This blog has previously discussed the importance of Will I? and Which one?, the two decisions our customers make before almost any purchase. If you want to know more try this post Will I? Which one?.
Recently, while working with a company on their pricing strategy, I asked, “Do your customer purchase just after the Will I? decision or do they consider other alternatives (i.e. Which one?)?” They replied, “85% of our business comes after only deciding Will I?.” Hearing this, I suggested their customers weren’t very price sensitive and they could probably get away with raising prices.
They agreed with me, but then one clever person in the room asked, “But won’t that effect how many each customer buys?” He’s absolutely right! Although Will I? and Which one? are the two most common decisions our customers make, regardless of industry or business, often price effects other decisions our customers make. When we understand all of these decisions, we can then determine or at least consider how price effects each one.
Here are several examples.
How many? It is very likely when we sell more than one of an item to a customer, the higher the price the fewer they will buy.
Where? When we sell through multiple resellers, they compete with each other. Differences in their prices may influence where people buy.
Which channel? If we sell through resellers, direct on the web, and with a direct salesforce, many customers make a conscious decision on which channel they want to buy through.
When? Sometime customers wait for sales or other events.
How frequent? Similar to how many.
Which products to consider? Customers use heuristics and simple rules to make sense of the world and narrow down their decision process.
Your takeaway is to brainstorm about all of the different decisions your customers make. Then ask yourself, or even your customers, “what role does price play in that decision?”
Photo by Vancouver Film School
Of course we do. But it’s not that simple.
Ask a salesperson why we lost a deal and you’ll hear one of two answers: The price was too high or the product wasn’t good enough. Ask him why we won and you’ll hear it was because he had a great relationship with his customer. Of course all these things matter, but they are rarely the driving factors.
First, price is involved in every purchase decision your customers make. Every time a customer buys from us, price was an important part of that decision. Not the only part, but important. Sometimes we price too high so yes we lose on price. But that’s because we didn’t offer enough value for the price we were asking. We should be striving to learn what our customers value and charging appropriately.
Here’s the important point today though. Sometimes we lose a deal before the prospect even sees the price. Then it doesn’t matter what price we charge. Our prospects may eliminate us early in the buying process. Maybe we didn’t make the first page of their google search. Maybe we didn’t have good enough Yelp reviews. Maybe our marketing wasn’t clear enough for them to understand we solve their problem. Regardless, we likely lose many deals before price is even a consideration.
When we are talking to our market, learning why we win or why we lose, (you are doing this aren’t you?), make a special effort to find some situations where price wasn’t even considered. When we lose very early in buying process something else needs fixed. We need to know what that is. Find companies who bought from our competitor when we didn’t even know they were in the market. Ask, with sincere curiosity, how them arrived at their decision. We have a lot to learn.
My answer: ”Yes!” Effective pricing requires participation from all of these departments.
Finance must provide margin guidance and help with monitoring of actual results against the expected results. Finance and other executives are often involved in crafting the right pricing strategies. They run what-if analyses to help predict the results.
The product lines must understand the market and the value the products have to the market. They must be intimately involved in setting the price. They are also the last level of escalation to approve deep discounts for important strategic customers. Since profit and loss responsibility typically lies with the product line, they must have a lot of say over pricing.
Marketing needs to understand pricing exceptionally well so they can communicate the value to the customers. They need to create the tools that empower salespeople to win at the highest possible price.
Sales Operations or the deal desk quotes individual deals. They are often the front line to the customer for price. They execute the pricing strategies and levels so they need clear guidelines to follow. They are often involved in the monitoring of the success or failure of pricing.
Salespeople are truly the front line of value communication. They negotiate with the largest customers. They MUST believe that the value delivered by our product is far more than the price we are charging. Sales has a huge impact on whether or not the company achieves the prices set by the product line.
Back to the original question, “Who owns pricing?” Every department owns a piece of pricing. If you decide to bring on a pricing team, they need to have influence over every one of these groups. That means one of two things: 1. You bring on a team of highly influential leaders who can lead and generate change without authority or 2. You put pricing in the most powerful department in the company, possibly even reporting to the CEO.
My preference is #1. Hire true leaders. Then it doesn’t really matter where pricing sits.
Picture by Colleen Simon for opensource.com
I recently received this question:
“Hi Mark, I’m a consistent reader of Pragmatic Pricing and try to apply each concept to my own business. As a consultant, I take on projects and bill by the hour. How can I apply Good, Better, Best? Thanks, Bill.”
