Pricing for Different Sales Channels

If you are a fan of Bay Area farmers markets you likely would have tasted samples from an enthusiastic vendor selling Bolani.

If you ever went beyond tasting the free samples and bought a few, you would have paid $6.00 per unit.

If you walk into Bay Area Whole Foods you will find Bolani being sold for $6.80.

If you want to order online from their website it will cost you $6.99.

Can you think of possible explanations for selling the same product at different prices through different channels?

First we do not know whether or not $6 is the right price. Let us assume it is. You could argue that the vendor would have collected demand data over hundreds of weeks to set a price based on what customers value and willing to pay rather than based on what it costs them and tack on a markup. (Tall order?)

If we accept that then it is not hard to see that customers who buy through  different sales channels are different. Even if they are the same customers their purchase occasions and reasons they buy are different. Hence their willingness to pay for the same product at different sales channels are also different.

Pricing is not just tied to the product. It starts with customer segment, determined by their perceived value and varies even for the same customer based on the time, situation, and specific job they are trying to get done with the product. Understanding customer segment, job and purchase occasion helps you set the price to maximize profit without leaving money on the table and without remorse.

Foot note:

While this vendor has control over channels they control (their site at farmers market and their online channel) they have no control over pricing at Whole Foods. They have to settle for a wholesale price Whole Foods is willing to pay as long as the total profit from adding the sales channel is more than they would have had otherwise. (See a detailed discussion on math on adding a sales channel in my book.)

Your Mileage May Vary – Going Grubhub?

Does adding Grubhub to your restaurant channel mix help or hurt?

If the answer is anything other than, “I don’t know. Let us start with customers, business objectives and alternatives”,  it is wrong. There is one such categorical answer in recent Bloomberg Businessweek article.

The article quotes one case study, a restaurant that used to hire Seamless (now acquired by Grubhub) as sales channel found its margins go up despite smaller sales.

On its first night without Seamless (Aug. 16, a Saturday), Muñoz says Luz took $669 worth of delivery orders. That’s down about 16 percent from the $800 in orders the restaurant typically received on Saturday nights when using Seamless and GrubHub, another online delivery service that recently merged with Seamless. Instead of losing 14 percent of the total to commissions, though, Luz paid only $16 for credit card processing and other ordering-related fees, meaning the restaurant netted $653—just 4 percent off the $680 it would have made with the help of Seamless and GrubHub.

They use the word margin to refer to net amount they get to keep after transaction and channel charges.  Sites like Seamless and Grubhub create value by bringing in sales that restaurants would not have realized through other channels. They get their share of that value created by charging 10-14% commission.

As I wrote before, restaurants should be happy to pay this as long as they are making profit on each GrubHub transaction and it is new sale they would not have had otherwise.

Let us take this specific case of Luz restaurant. It appears from the numbers they have the wherewithal to generate $669 (average?) sales through their own gumption. What Seamless did for them is simply redirect $669 through its website and only added $131 worth of new sales.

If that is the case it does not make sense for the restaurant to pay 14% on $669 – sales they would have had without any help from Seamless.    Given these numbers it appears Seamless share is $112 from a mere $131 worth of sales.  The restaurant should have done this math before signing up for Seamless or explored its sales channel alternatives.

On the other hand if a restaurant has $200 in takeout revenue and Seamless increased it to $800. Then at 14% commission, Seamless share of value is $112 from $600 new sales they created. A far better number for some restaurants.

The answer for your restaurant is not a simple yes or not based on the extreme stories you see but starting with your customers, business objectives and channel economics. Do not rush to sign up or ignore Grubhub based on popular news stories.

Here is a much bigger question that even large enterprises grapple with – compensating sales team on repeat revenue.  It makes perfect sense to compensate the sales channel for acquiring new sales. But once you got that customer, aren’t they your customers? Should the sales channel be compensated for repeat revenue from the same customer? Especially at the same 14% level?

 

Do you need to maintain pricing parity across all channels?

Let us look at this case study:

Airport terminals are not gourmet ghettos. We mostly get a food court with the usual chain restaurants. Wouldn’t it be great to give the travelers – locals, those in transit, and visitors – a taste of the local flair? Phoenix airport is trying to do exactly that. They are giving the local coffee shops, bakeries and restaurants an opportunity to open their shop at the airport terminal.

It does provide the local businesses a new revenue opportunity by adding a new sales channel. Forty million people pass through Phoenix airport every year. That is a large Target Addressable Market (TAM), even a 5% conversion with average tab of $8 means adding another $16 million in new revenue from one location. There is also the positive side effect of marketing exposure.

But it does come with many drawbacks.

First the rent at airport can be up to 10 times what these local restaurants pay in city locations. Second the hassle and costs associated with security and regulations. Third the additional infrastructure cost in equipment and other things to make the place resemble the city location. Lastly, customers want to pay same price they pay at city locations.

