This past Thursday I taught the first fully released pricing course for Pragmatic Marketing. The day was better than I could have hoped. The students were energized, asked great questions, contributed their own stories and I’d like to believe they all walked out with a smile on their face and several action items to help them in their pricing endeavors.
However, about three quarters of the way through the class, I put up a slide and to emphasize its importance said, “this is my favorite slide.” A lady in the front decided to make fun of me by asking, “how many favorite slides do you have?” Embarrassingly, I had to admit that I’d said that line many times during the day. And it’s kind of true. There are so many great concepts in pricing that can help companies be more profitable. So many concepts that aren’t obvious and produce aha’s in the students. Many of these concepts seem to be my favorite.
But it did prompt me to think, “what should be my favorite slide? What is the most important concept in pricing?”
The answer: The most important concept in pricing is to price based on what your customers are willing to pay, not your costs.
I teach that concept first thing in the morning. Companies must use Value Based Pricing. Charge what your customers are willing to pay, not costs. There is a little pushback at first, but soon everybody nods their head and has accepted the concept, almost. Throughout the day, students sometimes make reference to why they needed to use costs to price. Of course I’d have to correct them. By the afternoon, they were catching themselves whenever they were about to mention costs again. It’s amazing how ingrained pricing based on costs really is.
What about you? You may nod as you read this, agreeing with me, but then do you go talk to your company about costs and pricing? It is fascinating that pricing based on costs has penetrated us so deeply that it’s hard to let go. That’s one reason I think Value Based Pricing is the most important concept.
The other reason though, if you don’t accept value based pricing, then you lose the power of all of the pricing strategies that come with it. There’s no need to segment pricing based on willingness to pay if you only price based on cost. You can’t take full advantage of a good-better-best strategy if you only price on costs. There’s no reason to think of pricing portfolios if you only use costs.
Yes, value based pricing is without a doubt the most important concept in pricing. But that doesn’t mean I can’t have more “favorite” slides does it?
Photo by Valerie Everett
Do you like Freakonomics? I sure do. Levitt and Dubner’s latest book, “Think Like a Freak”, is a fun read which I highly recommend. But I had to think hard about chapter 7, “What do King Solomon and David Lee Roth have in common?”.
If you haven’t read that chapter, you should, but here’s a very quick synopsis. (spoiler alert) Both King Solomon and David Lee Roth used game theory to create separating equilibria. This essentially means they set up a “game” so that people inadvertently reveal their true identities.
One of their examples was why David Lee Roth used to ask for M&M’s with all of the brown M&M’s taken out. At first glance this seems like another wacky, self-absorbed superstar demanding eccentric treatment. However, David Lee Roth added this requirement for a very strategic reason.
When they were touring, they had a wild show, with pyrotechnics, lights, complex stages and heavy speakers. If the stage was not set up exactly as the contract specified, someone could get hurt. So how could Roth know which venues carefully read the contract and set up the stage according to specifications? He needed a separating equilibrium where he could tell the two different types of venues apart.
So Roth buried a clause deep in the contract stating he wanted his special serving of M&M’s. When he showed up at a site, if his M&M’s were there, without brown ones, he was more confident that the contract was read and followed carefully. If not, they assumed the contract was not read carefully so they had to carefully check the entire setup.
Why is this a separating equilibrium? Because two different behaviors indicated two different “types”. Venues who didn’t read the contract carefully wouldn’t serve the M&M’s properly. Those who did read it would. Just by looking for M&M’s he was able to tell which group read the contract and which didn’t.
After reading this, two questions came to mind. 1. How do we set up our own separating equilibria? and 2. What does this have to do with pricing? Sorry, but I haven’t figured out how to answer question 1, but question 2 is what prompted this blog.
Is there a mechanism which produces a separating equilibrium whereby we can distinguish customers with high willingness to pay from customers with lower willingness to pay? Yes. Think coupons. Only people who are price sensitive go through the hassle of finding, clipping, storing, carrying and remembering to use coupons. People who are not price sensitive don’t.
We can use a similar concept to create more separating equilibria. In essence, anything that offers a discount for effort (or anything negative) would be a separating equilibrium. Imagine when you get to the grocery store checkout, the clerk offers you a discount if you let her stab your arm with a thumbtack. Some people, who are very price sensitive, might say yes. Most of us would not. That is a separating equilibrium.