Thanks for the question, Bill. Many people sell their time by the hour so you’re not alone. However, you are right to notice that it’s very difficult to use a Good, Better, Best strategy when you charge for your time. Instead, let me ask (beg?) you to consider charging by the job instead of by the time spent. Then you have the ability to use price segmentation strategies like good, better, best.
Most people who charge by the hour do so because it seems fair to both you and your client. Also it’s hard to accurately predict the size of the job (number of hours). Both reasonable answers at first glance, but let’s dig a little deeper.
Is it really fair? The client wants the best job done at the lowest possible price, of course. However, your incentives are not the same. You are paid more the longer the job takes. Once you finish this job then you have to go find another. Why not drag this one out, at least a little. Of course you don’t actually do this, but this is exactly what your client is thinking … “Is this detail necessary?”
Can you predict the number of hours? Maybe not. But it turns out many service providers who have been doing their job for a long time pretty much know about how long something is going to take. The more experience you have, the easier it is to make these estimates. Do you ever say to your client, “This should take about two weeks of work”? If so, you do know how to estimate time. You just don’t want to take the risk of being wrong. Instead, you put that risk on your client when you charge by the hour.
What I really hate about hourly pricing is the price is not directly correlated with the value the client receives. Instead, it’s correlated with your costs (your time). It’s almost impossible to use value based pricing by the hour.
It turns out, your clients would prefer to pay a fixed fee. Then they know they are getting value for their money and they don’t have to worry about the gotchas. When you get your oil changed, would you rather pay by the hour or by the job? I’d much rather pay by the job knowing that if something goes wrong they are responsible.
My suggestion is always offer fixed fee WHEN YOU CAN. Many jobs you have done numerous times. You have much more knowledge about how long it takes to do one of these than your customers do. Figure out what the average time a job takes and then add a percentage (like 25%) since you are assuming all of the risk. Then, you can offer your customer the following deal: This is my fixed price. If it takes much less time I’ll charge you less. However, if it takes much longer I reserve the right to raise the price but only with your permission. At that point you can choose to take the business elsewhere. For normal jobs or jobs that really are fast, bill them 10% less and you’ll get tons of referrals while making a much higher hourly rate.
Back to the original question. Once you’ve moved to fixed fee pricing, it becomes much easier to offer good better best. Think of the different services or outcomes you could bundle together. Then, you can create 3 packages. One that’s barely acceptable to some of the market, one that hits the sweet spot, and one that offers a ton of service for a very high price. This will help you win more deals and win some at much higher prices.
Hope that helps and thanks for the question.
Bloomberg and others recently reported that Netflix is testing a price “increase”. Congratulations to them!
I’ve been pretty harsh in the past with how poorly they handled pricing. This time I think they are absolutely spot on. Two things we should learn from what they are doing.
First, they are TESTING! They aren’t announcing a large price change without thorough testing. How often do we work ourselves up into a frenzy, believing we have the right answer, dive into the deep end and find out we made a mistake. Pricing, like most customer facing decisions, can and should be tested.
Second, they are testing a strategy of price segmentation based on how much value their customers receive. They are looking to create different packages and charge based on the number of users (or the number of screens). This means that a family of 4, each watching separate streamed shows on their own devices, would pay more than a single person watching his/her favorite shows. It makes sense that more users receive more value, so they would likely be willing to pay more. Not that they want to pay more, but they would be willing.
Some news agencies somehow got wind of this test and reported it. Netflix has not yet created messaging since they are just in the testing phase. This becomes extremely obvious when you read some of the comments readers of the article made. They think Netflix is simply trying to raise prices to take more money from their subscribers.
My advice to Netflix. When you announce the new “products” be sure to compare your new programs with Dish, DirectTV and the cable companies. They all charge an additional monthly fee based on the number of set top boxes users have. You can use this as a direct analogy. However, you will want to test this message as well before rolling it out.
Nobody likes their prices to be raised. Netflix needs to carefully position this price increase so as to not upset their customers. That said, everything I see so far says they are doing this one right.
What should you take away from this? First, test your price changes (and your messaging) whenever possible. It’s not always easy, but it’s much easier than trying to appease an entire upset customer base. Second, segment your pricing based on what your customers are willing to pay. We’ve said this a hundred times in this blog. Create new packages and offerings to segment your market and capture more of the value your customers receive. Yes, we’re being repetitive, but are you doing it yet?