There are many questions here. Primarily should a business consider adding airport location given the huge exposure and opportunity. That is a topic for another day or you can hire me to help you with the analysis. Here I want to address just the last drawback

Customers want to pay same price they pay at city locations. One restaurant decided to do just that,

what you pay for a salad at Chelsea’s original Phoenix location is what you’ll pay at the airport.

Is that the right thing to do? Doesn’t it matter that the restaurants incur significant incremental costs when they open a sales channel in airports? Shouldn’t that costs be offset with a price markup on products? How should the pricing be for a new sales channel?

If you know the answers you can skip the rest of the article.

Here is what you need to consider.

Where do you start for pricing? You start with customer segments based on their needs. In airports you have

1. Those who hire your restaurant as a better (healthier, tastier, fresher …) alternative to greasier and generic options available. This segment includes some members from all travelers.
2. Your loyal locals who are happy to have their favorite option available before they board the plane (without having to make a side trip).
3. Those who hire products simply based on price.
4. Those who hire products based on brand – a local restaurant likely has no brand recognition outside of locals going through the airport
5. Lastly, most ignore this segment, those who work at the airport and need better options for their meals.

This is a case of adding top-right and bottom-left quadrants from Customer Jobs Growth Matrix.

The question of price parity does not come into play with (3) and (4) and anyone that is not local in (1). Stated another way you only need to worry about pricing parity if they already have a reference price – what they pay at your city locations.

Your options?

You could maintain pricing parity as long as the profits far outweigh profits from opening other city locations for the same investment. That is consider your opportunity costs. But don’t charge same price because it is the “right” thing to do or your locals demand that. This is as bad as simply adding your airport cost overheads to your local prices.

You have access to a segment (likely large and constantly refreshed) who value the better options at airports and have higher willingness to pay. You should find a way to capture this value with better pricing.

If only you could do third degree price discrimination – say asking for driver’s license – and give a price discount to locals you are good. But that is a hassle and mostly not something you want to do because of overall customer experience.

That leaves you the following options to capture additional value from customers choosing your restaurant in the airport location (that flows from the recommendations in the Growth Matrix)

1. Price Higher and Use Cost Argument – Recognize it is okay to not serve all customers. Don’t focus on 40 million customers, ficus on who perceive higher value from our offerings. Do a marketing research if need be. You may want to give up on some of your locals buying at airport and choose to target only those with higher willingness to pay.
   Most times you can convince locals of hardships in running your restaurant in airports and charge a premium over your city location prices. You are not doing cost based pricing – you will set prices based on what customers are willing to pay at airports – you are only using cost to justify higher prices.
2. Product Mix – Play with your product mix. Add newer options that are available only in airport locations and charge a premium for them. These could be simple variations of your menu choices. You should do this even if you don’t have pricing pressure.
3. Creative Packaging – Consider different sizes – think smaller for same prices as city locations. A 10-20% decrease in marginal cost can stand in for not raising prices. Apply creative messaging like -ToGo, OnAir etc. You should do this even if you don’t have pricing pressure.

The cardinal rule however is start with customer segments before you decide on pricing. Be it opening an airport location, adding food cart version of your restaurant or serving down markets with your enterprise products – start with customer segments, their needs and their current alternatives.

How do you set pricing for your different sales channels?

Celebrate the Second Anniversary of My Groupon Book

It was two Super Bowls ago I published this book, same time Groupon had their infamous Ad featuring Tibetian restaurant. Since their IPO a few months later their stock is hovering around $5 – far below its opening day pop but 150% growth over their 52-week lows.

How do you make informed decision about whether or not a business should run Groupon promotion?  Here is a chance to read this book for free, because you likely spent all the money on iPad and iPad mini. Or worse lost it buying high and selling low Groupon shares.

Fill out this form and the first 50 people will get the book that sells for $9.99 for free.

Even if you are not a small business owner you will find the chapters on demand curve and sales vs. marketing channel a refresher course for you.

Here is the link : Groupon Book

Surely you are not surprised by Groupon woes?

Update 11/1/2012: Groupon valuation is back in news because of its rival LivingSocial’s woes.

In Amazon’s 10-Q filing late Friday afternoon, it disclosed that Living Social saw revenue of $372 million for the nine-month period ended Sept. 30. While that is up 120% from the same period last year, it reflects third-quarter revenue of just $124 million – down 10% from the June period.

If that sequential drop reflects an overall weakness in the daily deals business for the third quarter, then it implies potentially disappointing results for Groupon when it posts its own results for the period next week,

When valuing a company’s stock it pays to understand what pressing customer needs it serves and what unique value it adds. That is assuming you are Benjamin Graham, Warren Buffett type investor who takes the time to understand the business before investing.

Business model is value-creation and value share. A business that creates net new value for its customers gets to share in it. A business cannot get its share of value it did not help create, let alone grow exponentially.

