You go into Apple store and they charge you a price between $499 and $929

Jimmy Kimmel, in his Late Night Show on Halloween, was making fun of iPad Air pricing. It went something like this (you can Google the video),

“iPad Air costs from $499 to $929. You go in the Apple store and they randomly charge you a price between $499 and $929”

Isn’t that close to a profit maximizing marketer’s Holy Grail? People walk into the store and each one pays a price that is specific to them – their price at which they are happy to get the product over keeping the money.

Granted we would like unbounded upper limit – not constrained at $929 and we do not want it to be a random price, we want each customer to pay precisely the exact price they are happy to pay to get the product.

That is impossible in practice and likely is illegal. You wouldn’t like it that I get to pay only $199 for iPad Air (because I am far too happy with my iPad2) and you have to pay $879 because you just pulled up in your Tesla.

I also will not like it when they pick a random number  and ask me to pay that price. Except of course if it is like a Becker-Degroot-Marschak method where they ask me to first write down my price between$499 and $929, then they pick a random number between these two.

If the price I wrote down is higher than the random number they picked, I get the iPad Air at the number they picked, otherwise I walk out losing my chance to be “awesome” and damned to eternity in Luddite world.

Since forcibly charging different prices for different customers or randomly asking them to pay different prices is not possible, Apple has the next best thing in pricing – making customers willingly self-select themselves to pay the price they want by choosing the particular product version they want.

That is why Apple offers 8 different iPad Air versions to spread the price spectrum from $499 to $929. In some sense Jimmy Kimmel is not all wrong in saying, “randomly pay”, you could argue arrival rate of customers is random and the version they will like and buy is also random. Only thing is customers willingly pay that price and the marketer enables this with multiple price points.

Do not for a second think the prices are different because of the cost. You do not believe it costs Apple $300 or even half that to go from 16GB to 128GB do you? Compare this to cost of going from hard drive to flash in non-Retina MacBook Pro and you will understand.

The prices are different because we are different and we all value products differently and willingly pay higher prices than others for the same product.

That is just versioning done right.

In fact the price spectrum for iPad is wider than $429 to $929.

If you include iPad2 it is $399 to $929.

If you include iPad mini and mini Retina is is  $299 to $929.

There is no one price to rule them all. You build and deliver products at multiple price points to let customers choose the price they want to pay.

Before you go and introduce versions at dozen different price points, see also 4 costs of versioning.

Recognizing upside of price unbundling – Southwest says bags may not fly free

For a while Southwest has stood steadfastly against charging for checked-in bags. They ran several advertising campaigns delineating this clear absence  of extra fees. They told us bags fly free. They told us how the bag fees add up to additional $100 per leg. All the while other Airlines were happily charging us for our bags.

Revenue from bag fees alone reached $769 millions in 2010 (the peak of SouthWest campaign against bag fees).  While most airlines face some level of customer backlash they successfully overcame complaints with better management of reference price. Emboldened by their success Airlines (all but Southwest)  “drained the pond” to expose all the hidden obstacles to value capture.  After scrutinizing every freebie thrown in with the ticket they moved from charging for extras to delivering products that deliver value and pricing for that value delivered.

The result? $6.1 billion in new revenues and with huge upside potential from other service enhancements. After all cost reductions have a lower limit, you can only cut so much but revenue upside from value creation has theoretically unlimited upside.

Southwest stood by for the past seven years letting the revenue innovation pass by and not partaking in the fees growth. As I wrote before, it did not matter they were the only one not charging fees. Customers are trained to pay the fees everywhere and they are more than accepting of such fees. In 2008 I wrote differentiating on no-fees was not a good strategy for Southwest.  It could be argued fees are a fairness issue, shouldn’t passengers who do not checkin bags get a discount on their ticket price?

This week, five years later, we read they heard my message loud and clear.

Southwest CEO, Mr. Gary Kelly, said recently

 in one of his strongest hints to date that the policy could change, Mr. Kelly said that if fliers come to better understand and maybe even prefer “an a la carte approach…we’d be crazy not to provide our customers with what they want.”

Kudos to him for not holding on to a sub-optimal strategy just because they spent all these years supporting it. Not many have the courage to refine or toss out failed strategies, both due to sunk cost fallacy and fear of being seen inconsistent.

If the customers come to better understand value and are willing to pay price for it,  you too would be crazy not to provide that value at a price that lets you capture your fair share of value created.

What is your pricing strategy?

How to fix your wrong 1.0 pricing?

Fitbit, the San Francisco based maker of wearable fitness devices, recently announced a new device Fitbit Force. This new product launch comes less than six months since the release of their last device, Fitbit Flex. When you look at the two devices side by side they do look almost identical  with some feature additions.

