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.

Magic Beans Marketing

Sometime back Motoko Rich, economics reporter for Times, wrote this about the lessons he started seeing in children’s stories.

These days, perhaps because I’m covering the national economy — or because current economic troubles are too much to ignore — I often stumble across passages in children’s books that inadvertently teach economic principles.

When Rich reads story of a little girl buying back an item wrongly sold by her sister for lot more than what the seller paid for it, he sees pricing lesson

Pricing is often a function of who wants something more, and what that person is willing to pay for it.

Note that Rich is well grounded and knows why he is seeing these lessons in unexpected places.

It’s just that once economics is on the brain, it suddenly seems to pop up a lot in children’s literature.

And it is likely the news items that were current in his mind were the lessons he saw. Had he been a marketing guru whose school of thought is – all marketers are liars tell stories – that is the type of lessons he is going to see. Unfortunately those could be just plain wrong interpretations.

It appears Mr. Seth Godin, marketing guru (and author of All Marketers Tell Stories), seems to have read Jack and the Bean Stalk and no surprise he sees lessons on telling stories and word of mouth marketing. Before you join the 999 others who shared the story on LinkedIn, ask some questions on the three steps to successful marketing

1. The individual has to be open to hearing the offer at all –  What is your role as a marketer here? You could start with the right segment to target and reach them through channels in which they seek information. Or take a calculated and deliberate scattershot approach so some individuals will self-select themselves to hear your offer. Either way it is about your action.
   An example of second approach is the Nigerian money laundering mails. I see lot of similarity between the magic bean scam and email scam,

   Since gullibility is unobservable, the best strategy is to get those who possess this quality to self-identify. An email with tales of fabulous amounts of money and West African corruption will strike all but the most gullible as bizarre… Those who remain are the scammers ideal targets. They represent a tiny subset of the overall population.

   So it is not about the individual being open to hear your story, it is about you finding those prospects using segmentation and analytics.

2. The person hearing your story has to want to believe it – I do not get the subtlety Mr.Godin says this point has. It is not about the person wanting to believe the story as much as how you are positioning the product in his mind. If segmentation is about identifying customer jobs you want to serve, positioning is about telling those customers, “what job is your product applying for and why it does it better than alterntives”
   And his Uber ensuing example seems to put down Uber and confuses me.

   Uber, for example, offers a newfangled way to call for transport in big cities. Many people haven’t heard of it or used it, largely because they don’t think they need it, aren’t open to something new, or are unwilling to go through all the steps necessary to get the app, etc. So, even if it works as promised, there’s no urgent need felt by some, so they don’t care.

   It does not matter to Uber or other such marketers that not all people use their product. Marketing is about segmentation. Uber as a product targets those who are willing to pay higher price for better value. You do not want everyone who wants your product to be customers, only those who willingly pay prices that maximize your profit.

3. It has to be true – This is mom and apple pie advice. I cannot argue with this. More like a ‘deepity‘. On one hand the statement is trivially true. But the truth is indeed relative, it is in the minds of the customers. If you are selling on economic value add to customers then you are not making a marketing promise but showing proof of value you create and get your fair share of the value created.  On the other hand, think of all the luxury products out there – do the stories have to be true? Or what is true other than the utilitarian aspects?

Marketing failure occurs because you failed to – start with customers needs you want to address, choose those that you can profitably address  and tell them how your product fills those needs better than alternatives.

Charging Men and Women Different Prices

A supermarket in Germany is now selling separate men’s and women’s sausages. It is the same meat but the packaging and pricing are different.

The version targeting women is half the size of the version targeting men. And for good measure it is priced more  than men’s version. To see the price difference you need to look very closely at how they listed unit price for the two making the comparison difficult.

For women’s version they list unit price for 100 grams. For men’s version they list unit price for 1 kilogram. This requires customers to stop in their tracks and do the additional comparison math even though it is a very simple conversion.

Note: If you do the math you will see this could be just a case of non-linear pricing (volume discount), more on that near the end of the article.