Okay, maybe that last example was over the top. Besides coupons, are there any other separating equilibria in use in pricing today? Sure. Think about who shop at stores like Macy’s, who have frequent sales. Some people just walk in and buy what they want when they want it. They are not price sensitive and usually end up paying full price. Others wait for Macy’s to have a sale and then shop. Only price sensitive people are willing to wait.
Many stores, including Macy’s, will offer you a discount on a full price item if you ask. However, only price sensitive people have the gumption to be willing to ask for a discount. In January 2014 NPR’s This American Life (available on podcast) had a fun story on one of their producers trying to get the “good guy discount,” simply asking for a discount. It certainly doesn’t always work, but it does sometimes.
You never know when or where we can learn pricing lessons, but it’s certainly fun learning them from the Freakonomics guys.
Pragmatic Marketing’s box of the month is Innovation. At first glance, what does pricing have to do with innovation? After all innovation is about solving customer problems. Usually with new technologies and capabilities. It’s about new products. It’s about invention.
Innovation is about solving customer problems. We sometimes have the chance to innovate using business models. When you hear the phrase “business model” you should think “pricing”.
Netflix changed the business model for renting DVD’s from daily rentals to a monthly fee. They solved the problem that people didn’t want to pay late fees.
In October, 2007, Radiohead (a music group) used “Pay As You Wish” pricing for their album In Rainbows. This solved the problem of prices being too high to attract new listeners, but still collected revenue from their fans.
In 2013, Kid Rock announced he would lower ticket prices and make up that revenue with a share of the concessions. Again, solving the problem of price being too high to attract new fans.
There are many more possible new business models. Freemium has become huge in many software businesses. (think LinkedIn). Uber changed the business model for taxis. Airbnb changed the business models for nightly rooms. Craigslist changed (obliterated) the business model for classified ads. The list could go on for a very long time.
The big question though, how can you change your business model? Should you?
Here’s an idea. Determine what your customers purchase from you. Not the physical product, but the benefit. Can you deliver that benefit another way?
Think back to your college marketing class where you probably heard the lesson from Harvard Business School Professor Ted Levitt: “People don’t want to buy a quarter inch drill. They want to buy a quarter inch hole.” If you are currently selling drills, realize your customers are actually buying holes. Is there the possibility of a new business model? Absolutely.
Back to Netflix. Customer buy the experience to watch a movie in their own family room. They weren’t “renting DVD’s”. Netflix found a new business model to serve that need.
Your homework for today, think hard about what your customers actually purchase from you. What is the benefit they are trying to achieve? Then, determine what gets in their way of more efficiently reaching that benefit. That is where you may find an opportunity for innovation in pricing.
Oh, instead of thinking about what, why and how your customers purchase, you might actually try asking them.
Psychological pricing is fun. In this field we get to study the effects of prospect theory (where losses loom larger than gains) to yield such odd behavior as the endowment effect (where we value what we have more than if we didn’t own it) and reference pricing (where we use the price we expect to pay in our decision making). We also have price endings, anchoring, dominated alternatives, good-better-best, and many more pricing tactics.
Psychological pricing can be defined as using pricing to take advantage of buyers’ lack of rationality. The books on this topic are quite fun to read. I recommend Dan Ariely’s book Predictably Irrational.
Experience shows that some of these tactics are pretty powerful while others are more interesting than impactful. Good-better-best and reference pricing are two that typically have a major impact. However …
Psychological pricing tactics pale in comparison to pricing for value.
Pricing for value (aka value based pricing) means understanding what your customers are willing to pay and charging as near to that as possible. If you are not yet committed to value based pricing, then focusing on psychology has minimal effect. By far the biggest impact you can have to your profitability is to adopt value based pricing. After you’ve adopted this most powerful pricing strategy, then you can worry about the psychological effects.
Picture by Pixabay
Question: My company provides training for more than 30 courses. There are 4 other companies which also provide the same courses but they do not show their prices on their website, they tell the price when a customer calls them. Till now whatever price I had shown on the website they used to charge 10% less than that. What should be my strategy now to increase my market share and revenue?
Answer: First, from the tenor of the question, it sounds like you believe that almost every purchase is a price decision. In other words, customers only purchase the lowest priced alternative. My first advice, is to stop believing that. Your company needs to create more value than your competitors. You can do this by offering more capabilities than your competitors, by delivering and proving higher quality, by building a better brand name, and even by better marketing. If your market believes you offer a truly better product, they would likely pay 10% more for it.