The Force, as you can see, adds a display that gives more descriptive metrics than just four LEDs progress bar in Flex. Internally it also adds features like stairs counting.  It is still a product evolution. Yet, instead of choosing to call their new version as Flex 2.0 they chose to introduce a new brand, Force.   To give an analogy it is like Apple deciding to call iPhone 5s as  iPhone Force or some such name.

The answer to why they chose to introduce a new brand for a product evolution lies in how they chose to price Force. Fitbit Flex, when launched in May, was priced at $100. Force is priced at $130, a price realization of additional $30.  Surely you do not believe their marginal cost to add the tiny display or the altimeter is  $30 do you?

After  Fitbit launched Flex at $99, it is highly likely they realized that  a device someone sports on their wrist is lot more about image than about pure fitness. That is, in a basket of reasons why customers buy a product the hedonistic reasons outnumber and outweigh the utilitarian reasons. And hedonistic reasons carry higher willingness to pay over utilitarian ones (just look at the luxury market).

Another aspect is the profile of customer segment. Those who buy a fitness band to proudly display on their wrist are less cost conscious, have higher willingess to pay and have higher disposable income (wherewithal to pay).  So with $100 pricing, Fitbit was leaving too much money on the table by not capturing more consumer surplus.

They needed to fix this initial pricing mistake. And introducing 2.0 version was not going to do it because of previous reference price and its inability to properly serve the hedonistic aspect. Besides they would have to drop the price of Flex below $100 or discontinue it.

So they took a trusted play out of the pricing playbook – Shift the product category, which you can do by deliberate product positioning or by branding. With new brand, Force, they are telling their customers that this is a new category. More importantly their customers just want a reason to give more of their consumer surplus and this new brand gives them that reason.

Previously I wrote about this category shift in moving from free to fee. The same rules apply in fixing your past low price  mistake and getting price realization. It is a new device. It is a new brand. It is a new category. It breaks the comparison and helps them set a new higher price. It gives their customer a reason they are looking for to pay the new price.

Fitbit Force also took another additional step that results in better price realization. Flex ships with two bands for different wrist sizes. That was additional marginal cost with no profit driver. Force switched to one model one size, saving cost of extra band.  Don’t add a cost  component that does not serve a value driver.

Overall good moves by Fitbit. Not great, as I still believe there is more to be gained with even better price realization because wearable fitness devices are extreme form of hedonistic consumptions, they are conspicuous consumptions.

Can you think of another marketer who recently fixed their pricing using branding and category shift?  Amazon’s KIndle Fire HDX. Think about why they branded the new HDX thusly and its $229 price tag.

How do you fix your past pricing sins?

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.

 

Pricing Flash Storage in Tablets – Don’t Call This As Markup

The New York Times Bits blog laments about the giant markup Apple and Amazon charge on flash storage. Bits blog not only complains about the price vs. cost difference but also caught on to the price difference between Kindle and iPad for the same storage.

Kindle: 16 gigabytes for $300 and 32GB for $370; to enjoy 16 extra gigabytes of storage, a customer pays $70 more. For its smaller 7-inch tablets, Amazon charges $50 more for an extra 16 gigabytes.

iPad: You can get a 16GB model for $500, a 32GB model for $600 or a 64GB one for $700. That’s $100 extra for that first 16GB bump, then a relatively cheap $100 to get from there to 64GB.

At the outset let me point out I have lamented on the same topic as well but mostly admired it and only lamented it a bit as a consumer. Let me point out how the flash storage prices vary even within Apple’s different product lines,

Yes both Kindle and iPad are able to extract lot more consumer surplus with their flash pricing. That is because they figured out their customers value the additional capacity lot more and are willing to pay the additional $100 (or $70) for doubling capacity. This is not markup and the fact that flash costs 50 cents per gigabyte should not matter.

Using words like markup comes from cost based pricing (add up all the costs then mark it up to get the price, hence markup), as is shown by this text in the same Bits blog post,

Of course, when you buy a new gadget, you’re not just paying for a slab of components. The maker of the product is trying to get you to cover the cost of research and development, manufacturing and advertising, and still rake in some profit.

Note how sure the author is – “Of course, you understand the price you pay is …”.

Let me do my own convincing and point out that – of course  customers are not concerned about your costs. They are not paying the price to defray your costs. Besides R&D, Manufacturing and Advertising costs are sunk and are not attributed on a per unit basis.

Customers pay for what they value and marketers charge for that value. If marketers figured out a way to deliver the value at  the lowest possible price it does not mean they have to pass on the savings as lower prices unless they are forced (by market forces) to do so.

Call this effective pricing and don’t call it as markup.

As a customer do I lament alongside Bits blog? I do. But as a product guy I admire their pricing.

For extra credit see my articles on

1. Nexus 7 flash pricing
2. Second degree price discrimination infographic
3. Why Apple does not include earphones with iPad?