One another difference in packaging is labeling –

The male sausage features an alluringly-clad woman – in front of a flaming background – while lady shoppers are being drawn to part with their hard-earned cash by a topless gentleman with excellent muscle tone in front of a serene, cloudy background. (Source and Picture Source)

So is this good or bad price discrimination? Gender based price discrimination is just plain wrong. I have written about Good and Bad price discriminations before.

Journalist  Susanne Enz sees this as “dull sexism.”

The sausages’ marketing, she said, implied that “men eat a lot and heartily, while women mainly want to be thin… Women are there to please, while men are allowed to enjoy.”

There is lot of truth to what Enz says here but there is also lots of bad marketing while not necessarily bad price discrimination here. For price discrimination to be labeled good  and effective it has to meet the following two criteria

1. To be labeled good: Customers must have choice and control to buy whichever version they please and not limited by who they are but only by their willingness to pay and wherewithal to pay. (See Amazon pink watches)
2. To be labeled effective: Price fences between versions must be defined such that those who can and willing to pay for higher priced version will not adversely self-select themselves to the lower paid version. Like 13″ 256GB MacBook Air vs. 11″ 128GB MacBook Air.
   Sometimes the fences end up done badly that they also punish those who can only afford the lower price version – like roof-less third-class train cars in olden days. (See tyranny of versioning)

Let us evaluate the German sausage  pricing on these two criteria.

Good Price Discrimination

Do the customers have choice? Yes. Both women and men can choose any of the two versions. So it is a case of second degree price discrimination (which is the best form of price discrimination despite its ominous name) and better than third degree price discrimination.  Third degree price discrimination is when the super-market checkout clerk charges one price for women and another for men at the time of checkout.

This is not that different from the  shaving gel case study I wrote a while back. Since nothing prevents  women from choosing the cheaper version targeting men, this is good price discrimination.

There is also merit to Enz’s statement that it implies, “men want to eat more”, but I would not take that claim any farther.

Not So Effective Price Discrimination

What are the price fences here ? Price fences are the features and triggers that make sure the higher willingness to pay  segment stays with its positioned version and not tempted to choose the version targeted for lower willingness to pays segment.  The fences here appear to be the amount of meat and the  picture on the label.

There is merit to the supermarket’s thinking that smaller sized version will be more attractive to women and hence setting a higher price.  But their price fences are awful – using pictures of “alluringly clad women” on men’s version and “topless gentlemen” on women’s version. Both are insulting to respective genders.

One variation that would have made improved this bad situation is – using “alluringly clad women” on men’s version and use a sane and sombre labeling that appeals to women’s intellect on women’s version. This would be the equivalent of roof-less third-class cars and shaving-gel. The hypothesis here is, women will be disgusted by the picture on the other version and will naturally gravitate towards their version with better picture.

So this gets mixed grade on effectiveness criteria.

Finally is this a case of price discrimination or simply a case of non-linear pricing unnecessarily confused with irrelevant packaging aspects?

If I do the math based on unit prices I see on the picture, the respective unit prices are

250 gram version has a unit price of €0.80 per 100 grams

500 gram version has a unit price of €5.98 per  kilogram, or €0.598 per 100 grams

Non-linear pricing is where you give better unit price to customers when they buy more units. Like Costco giving you better unit price on the 50 gallon mustard bottle. It appears that the price difference here fits that mold. Why the marketer chose to erect price fences and extract additional rent from women customers is beyond me.

What do you think? Is this good and effective price discrimination?

Let me leave you with a thought experiment. You likely know most public toilets in Europe charge you for usage. What if they charged different prices for men and women?
Will that be good price discrimination?
How will you make that both good and effective?

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?

What job do these brands want their product to be hired for?

The product is wrist watch – one with simple utilitarian job to be done. We sure all need some version of it and there are many versions available at our disposal. And there are non utilitarian jobs – hedonistic and even conspicuous consumption. Not all segments have these second level jobs but some do.

