The $100,000 Product’s Customer Segmentation – Part 2

Last week I wrote about a product that has an average selling price (ASP) of $100,000, takes about an year to make and sells just about 2500 units a year. That product is  Steinway Grand Piano. On the surface it would have looked to a casual observer the high price tag is a direct result of the cost and complexity of building the product and the incredible attention to details. One may be forgiven for thinking that the marketer had no option but to pass on those costs and likely makes razor thin profit from each unit.

However a simple math based on their financial accounting statement and their overall product mix established that what appears to be high cost- low profit product is in reality the main profit driver while the low cost volume products bring less than quarter of  profits despite their volume. The moral of this story and other such stories that try to justify higher prices based on product features alone is – do the math.

If LVB sells 2500 Steinway pianos in a year, it sells 7500 units of Essex and Boston.  At three times the volume of Steinway pianos these two brands account for barely 20% of the total profit. Stated another way, at one fourth of total unit sales the premium brand Steinway brings in 4 times the profit from its volume brand.

The right place to start to set prices is to start with customers and the reasons they buy the products. Different customers – different reasons and you have customer segmentation. Another way to look at the reasons they buy a product as – “What jobs are different customers hiring a product for?”. That is customers have jobs to be done (needs to be filled) – they hire (which implies they can fire and switch to another) a product that best fills those needs.

The needs could fall anywhere in the spectrum of perfectly utilitarian and perfectly emotional. But very few products get hired for purely utilitarian reasons and almost no product gets hired for purely emotional reasons. For the latter, the product should meet basic utilitarian threshold or given enough utilitarian reasons that will help rationalize the buying (hiring) decision.

This is the spectrum of reasons to buy. Do customers fall in this spectrum too? That is some customers are all rational, some less, and some are all emotional?  May be. We cannot make such a stronger claim. A more reasonable claim customers do not fall in a fixed band in spectrum only their purchasing occasions do. Even the most rational customers have occasions that demand them to be emotional and splurge. Even the most emotional customers have occasions where they skimp and go for utilitarian products.

You can substitute “reason” with “job to be done” and you can see the role of a product is to get the job done.  Different jobs, different competition and different prices!

Given this framework it is easier to see  where the Steinway and its lower-priced brethren fall in.

For those kids that are truly interested in learning piano, parents who wished they had learned piano and vicariously living through their kids and hundred of thousands of amateurs there is the low-end Essex and Boston pianos. For $2000 a pop these pianos get the “job” done better than other alternatives. Willingness to pay is one thing, wherewithal to pay is another. Most of us cannot afford to pay the price or have places to keep a grand piano.

For these customers, the $100,000 grand piano, while will do well, is not the right candidate. It makes no economic sense for these customers to buy a $100,000 piano nor does it make any marketing sense for the maker to try to convince these customers to buy one.

That leaves segments that –

1. Buy for mostly emotional reasons
   

   “He may have a private plane, he may have an estate. If he has an estate, he may very well have, or desire to have, a Steinway piano in his home.”

2. Has significant wherewithal to pay (the same “He” above and)
   

   Then there are professional musicians. (who likely get paid enough to afford one and need one to support their own brand)

3. Buy for rational reasons because they are extracting value in another way (the pros above and)
   

   “majority of major concert halls around the world use Steinways”

 

That is the customer segmentation for a $100,000 product.

The $100,000 Product’s Customer Segmentation – Part 1

The first step in pricing a product is starting with customers and their needs. Different customers, different needs, different alternatives to fill those needs, different value perceptions  and hence different prices you can charge.

What about a  Steinway piano that costs upwards of $100,000? Why is it priced thusly? How did they set the price?

Here is what the Steinway homepage says about how the pianos are made,

Steinway & Sons crafts approximately 2,500 pianos a year worldwide. In an age where many piano manufacturers have outsourced the building of their pianos to areas with cheaper labor, Steinway & Sons continues to handcraft its pianos only at its Astoria, New York and Hamburg, Germany factories using many of the same techniques developed by the Steinway family.

And here is what the PBS documentary  on making the Steinway pianos has to say,

Craftsmen labor for nearly 12 months — using the same methods created over 150 years ago — before a Steinway grand is ready for the stage.

The bridge must be notched for the strings in the “belly” department. It takes years of training for the craftsmen to master the task of notching the bridge.

each piano’s journey is complex — spanning 12 months, 12,000 parts, 450 craftsmen, and countless hours of fine-tuned labor.

It is easy to fall into the trap of thinking the price tag is driven by the high cost of painstakingly making these pianos. The cost of labor for those highly skilled and experienced piano makers (who learn their skills only through master-apprentice practice), the complexity of the process and the thousands of parts and details, all these must  cost a lot for the manufacturer.

What do the numbers say?

Luckily for us Steinway is a publicly traded company (not for long however) and its financials are available to us to see. It trades under the stock ticker LVB. It will soon be acquired by a private equity firm. Before then we can look at its margin numbers. In 2012 its gross margin was 34.7% and it held steady over the years.  Seems reasonable profit for a product that costs so much to make? But this average hides details.

Little known to most, LVB also makes cheaper brands for the mid and low markets (you know for those amateur players and those who do not live in San Mateo county). You won’t find its two mainstream brands Essex and Boston,  anywhere near Steinway home page, dealership or communication channels. And just like any other manufacturer that Steinway webpage puts down, the manufacturing of these brands is outsourced, made in Asia.

If LVB sells 2500 Steinway pianos in a year, it sells 7500 units of Essex and Boston.  At three times the volume of Steinway pianos these two brands account for barely 20% of the total profit. Stated another way, at one fourth of total unit sales the premium brand Steinway brings in 4 times the profit from its volume brand. That is the $100,000 ASP Steinway that is so cumbersome to make requiring 12,000 parts, skilled labor and almost an year is the profit driver. The gross margin is far higher than what the average 37.5% suggests.

So if you were  thinking cost as the driver for the price I hope the numbers put an end to that notion. Hidden in plain sight is the conscious and deliberate choice they made to run a profitable business. They had the option of outsourcing, automating and mass producing to drive down costs for Steinway. Yet they realized not just the piano but the very process it is made is part of the offering and conveys significant value to certain customer segments. They chose the segments that value the offering and are willing to pay a premium price for it.

What are those segments and what jobs does Steinway want those segments to hire the $100,000 Steinway Grand piano for? Stay tuned for Part 2.