Price Realization Through Creative Packaging

This is how you do better price realization through creative packaging without upsetting customer reference price.

Customers are used to $3.49 price they pay for similar almond bars but with less than half of protein. Nature Valley could have introduced the new protein bar at higher price to attract different customers. But they found it is better to appeal to their regular customers if they can get better price without unsetting their reference price of $3.49.

The result is the creative packaging – maintaining same box dimensions and reducing the number of bars from 6 to 5 – a 16.7% savings in marginal cost that flows directly to profit.

Did you know there were only 5 bars in the Protein bar box? I didn’t until now.

And there is absolutely nothing wrong with better price realization through creative packaging.

 

Forced to Choose Between Profits and Customers

Customers or Profits – is that a fair choice?

Do businesses really have to decide between making profits and serving their customers?

Stated another way, when businesses decide to make a profit do they do it at the expense of customers?

There are two really prominent business leaders, one from Japan and another from USA state so. The first is the CEO of SoftBank, Mr. Masayoshi Son, who has declared war on AT&T and Verizon Wireless with his investment in Sprint and his declaration to wage in price war. He declared,

(AT&T and Verizon) are burdened with the need to keep shareholders “rich and happy” with healthy profit margins and big dividends.

He signaled his intention to wage a price war to force the two leaders pick between keeping shareholders happy vs. keeping their customers happy. Just when AT&T and Verizon did an elaborate (and this time explicit) price signaling dance to get better price realization they may see themselves pulled back into a price war with Sprint.

In case of Amazon’s Mr. Jeff Bezos he strongly signals that his strategy is not to make profit by pricing high. In his open letter to customers on Kindle Fire he wrote, “There are two kinds of companies”

Amazon’s approach to eCommerce has been to completely drain the profit out of the market with lower prices and beat the competitors with better cost structure and efficient operations. It has been successful as a retail channel, forcing some to go out of business and the remaining to match its low prices. Notably Best Buy that suffered the biggest impact of showrooming could be next according to this report.

Is the choice really between profits and customers? Do companies that work hard to charge more face imminent demise?

Definitely not.

Businesses thrive not because they work hard to charge customers less but because they offer best products that fill compelling needs at prices customers are willing to pay.  That’s what is happening with Apple, REI, Lulu Lemon and all other luxury products. Apple makes more hardware revenue than entire electronics category of Amazon. If customer choices are driven only by lower prices this wouldn’t be the case, would it?

Businesses fail not because they work hard to charge customers more but because they have been charging for value they did not help create and hence it was not never theirs to begin with. That’s what is happening with Best Buy, Sears and other retailers who keep charging for value that customers do not get or want. Their strategy had been to open big box stores in affluent suburbs and hope customers didn’t mind the prices. They didn’t until they found alternatives. And now it is not these customer’s responsibility to offset the cost of bad strategy.

To be precise it is not a choice between profit vs. customers, profit come from customers,

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.

A restaurant in Palo Alto charges $2 to split pasta and $3 to split an entree, because _____ (Hint: not costs)

— Rags Srinivasan (@rags) April 7, 2012

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)

 

Will Apple introduce $299 iPad?

There  are rumors in Tech Blogs that Apple might introduce a cheaper iPad – could be a 8GB version or a 7-inch version, priced close to $299. The argument goes, Apple does not want to yield the lower priced tablet market to Amazon. If Amazon took the risk to invest in 7-inch tablet and uncover a market for it, there is likely no risk for Apple to take its share of the market.

So should or will they do it? (Let us not consider here what Mr. Jobs said about 7 inch tablets)
If three to five million people bought 7-inch tablets in the last two quarters, isn’t that an opportunity for Apple? Not to mention, those who are on the sidelines, because they did not like Kindle Fire and could not afford $499 price tag may enter the market, expanding the pie.

All highly likely scenarios. But there is a third scenario of similar likelihood that most ignore when making a case for introducing a new lower priced version of the product. It is those who currently buy their $499 version switching to the $299 version.

Without going into the details of Second Degree Price discrimination here is a brief description. When there is no $299 version of iPad, if the $499 version offers you enough consumer surplus you will buy it. When there is a $299 version as well, you will pick that instead if it delivers more consumer surplus than the $499 version.

The question Apple will ask (but not the Tech Blog savants who are often wrong but never doubt their claims) is,

Is the foregone profit from those trading down made up by profit from new customers we acquired?

You can see their track record of past product versions (iMac versions  and MacBook Air versions)  we can say with high degree of certainty that Apple will ask this question.

If we used the previously published numbers by iSuppli and others on cost of iPad, it costs Apple about $249 to make $499 iPad. Say their gross margin remains the same for $299 iPad (i.e., cost drops to $149). Then for every customer trading down from $499 to $299 version, Apple has to bring in 1.67 new customers.

That is just to break-even the trading down customers. In addition they need to find millions more  to justify their investment.

