Where Staircase Is the Value – Inversion of Elevator Story

A while back I wrote about the case of New York apartments without elevators. In 2011 I wrote,

I was surprised to read that there are still seven-story apartments in New York that do not have elevators and still rent to people. As you will expect, despite the location, the view and the benefits, these apartments are a bargain to those willing to hike 192 steps to get to their home. Apartments that go for $3500, go for $2000 – all because of no elevator.

There was clear value in the top floors and better yet there was more of it to come if you were to build more floors. Yet, no customer, except those in the most athletic form or those in dire need of a place with cheap rent, was willing to see that value and pay a price for  it.

What use is a feature when its value cannot be realized or the cost to use the feature  far outweighs the value?

Fast forward to the days when BitCoin is trading at $1,200. It appears there is indeed some segment that value apartments without elevators and are willing to pay a premium for using the staircase,

(a customer) pays $4,900 a month for a one-bedroom apartment on the fourth floor.

In the same neighborhood earlier this year, the rent for a fourth-floor one-bedroom at the West Coast, a large doorman building at 95 Horatio Street, was $4,475 a month.

“You can rent a one-bedroom at 95 Horatio Street all day,” said Mr. Sachs of Bold New York, who has handled units at the building. “One-bedrooms at 48 Bedford aren’t as big as at 95 Horatio, but your friends will walk in and say, ‘Wow, what a cool place.’ That is definitely worth something.”

Stairs, from being a hassle for some have become the differentiating feature in renting the apartment.

Not only are stairs more than usually important in a walk-up, but, he said, “you hear renters say that they are looking for something with character — that character is an amenity. The staircase is a great place to find that, because it is the place where interactions with neighbors happen.”

It sure adds more credence to the theory that it is customers who decide value and it is the job of marketer to understand that  and deliver them a product that delivers them that value. Of course the marketer gets to share that value in the form of better price realization.

 

Does Price Affect Value Perception – Wine for Thanksgiving

This is not yet another blind taste test study on how price of wine affects how we perceive its quality and taste. There are enough of those stydies. Here wine is simply a tool to test a hypothesis of whether or not the price we paid affects how we later perceive the value of a product. If you have not answered the poll I asked you to, stop here and answer it so you do not see the spoiler.

 

So here is my hypothesis – I do believe we closely align our value perception to the price we paid even in situations where clearly the price should not diminish the value in any way.

The case here is buying wines on a Buy one get second one for 5 cent deal.

Suppose you bought two identical bottles of wine, price exactly the same. Just randomly you paid full price for first bottle and got the second one for 5 cents. Later you have to make a decision choosing a bottle to give away and a bottle to keep for your own consumption.

Theoretically it should not matter which you decide to keep and which you want to give away after controlling for all wine factors. In fact if you did not know which bottle is which you would have picked one at random. However if you clearly see which bottle cost 5 cents you are more likely to view its value by that price. Hence you most likely will decide to keep the other full price bottle and take the one that you know you paid 5 cents to your friends Thanksgiving dinner.

I however think the answer will differ between men and women.

What do you think?

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.

 

Value to Customers Comes from?

Why do you think 10oz mini Pita pockets are priced 18% more than 12oz pita pockets?

Don’t just focus on quantity consumed? Value to customers comes from many aspects – from ease of use, convenience, fit, …

To be precise customers value a product that is a better fit for the job at hand and easy to hire for that job. Be it form factor or ease of doing business.

Focusing on just one aspect leads you to not capture your fair share of the value created. What you see is the case of value staircase the flip side of value waterfall.

Plug the value leaks, you get to capture a share of it as better price.

How do you determine what your customers value?

 

The iPad mini Price Premium

A common analytical method in pricing is Conjoint Analysis. While this has evolved into far more sophisticated methods, at its core Conjoint Analysis is about finding how much utility different customers assign to different “features/aspects” of a product. If you know the utilities you can find how to price different product versions.

Here is a quick tutorial if you want to know more.

In the case of tablets you can think of iPad and Fire to be a collection of  features (or benefits) that customers assign perceived utilities. So when you add up the utility assignment for each feature you get the total utility.