Second, if you believe strongly you are losing on price and you don’t want to, consider adding a price matching policy on your website. “We match all competitor prices.” This one policy has three great effects:
- Customers may come back to you if they find a lower priced competitor.
- Customers may believe you have the lowest price and won’t shop around.
- Competitors may stop undercutting your price because they know you will match their price. Competing on price just lowers everyone’s profits.
Third, considering raising your prices. If you really believe your competitors simply price at 10% below your published price, by raising prices you can raise industry profits (including yours). Then, you also have the ability to offer discounts to any customer who calls in to complain about price. Of course, if your competitors won’t follow you with higher prices, then you probably don’t want to do this.
Of all three of these, the first is the most important. Create value. Communicate value. Prove your product is worth more than your competitors.
My favorite quote from Hunter’s piece: “If price is the reason a customer will or won’t buy, then there is no reason to have salespeople.” What he is saying is it’s frequently something other than price that drives buyers’ decisions. Hunter gives us 4 ways to help sales deal with price.
- Management must embrace and support the price.
- Salespeople must have a solid understanding as to why the price is the price
- Salespeople must be trained on how to handle the price question when it comes up on a sales call.
- Salespeople must be confident in their selling skills, including communicating the price with clarity and eye contact.
As pricing and product people, we are responsible for making sure #2 happens. That was the point of my earlier blog. Sales has to be able to sell (items 3 and 4), but WE have to arm them with the knowledge and tools that define our value. They won’t get this without our help.
Many of us make fun of salespeople especially because they are always asking for discounts. Can’t they sell value? If they lose a deal, they often blame price. Price, price, price. If we listen to sales we’d believe that every customer only wants to pay the lowest possible price. Yet, it is true that every customer wants to pay less. But pricing (and selling) isn’t about what customers want to pay. It’s about what they are willing to pay.
You know the above paragraph is true. So instead of making fun of sales, let’s take a long honest look at ourselves. What are we doing to help our salespeople win at the price we think we deserve?
If we want our salespeople to win at higher prices, we must give them the knowledge and the tools.
Your salespeople probably don’t know as much as you do about the value of your products. When you complete Value Based Pricing exercises you compare your product to your competitors and look at the relative value. This is the information that your salespeople need to have at their fingertips. To win at higher prices sales must understand and be able to communicate your value relative to your competitors’.
Why can charge more than a competitor? You probably have more capabilities that the competitor. Make sure you document these differences and make them easily available to your salesforce. Maybe you have a lower total cost of ownership. Document and share it. Maybe you have the best lifetime value. Get that out to your salespeople.
Salespeople want to do what’s right and best for the company (and their pocketbook). However, they are not going to do the hard work of comparing your products to your competitors. They have other products to sell. It’s your job to make sure sales has the ammunition to succeed.
Your price and your value is relative to each one of your competitors. You will want to document what your value is relative to each and justify that price. Even when you are at a disadvantage, be honest with sales. They are on your team and you want them exerting effort on deals they are more likely to win.
The other key advantage to sharing this with sales is they will share back with you what your customers really think. This is great information as we try to tweak our prices.
My recommendation: Commit to giving sales the knowledge and tools they need to communicate your value to potential customers. Then make it happen.
Oh, and if you know any good sales jokes send them my way. :-)
The ability to price higher than your competition comes from having differentiated products. Your products must be better than your competitors’.
When we think of positive differentiation, we usually think of what features can we build that our competitors don’t have (yet). However, one very powerful “attribute” of a product that can create positive differentiation is brand. If your brand name becomes synonymous with trust and quality in your industry, you have earned the ability to charge more. People pay more for well known brand names.
Here is one of my favorite examples:
Take a walk with me down the vodka aisle at your local liquor store. You will likely see something very similar to what I’ve seen at my local Beverages and More. Stolichnaya Elit Vodka is priced at $59.99 for 750 ml, Grey Goose Vodka is $26.98, and Nordic Star Vodka costs $7.99 for the same size. Three different brands, three different prices. We assume three different quality levels.
