40,000 to $100,000 a year.To give those customers a reason to return, Panera has been touting new products with fresher ingredients. (WSJ)
- Incremental analysis: When almost every other restaurant is slashing prices and sending coupons to attract customers Panera decided to keep prices steady. As other restaurants found out the promotions came at a very high price and did not generate sales as expected. We can infer that Panera’s decision was based on their analysis of their demand curve and incremental profit from price promotions.
- Customer Margin: They do have lower priced options, but make higher total margins on incremental sales. For instance customer tab runs to $9.72 including drinks and other purchases.
One additional thing they are practicing is taking a lesson out of consumer behavior – offering a sandwich priced at $16.99 while most sandwiches are offered at much lower prices. The presence of $16.99 helps to set higher reference price in the minds of customers and helps to sell other sandwiches that are priced at $6.99. Not many may order the most expensive version but are nudged to order the versions that are priced in the middle.
When every other restaurant was dropping prices based on“conventional wisdom”, Panera ran in the opposite direction based on analysis. No wonder their profit movement is in the opposite direction to the rest of the category.
Procter and Gamble and Kraft, the two Consumer Packaged Goods (CPG) leaders, reported identical revenues and earnings growth in their last quarter. Analysts interviewed by Barrons magazine prefer Kraft over P&G for one major reason: Kraft’s pricing strategy that is focused on reducing discounting and solidifying pricing power in the face of competition from low priced private label.
Kraft Chief Executive Officer Irene Rosenfeld seemed confident that the days of branded foods being nibbled to death by cheaper private-label goods have come to an end. Rosenfeld says the company has expanded operating margins and plans to continue increasing its “pricing power.”
What about P&G pricing? According to Jason Gere of RBC Capital Markets, discounting and price cuts are not guaranteed to drive volume.
Although the company will likely spend heartily on price cuts, advertising and brand-building in the coming year, it’s unclear whether the strategy will work, says Gere, who rates the company at Market Perform.
Does P&G practice effective price management? Mostly it does, but analyst comments raises questions on some of the components.
- Value add to segments: Does P&G has multiple brands that appeal to different segments and keep the customers within their brand family as they trade down? I believe so. Mr.Lafley, Ex-CEO of P&G, made it clear that P&G will expand product portfolio to cater to changing consumer behavior.
- Incremental analysis: What is the incremental profit from price cuts and increased advertising spend? Jason Gere’s comments above seem to indicate there is uncertainty on this aspect.
- Customer Margin: Can P&G capture a larger share of customer spend? The decline in organic sals growth indicates challenges in capturing larger share of customer spend at the stores.
Ultimately it comes down to effective price management to drive profit growth and stock prospects.
Here is another CEO who clearly believes lowering prices does not automatically guarantee sales increase: Macy’s Terry J. Lundgren. In his inteview with The Wall Street Journal, Mr. Lundgren said,
WSJ: Do you think about lowering your average selling price or changing your product blend, as some of your competitors have done?
Mr. Lundgren: Here’s the challenge. We have [a men’s pants brand], and they typically go out the door between $29.50 and $32.50, with all the coupons and everything.
What Mr.Lundgren refers to as “out the door price” is the “pocket price“, the net price after all discounts. The net effect of the discounts and coupons is price leakage that erodes profit, clearly Mr. Lundgren is driving Macy’s to focus on its price waterfall.
Mr.Lundgren’s management serve as the best case study so for on the three components of effective price management:
Knowing the value add to segments:
Our purchasers are women. She’s spending the same amounts but just shopping with a great deal of discretion. Value is the word, even if it’s at regular price. The intrinsic value of what she’s buying is very important.
Incremental analysis: How much should sales rise to compensate for loss in profit from price cuts? (Lundgren is on the direction but he is comparing top-line while he should be doing incremental math on lost profit. There is also numbers error as pointed out by the commenter.)
So we were getting tremendous sell-through at low price points and no margins. And I am not making my pants sales for last year, because my average sale dropped by 30%. It’s really hard to make the math work. I have to have 30% more transactions on this product to break even.
Customer Margin: Understanding that loss leaders are effective only if they help generate incremental profit from customers who are attracted to the stores by low prices of loss leaders.
We and the manufacturer together agreed to mark them (pants) down to $21.99 or something like that. Selling like hotcakes. Every other pants around them stopped selling.
Does your business practice effective price management?