We are willing to pay a price based on the job we hire the product for. It is under brand’s control to choose the segment with certain high paying jobs and positioning the product with a price to go with it.

Let us look at the positioning of luxury watch makers to see what job they want their customers to hire their product for.

Breitling – Instruments for Professionals
Nothing about time here and the other instrument often associated with the watch? Airplane! And a price to match those private jets.

Patek Philippe – You never really own a Patek. You merely look after it for the next generation.
And you don’t buy it to tell time either. It is a investment for generation and hence the price.

Rolex – The Crown of Achievement
No mincing words about conspicuous consumption. Nor are they giving any utilitarian rationalization reasons. It is about targeting those with achievement to flaunt.

Sure these watches tell time and there are billions of customers who have that job. But there are many other candidates for that job and no one is willing to pay much for that job. Hence these brands chose the small segment with the second level jobs and have the wherewithal to pay for the job.

That is some positioning, telling select segment of customers exactly what job the product is applying for and setting a price based on that.

How do you position your product?

 

When segmentation fails do you pivot to a new one?

A few months back this is what I wrote about economic value add for business vs. consumer segments while writing about price of LED bulbs,

Here is a case study done by US Department of Energy for LED bulbs. The initial price is almost twice as much as traditional lighting systems. While consumer segments most likely are not willing to pay twice the price for LED, business segments are. That is if you show them the value.

For instance, you and I may not mind changing light-bulbs every year because our opportunity cost is $0. But for businesses there are real costs associated with maintenance. Every bulb change avoided is not only savings in bulb cost but savings in maintenance costs.  If you add these all up, despite the high initial cost, the LED systems  deliver 9% in total cost savings over the lifetime.

Then I went on to show the economic value add from switching to LED bulbs

It seemed no brainer to start with the business segment that had real costs and savings (and budget to spend),  show them value using hard numbers and gain adoption. So did Cree, the maker of LED bulbs, think. Cree based their strategy on a similar analysis that pointed to increased adoption by businesses because of energy and labor cost savings from switching to LED bulbs.

As it turns out their segmentation strategy did not work out and they decided to shift focus from business segment to consumer segment,

the company is making an about-face. Durham, N.C.-based Cree is putting out a new line of bulbs built around light-emitting diodes, or LEDs, for the masses in hopes that greater use by consumers will eventually affect the choices made at their offices

Why did their initial segmentation fail to pan out? There are two main reasons I see,

1. Value Waterfall – As someone who defined value waterfall, even I failed to take this into account while I did the economic value add math for LED bulbs. Despite the real value there are several aggravating factors like cost of doing business, trust discount, switching costs, etc. that knocked down perceived value.
2. Pricing Model – The LED bulbs are priced twice as much as incandescent bulbs and deliver their value over long period of time.  That is the LED pricing captures value upfront while delivering customers value over time. A better model for businesses would have been a subscription pricing model based on usage. Cree needed monetization model innovation to go along with their product innovation.

I do not believe their segmentation failed nor do I believe they need to switch from business to consumers. But Cree believes,

The bet is that light bulbs might follow the same trajectory as touch-screen smartphones, whereby consumers grew comfortable with the technology at home and then insisted on having it available at work.

While that worked for phones that we use everywhere and at work and think of it as part of our self the same logic does not extend to light bulbs what are simply part of the environment.  Besides how can they get consumers to pay twice the price when the economic value add math does not add up and the fact that it does not have aspects of conspicuous consumption like a smartphone does?

I wrote recently how monetization model innovations follow segmentation. Cree’s segmentation was not wrong it is their product positioning and monetization model that need to be realigned to the business segment.

When your well thought out initial segmentation fails it does not mean you chose wrong and you must switch to a completely new one. Segmentation is a strategy and changing it is not like a product pivot. And there is no guarantee you will succeed with the new segment if you commit the same mistakes you committed with targeting, positioning and pricing with the first segment.

How do you choose your segment and what do you do when your product fails to get traction?