This doesn’t seem unusual until you read Section 5.22 of the U.S. government’s Standards of Identity for Distilled Spirits which defines vodka as “neutral spirits so distilled, or so treated after distillation with charcoal or other materials, as to be without distinctive char- acter, aroma, taste, or color.” In other words, by law you should not be able to tell one vodka from another. In this case (or bottle) it really may all be in the brand.
Brands are expensive and time consuming to build, but as you can see, they yield strong pricing power.
Photo by Hippietrail
In B2C transactions, mail in rebates are profitable largely because the consumer uses them when making their purchase decision but then often doesn’t send in the forms to receive the rebate. This is free money to the company offering the rebate. For example, nearly half of the 100,000 new TiVo subscribers in 2005 did not redeem their $100 rebates, allowing the company to keep $5,000,000 in additional profit.
However, B2B companies don’t offer mail in rebates. Rather, they typically offer rebates when their customers achieve some threshold. It could be total spend, a specific number of units, purchasing a collection of products or even a marketing objective like a published referral. In these cases, the B2B vendor calculates which customers earned the rebate and automatically send it out. There is no free money here (at least not for the vendor).
In fact, often it’s worse than simply not collecting free money. Many B2B companies who offer rebates find that these rebates simply become expected discounts given out year after year because they gave it out the year before. They stop checking if the customer reached the necessary threshold. This is the opposite of free money. This is lost money. The main cause for this is not having systems in place to methodically check on who deserves the rebate. Rebate programs are easy to talk about but much harder to implement well.
B2C rebates work because the same buyer who makes the decision also receives the rebate. This is often not true in B2B. A purchasing agent is typically evaluated and compensated based on the discount she negotiates for any item. Rebates are typically not calculated into these discounts because they are not certain. Hence, rebates are nice for the receiving company, but they don’t incentivize the decision maker to decide in your favor.
However, when these two negative effects are accounted for, B2B rebates have a powerful purpose. They can hide your best prices from your distribution channel.
The problem is distributors have so much information about your past pricing behavior that if you offer a discount to a strategic customer through a distributor, that distributor now knows how low you are willing to go. When the next semi-strategic customer comes along, the distributor will ask you for your best price, which they know because of past discounting behavior. What’s really frustrating though is that sometimes the distributor doesn’t even give that best price to the customer. They pocket the extra margin themselves.
Rebates can stop this. When you need to give a lower price to a strategic customer who’s buying through distribution, consider offering the customer a rebate. That way the distributor never sees the lower price and the customer gets the benefit.
My advice though, enter into a rebate program very carefully. Be clear about what to expect. Don’t just give away the discounts, validate that they are earned. Know what benefit you will get from the program and monitor it. If you aren’t getting the benefit, kill the program. Rebate programs are a hassle to implement and execute.
Photo by Brandie
We often think of pricing as putting a price on a product. This is true, but it’s so much bigger. Here are several examples.
Scope: When we sell one item, we can probably sell more. Think of this as complementary products. By pricing low on the products our buyers use to make the decision, we may be able to win the deal and then make real profit with complementary products.
Scope: When large companies negotiate with large companies there are usually multiple transactions happening at once. Imagine Dell and Intel. Dell buys from Intel. Intel buys from Dell. Dell could also buy AMD. Intel could also buy from Acer. Dell could purchase a multitude of different products from Intel. Intel could do the same. When purchasing for one company is negotiating a part and a price, they almost always make it bigger. More parts. Total spend.
Deal size: Sometimes our customers use more and more product over time. This is true with consumables and when selling parts to manufacturers. The bigger deal is to buy more, commit for a longer period of time. Sometimes buyers will offer to do this to get a better deal. Sometimes sellers will insist on this when buyers ask for discounts.
Deal size: We often see volume discounts. If a buyer is willing to commit to more, they can get a better per unit price. The game is bigger.
Loyalty: Think lifetime value of a customer. If you can gouge them today, you might lose them as a customer in the future. By maintaining loyalty they buy from you over the long term.
Strategic relationships: A purchasing agent might say, “If you give me a better price I’ll help you get designed into the next product.” Similarly, a salesperson might say, “I might be able to get you that discount you need if you can help me get designed into the next product.” Instead of the next product it could be a joint white paper, an introduction to another company, a referral, anything that’s strategic to the seller.
There are many more examples. The point is that it’s almost never simply one product and one price. There’s almost always a bigger game. Can you identify the bigger games you play? The goal is to play the big games as well if not better than you play the small ones.
Photo by Ytoyoda