Willingness To Pay Vs. Wherewithal To Pay

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Market Segmentation Based On Consumer Behavior

Pricing For Richistan

Richistan is the name of the book by The Wall Street Journal columnist Robert Frank. The book is about the lives of the wealthy and high propensity to consume. Frank says in that book,

Pricing for Richistan is like pushing an unlocked door – no pressure

Through @pricingclub I saw the USA Today news on $4000 sunglasses by Oakley.

“I could have seen something like this selling three years ago,” says John Horan, publisher of Sporting Goods Intelligence newsletter. “But conspicuous consumption is out.”

Conspicuous consumption is not all out. While marketers (like LVMH) targeted Richistan there were a few other segments which self selected themselves. They had high willingness to pay but not the wherewithal to pay.  Only these segments are now out. Since the economic downturn we do not know the population of Richistan. Their ranks may have shrunk but as it does I hypothesize that those who are left in it have increasingly low price sensitivity and are willing to splurge lot more than. So it makes sense to introduce super and ultra premium products like the $4000 sunglasses.

Oakley is producing just 200 pairs, thus making it exclusive and its stated target segment is “the guy who doesn’t blink at spending $300,000 on a car”. This is super narrow targeting, males of Richistan that can buy expensive cars without a thought. Compared to $300K price tag the $4K is going to look relatively small.

Another reason why this will help Oakley is the presence of $4K per pair sunglasses helps to improve customer reference price and make their $200-$500 prices look like a great deal.

Great marketing strategy. But, what is surprising to me from that story is not the price but the argument for the high price based on the cost.

About 80 layers of costly carbon fiber — a material more common to the aerospace and motor sports industries — are pressed into the frame. The ultracostly material and design make the frames more flexible and comfortable for athletes, says Neil Ferrier, Oakley’s advanced product development chief.

Another reason for the high price tag, Ferrier says, is the number of worker hours devoted to them. About 90 hours of machine time go into crafting each pair, he estimates.

Costs do not matter to customers and making a cost based justification makes sense only if a marketer expects push back.    So why bother even mentioning cost to produce?

Results From Pay-What-You-Can Experiment

Facing down economy, customers cutting expenses due to unemployment and overall drop in consumer confidence many small businesses  face excess capacity, high fixed costs  and drop in customers. One such business is Sensorielle spa in Boulder Colorado. For Sensorielle, or for any business, there were two options when they faced such steep drop in sales,

  1. Cut costs: operating costs  including staff cuts and marketing expenses
  2. Drop prices to appeal to wider customer base

Cutting marketing costs is not a good idea especially during recession. For a spa the differentiation comes from telling a convincing story and making a value proposition to customers that the services are far better than a simple massage they could get from cheaper alternatives.

The talented staff are the most important asset to a service based business like a spa, without them there is no convincing value proposition. It will also be very difficult to hire them back when the economy turns around.

Price cuts are never a good idea  especially when the service provided is valued highly by customers but they decide not to consume it because of changes in their wherewithal to pay. For a luxury spa, price acts as  signal of quality and value. It is also very difficult to increase prices after price cuts.

Ms. Jewl Petteway, owner of Sensorielle spa decided to experiment with “Pay-What-You-Can” pricing scheme. The net is, there are posted list prices but customers are encouraged to pay “what-they-can”. The pricing also served as marketing message to bring back customers, especially long time regulars.  A key point to note is that while this resembles “First degree price discrimination”, which is charging each customer their true willingness to pay, the “Pay-What-You-Can” is not aimed at capturing value.

Should this have worked? My hypothesis, when I first learned of this pricing, is that there are other ways to increase profits than leaving it up to the customer to pay. The customers do not always know the value they get. While the posted list price serves as a great anchor, “Pay-What-You-Can” tells the customers that the price is negotiable or that the list price is an upper bound the spa set but the true value is below that number.

M.Petteway published results from her experience in the Boulder Net LinkedIn discussion board. She talks about how  few customers interpret the pricing plan as “pay what I want” and ask for high-end services even though they pay less than the posted prices. For any rational customer (Homo Economicus) whose goal is to maximize their utility, it makes sense to pay the minimum they can get away with. But that is not the only reason why customers are paying less for the services.

When a business has a list price and then says, “pay-what-you-can”  it signals to customers, “you may value more but you don not have to pay the list price”. The list price is treated by customers as “full price”. Pay-What-You-Can ends up destroying value and decreasing the reference price in the minds of the customers. Even if there is not an explicit price cut, the signaling ends up decreasing customer willingness to pay.

My recommendation:  I do not believe in leaving it up to the customer to pay for the services. I instead believe in segmentation and targeting. They should have offered multiple versions at different price points and with unbundled pricing that allows customers to self select themselves to the version that matches their willingness to pay. The classic example in services is salon pricing. Price discrimination is not about leaving it up to the customers to decide what they want or can pay, it is about giving them enough choices and nudging them to the version they are most likely to choose and profitable to you at the same time.

Here are my other suggestions for small business pricing.