Can they do it?

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Side Note 1: When you uncover a new market or spend your resources to develop a new market, it is not all yours. Others will swoop in and get their share.

Side Note 2: If you run a frozen yogurt chain and want to offer a lower priced plain yogurt version, this is the question you should ask – Am I losing profit from those trading down to plain yogurt because they get better consumer surplus at its price point?

Challenging the Certainty in the Claim I often Make

I recently made a comment about a pricing article that recommends doubling prices.

That's it, pricing is as simple as doubling, http://t.co/1NTxkNU keep doubling, don't stop after one time!

— Rags Srinivasan (@rags) August 15, 2011

The article under question claims,

Higher prices simply work better. Here’s seven psychological reasons why… (and gives seven reasons)

You may think I make similar claim too. Well, am I on solid ground making a comment like this with bold claim?

If one price is good, two are better.

It states that if it were possible to sell a product profitably at one price, it is certain that there will be higher profit from two prices.  Note that the profit here means Price less marginal cost and does not include fixed cost. You might find there are other cost components that make the second price untenable. But that is a factor you can control.

Some time back I did take a critical look (to an extent I can suppress my own biases) at this claim.

It is impossible for me to re-do years of economic research on consumer surplus, price discrimination and other economic works. The  statement I make relies on those works first started by Pigou.

The point to note is that my claim is not inductive logic. It does not follow from this statement,

“if two prices are good, three are better”

Yet, I did not address adequately the certainty in this claim. Shouldn’t this claim be more like,

“if one price is good, two are likely better for most situations”

No.

Let us rely on the works of  Thomas Bayes for this (P is the probability)

What I am stating with my claim is,

P(2 are better | 1 is good)  = 1 and not

P(2 are better) = 1

That is a huge difference.

The first probability statement is conditional probability. It is the equivalent of stating, “you picked a random card from the deck, if it is Jack of Spade, then we are certain that it is a face card).

It states that if it were possible to sell a product profitably at one price, it is certain that there will be higher profit from two prices. Either a moment’s reflection will convince you or you need to dwell into tomes of economic research.

The second probability statement is false. To see that we have to expand it

P(2 are better) = P(2 are better| 1 is good) . P(1 is good) +
P(2 are better | 1 is not good) . P(1 is not good)

As you can see from practice, P(1 is good) is a much small number than 1 and hence the it is not at all certain “two prices are always good”.

Ignoring all these, the net of these to you the marketer/entrepreneur/product manager is

If you find a market for your product at one price, you will find bigger market (measured in $$) at two prices.

The Percentage Margin Trap

One of the income statement metrics that stock analysts obsessively focus on is operating margin expressed as a percentage.  Stocks get punished when the operating margin drops or did not meet the goals. So businesses align their marketing and operations to focus on this improving operating margin. To an extent operating margin expressed as a percentage shows the profitability of the operations but the obsessive focus on percentage leads to two errors:

1. Information loss – specifically the absolute profit earned. ( I am going to ignore here  a more rigorous number, operating cash flow and treat earnings as all cash.) Given two stocks of identical companies in the same market, one with an operating margin of 10% and the other 12%, both with a stated 5 year goal of 4% improvement, can we tell which stock is a better prospect? What about their absolute income level and growth prospects?
2. Causation Confusion – percentage margin is incorrectly treated as the driver of overall profit. Higher the operating margin, higher the profit. Margins do not drive your profits it is the other way.

Operating margin percentage is a computed number not an intrinsic metric that needs to be actively managed and definitely not a driver for your marketing decisions like pricing the products. Let us take the case of Mattel just because it was in the news recently.

Recently Mattel anounced blow out earnings, with 86% increase in profits with only a single digit increase in sales.  This is extraordinary but there is a concern on what they are focusing on. The WSJ news story’s title reads “Earnings Up 86% As Margins, Barbie Sales Jump“. Margins did not drive the profits up. Profits went up because of price improvement on their Barbie line. In its earnings call Mattel CEO, Mr. Robert Eckert, made the following statement

“We will price our products consistent with our goals of long-term operating margin of 15% to 20%,”

Determining the price to sell based on the stated operating margin goals is cost based pricing.  Pricing the products to  meet a derived metric is like putting the cart before the horse. Price is not driven by a businesses need for meeting its operating margin targets  set by stock analysts but by the customer’s willingness to pay. Based that price the business must either try to make the products at costs that are profitable (price driven costing) or choose not to compete in the market. I want to believe that Mr. Eckert meant here choosing only those products that can help Mattel meet its margin goals and not set prices regardless of the customers.

What drives shareholder value is absolute profits. Not percentages. As Ford said about costs, operating margin is always a computed number.

What drives products prices is value to customers and their willingness to pay, not stock analysts.

What sets prices and drives profitability is effective price management not meeting operating margins.