If you are such an investor then Groupon’s announcements about lax controls should not come as a surprise to you. I am not referring to the $2 drop in its stock today but the news that led to it.

It is hard to describe Groupon’s business. In fact even Groupon is not clear about what it is.

For starters, it is a two sided market. It essentially brings together small businesses on one side and end consumers on the other side.

In general a two sided market adds value by unlocking value, creating new value or removing inefficiencies. It then gets its fair share of the net new value added. A two sided market must be consistent in its positioning – it must serve as the enabler for the jobs the two sides are seeking to do. There should be no asymmetry.

Take for example, eBay. It positions itself as the market place for buyers and sellers to find each other. No asymmetry here. EBay adds value by enabling transactions that otherwise would not have been possible.

What about Groupon’s role as two sided market?

What is its positioning to deal seekers? It tells them about, “one ridiculously huge coupon everyday” and its tag line is, “Collective Buying Power”. In other words it wants the deal seekers to hire it as a sales channel to buy products at steep discounts.

What about its positioning to small businesses? It tells them about, “guaranteed new customers”, “big exposure”, and “measurable marketing”. The story line goes, “these customers fall in love with your service and visit you again and again, paying full price”. In other words it wants the businesses to hire it as a marketing channel.

That is asymmetry (to put it mildly) in its messaging. Groupon cannot be a sales channel to acquire ridiculously huge discount and a marketing channel to acquire valuable customers at the same time.

What value does it add?

Businesses bring value to the table in the form of 50% off discount. Deal seekers add no value but get 50% off. Groupon gets its share of 25% from the businesses.

 

You bring a full pie.
Give half of it to my email subscribers.
Give half of what is left to me.
Take home the rest and wait.
It will not only grow to become a full pie, it will multiply into many full pies.

To repurpose Omar Khayyam, “the deal seekers having scored a deal, move on. No level of customer service will bring them back to pay full price for your cupcake they can get for 50% with their next coupon in the bakery next door”.

There is no net new value add. Just value distribution – from businesses to deal seekers and Groupon.  Groupon cannot take its share of value it did not help create.

So we have a business that most do not understand, even it does not have clarity on the needs it serves and adds no new value. How can you place a valuation on such a business?

Surely you are not surprised that such a confused business finds itself again in the accounting hot water?

There is a WSJ report that SEC may investigate Groupon. I see no reason for such an investigation at the expense of taxpayers. If irrational investors want to bet their money on a business they do not understand or chose not to understand, why should they be protected?

We can turn Groupon into a daily habit for consumers

The Wall Street Journal interviewed Groupon CEO Mr. Andrew Mason about his IPO and his business. The Journal throws a whole bunch of softball questions to Groupon CEO Andrew Mason.

They either deliberately failed to ask or focused on the wrong things like these,

1. Valuation – It is perfectly acceptable for a company to expect and set any valuation. It is up to the market to buy the shares at that price or not. Why question him on the valuation?
2. Asking about current stock price: What is the point of asking about the stock price to any CEO? When did anyone answer anything other than,
   

   “I’m aware of it [stock price], but I think as a company we aren’t driven by it. It’s a futile exercise to be responsive to the stock.”

3. On the employee memo leaking out: Mr. Mason asnwers,
   

   “If I knew it was going to leak,”

   and the  Journal reporter lets it slide. Really?

4. Questioning his maturity: This is an insulting question. Ask about his challenges and how he rounds up his gaps with an executive team.
5. Asking, How important is profitability?:  Really? Now who is being immature, excuse me, being unaware of the number one goal of any business? This question lets Mr. Mason talk about the growth, market share etc etc.

What questions they should have asked instead?

1. Question the contradiction–  When Mr. Mason said,
   

   discount to deliver more buying power for consumers, as well as solve better inventory management for merchants, delivering them more profits

   The question is how can you say more buying power to customers and more profits in the same sentence? Profit implies share of net new value created. What is the net new value created?

2. Is it  a sales channel or marketing channel?  When Mr. Mason said,
   

   solve better inventory management

   The question here should have been – are you a sales channel to dispose of excess inventory without cannibalizing  current full-priced sales or are you a marketing channel to acquire new full-price customers?

3. What happens when Groupon turns into a daily habit?
   The title of this article is a quote by Mr. mason in the article. What would happen if customers are used to the  “ridiculously large discount” they get from Groupon? What does this mean to the small businesses?
4. How does the upfront investment pay off in the long run? – When Mr. Mason said,
   

   There’s an upfront investment that we know pays off over the long-term

   The question should have been, is that a guarantee? hope? insurance? promise?  What metrics are you providing to small businesses to measure that pay off?  There is no data or assurance that deal seekers come back. Besides didn’t he just say, “we can turn Groupon into a daily habit for customers”?

5. Did you read the book?
   Why not buy a copy of this book and give it to all the small businesses before signing them up to do Groupon?