Total Utility from Tablet = Fudge Factor +
Price Point ($199, $329)+
Utility from physical features (screen, wifi, etc) +
Utility from Brand +
Utility from Ecosystem

A few days ago Amazon ran a message on its main page comparing Kindle Fire and iPad mini, feature by feature.

The message essentially says Kindle Fire at $199 price point offers better features (by extension better utility) than iPad mini at $329 price point.

Likely true. But the point to note is the utility value from features is neither absolute nor intrinsic. It is perceived utility and it differs from segment to segment. Furthermore there are the “Fudge Factor” – the unknowns, Brand premium and Ecosystem Premium.

Apple likely found a sizeable segment – different from Amazon’s target segment – that assigns lot more value to Apple’s Brand and Ecosystem than they do for Amazon’s Brand and Ecosystem and hence is willing to pay $130 more for iPad mini. (Technically it is $95 more if you consider Fire without “Special Offers” and add price of Fire charger).

Amazon’s comparison is valid. But if the customer segments and their value allocation is not the same, then it does not matter that Fire packs better features at lower price. That is likely why Amazon decided to pull the Ad?

 

How Discounting Affects Product Value Perception?

It is fair to say everyone loves a discount. There is data to support the claim from years of Black Friday discounting that not only makes customers skip sleep and stand in cold weather for hours but also generates considerable revenue for the retailers. Then there are the group buying discounts made popular by GroupOn.

At the individual customer level, previous research done on customer preference for discounting point to both rational economic and emotional reasons.  Kahneman and Tversky showed, customers prefer discounts even if they saved lower amount in absolute terms.

Thaler in his work on Mental Accounting and Consumer  choice provide evidence of emotional (non-financial) reasons for why we may be motivated by discounts.

So we all value deals for rational and irrational reasons. But how much do we value the product after the initial buying decision? More specifically, since we do not know the absolute values, how much relative value do we place on a product bought on a discount vs. an identical and substitutable product bought without the discount?

There are three distinct possibilities.

Hypothesis 1: If we treat our customers as rational (ignoring the contradiction), once they bought the product at whatever price, the costs are sunk. How much relative value consumers get from each product should depend only on its own merits and independent of initial discount. At the very least, the choice between the two should be no different from  a random choice.

Hypothesis 2: If we treat our customers consistent with their previous action of seeking discounts for non-financial reasons, we should expect them to value the product bought at a discount higher than that of the one bought at full price.  This hypothesis is further reinforced by endowment effect and cognitive dissonance (I must really value this product, otherwise I would not have stood in line for it).

Hypothesis 3: Customers value the full price product more than the one bought at discount (remember the preconditions – identical and substitutable products).

So I conducted an experiment. The data and analysis show that  the last scenario, Hypothesis 3, is more likely than the other two.

The experiment was designed to get customers to reveal their preference by asking them to give away one of the two identical products of same price:

1. One they bought at full price
2. Other they bought at 50% discount

As it turns out, customers are more likely to keep for themselves the full priced product and happily give away half-priced identical product.  So while discounting may bring in customers, it may hurt by depressing the relative value of the product to the customers.

What does this mean to you as a marketer?

1. Think again before running 50% deals on any group buying site or allowing your product to be bundled and sold at a discount by other channels.
2. Attracted by large user base from giving away your product for free? Consider loss in perceived value to the customer.
3. Know the customer’s end use of the product. If they are predominantly buying it for their own use, discounting most likely will not help improve lifetime value of the customer.  If they are buying it for others, discounting helps.

Want more actionable insights? Talk to me.

Further readings:

Kahneman and Tversky – Choices, Values and Frames, American Psychologist,  1984

Thaler – Mental Accounting and Consumer Choice, Marketing Science 1985

Note on the Experimental Method:

I relied on convenient sampling and applied Bayesian hypothesis testing. Compared to conventional, run of the mill hypothesis testing, say testing for statistical significance at 95% confidence level using Chi-square test for this case, Bayesian Hypothesis testing allows to test multiple hypothesis at the same time and help state the results in terms of probabilities instead of as absolute truths.

Results are subject to sampling errors, and do not take into account segmentation differences. This is also stated preference study and not a revealed preference study.