I want to discuss a great example of profit maximization pricing strategy I saw. There is a main parking lot right in front of the Boardwalk, Santa Cruz that charges $10 for an all day parking. Parking right in front of Boardwalk and crossing the street to enter the beaches is a great convenience to customers. Is $10 the price for the convenience? I am not fully sure, it could be more. Definitely it is not less than $10 judging by the occupancy rate of this lot.
As you drive into the town and drive towards Boardwalk, you see several signs advertising $5 for all day parking. Those parking lot owners know their lot is of less value to a customer because of the walk (however short) from the lot to the beach. So they price their offering to reflect the “negative differentiation value”. Those with lower willingness to pay and do not mind the walk will pick this option.
But the most interesting pricing is the one practiced by a hotel on the street that parallels Beach st and on the other side of the $10 parking lot. Clearly their lot is no way near the size of the commercial lot that charged $10. They only had handful of spots. They advertise a price of $30 per day and clearly one can see that the sign they had outside is not hard-coded, it allowed changing the price figure at their will. They are practicing dynamic pricing, based on the demand.
Their advantage is, by 2 PM the main parking lot is all full and the hundreds of cars are routed through the street the hotel is located. As one can judge from the traffic backed up miles away from the exit to Santa Cruz, there was practically unlimited supply of cars coming in. The traffic on the Beach street was inching its way around the block, as people kept driving in with the hope of finding a nearby spot. After spending 30 -60 minutes inching around the Beach st, some of the drivers are bound to feel their time and convenience is worth the additional $20.
Clearly the hotel’s pricing is based on the observation of years of traffic pattern and pricing based on customer demand. Note that the marginal cost for each spot is $0 and if they had priced the spot for $15 almost everyone would have taken it. But they only have limited supply of parking spaces. Clearly they did not want to reach the wider market and targeting only those with a high willingness to pay so they can spend time on the beach instead of driving around for a $10 spot. The dynamic pricing option allows them to drop prices as they see traffic slow or when they still have empty spots near the end of the day.
That is pricing for profit maximization!
San Mateo Municipal Golf Course (Poplar Creek), a city owned public golf course is seeing red. According to CrossCurrents Radio two factors are contributing to its losses, the interest payments on the debt the part took for renovation and the overall drop in the number of golfs played due to recession. The city considers Golf course as a public service and is reluctant to raise prices, so it is primarily focused on the cost side of the profit equation. This is a classic example of the need for effective price management. Here is a pricing strategy proposal based on my earlier framework.
Incremental Analysis: The investment they had made in the past for renovation is sunk. Before making this investment they should have looked at the incremental profit (in the form of price premium, increase in volume) the renovation would have brought. Based on this incremental analysis they should have proceeded with the plan if only if the investment was net positive. It turns out that it is not. So the decision needed now is whether or not they can operate the golf course profitably, if they cannot then get over the sunk cost fallacy and shut down the course.
Price Elasticity: The city is afraid of raising prices as it might turn off golfers. A few interviewed for the Crosscurrents radio expressed that they may not play if the price were increased. These do not represent the opinion of the customer base – Poplar Creek should know the price elasticity for its service among its city residents.It cannot be making decisions without this data.
Value Based Pricing: I tend to believe that golf course is not a public service since it is not essential to the residents. So the city should price it at what the customers are willing to pay and not to just cover costs as it does now. The golf course is a premium service to a few residents and hence it should be priced as such. the city should do a competitive analysis to determine reference price and determine the price it can set to capture the value it adds to its customers.
Segmentation: Price increase need not be across the board. Currently their pricing schedule shows differential pricing based on residency, age, 9 or 18 holes, time of day and day of week. This is good, but by segmentation I mean more than a price list. Their customers are all not unique and the value proposition is different to different segments.Understand these segments and the value add to each segment, offer them versions at different prices. For example, why would some segments pick only a public golf course and specifically this golf course? Is there a segment that values a less-crowded golf course more, if yes then can you offer specific days with a much higher price to only those with higher willingness to pay for this benefit?
Cost to Serve and Customer Margin: Understand the cost to serve each golfer and track revenue per customer that includes rentals and Pro-shop sales. Change your customer mix to have a higher proportion of high margin customers. Unbundle services and offer fewer amenities and services to those price sensitive segments (for example no guaranteed reservation for lowest price).
The city has an opportunity here to make the golf course profitable despite the weak economy and without increase prices across the board.