The other day while traveling, a colleague asked me, “Why do hotels publish these ridiculously high prices on the back of the hotel room door? The sign says $799 but we only paid $150″. I went back to my hotel room and snapped this picture.
Although I was unable to find the definitive answer, here is an educated guess. Undoubtedly, Pennsylvania (we were in Pittsburgh) has a law requiring hotel operators to post the room rate at a visible location in the room. (Note that the paragraph below describes a PA law passed in 1913.) The law was probably written to protect consumers by keeping hoteliers from charging higher than normal rates. This was before the time when hotels would commonly adjust pricing based on market conditions and demand.
Under these circumstances and laws, the hotel is best off posting the highest rate they would ever consider charging for the room. They could always charge less, but they couldn’t charge more.
When I described this to my colleague, he persisted, “Who would ever pay $799 for that room? Why did they choose that price?” This answer was simpler. What could that hotel charge for a room if the Super Bowl is held in Pittsburgh? Especially if the Steelers were playing in it. $799 may be too low.
What we probably have here is an antiquated law that hotels must follow. Of course, hotels obey the law in the manner that is most effective for themselves. As a result, the only thing the law really does is make the hotels look ridiculous.
What can we learn from this? How about we shouldn’t pass specific pricing laws? How about we should revisit old laws? Maybe, but those are political issues.
As business people we must follow all pricing laws, but we can obey them in a fashion that is best for ourselves. Here are some lessons: First, when we must publish a price, it should be our highest price. We can always go lower but it’s very hard (if not illegal) to charge more. Second, if you must publish a ridiculously high price, hide it as best you can (like on the back of the hotel room door.) It only makes you look foolish.
The other night our friend James von Rittmann regaled us with fascinating stories of how before going to college he managed to buy the Americana, a 140 foot boat commissioned by Al Capone in 1927 and launched in 1930. James chartered the boat out in the New England area for large parties on a daily basis (at high prices of course) and as a result met many fascinating people. He told stories of how twice it was captured by pirates, the second time the pirates ran it onto a reef, which ripped a gaping hole in the hull. Unfortunately insurance wouldn’t cover the extensive damage so he had to move on in life.
Many years later, James found the Americana on the West Coast. After meeting the new owner, James excitedly chartered the boat for an event. He was given an exceptionally great price for the charter “because of who he was.” During the event, the new owner referred to the Americana as James von Rittmann’s boat.
OK, this is a pricing blog. Why the long intro? The nature of James’ current company involves, at least in part, putting on amazing events for premiere school alumni associations. These are often high-end affairs. He has since chartered the Americana many times for some of these events. The new owner gave a “strategic” discount to James, to win him over and gain repeat business. Smart decision.
Think of a strategic discount as one that helps us attain a longer term goal. This can be discounting to win a huge client (like James was for the new owner). It can be to build word of mouth or a great reputation. Maybe one customer has a lot of sway over other business. These are all strategic situations and we may want to offer a discount to be sure to win.
However, how often do our salespeople ask us for “strategic” discounts? It seems like every deal is “strategic”. In a way, every deal is strategic. Every deal does help our revenue and our reputation. But this doesn’t mean we want to discount every deal.
What should you do when you’re asked to discount for that “strategic” customer? First, vet the opportunity. Is it really strategic? Do you have a working definition of strategic for these situations? You offer a strategic discount because you expect to gain something in return. Can your salespeople clearly articulate what you will gain?
Second, start and maintain a Strategic Deal Log. This log should include the date of the deal, the customer name, the salesperson name, and details of the deal. Most importantly, it must include what you expected in return for the discount and the expected date of the quid-pro-quo.
Now, when a salesperson comes to you with a new strategic opportunity, you can search the log for other deals that salesperson has brought to you. Did any previous discounts we offer actually result in a strategic return? You can also check the customer name to see if they are on the log. Have they delivered on their previous promises?
Over time, you can use this log to refine your definition of a strategic deal. What are the characteristics of opportunities that live up to their strategic billing?
In the end, you want your salespeople to highlight the strategic opportunities so you can act strategically, just like the new owner of the Americana. However, you don’t want sales to use the phrase “strategic” every time they need a discount to close a deal. Try creating a Strategic Deal Log. It can’t promise smooth seas, but it is instrumentation that will help you reach your destination. (A little sailing metaphor.)
A reader sent the following email:
Mark, I always enjoy reading your Pragmatic Pricing site and got this link sent to me from a friend. Once I saw it, you were the first person I thought of.
The Cards Against Humanity team came up with this idea, got Amazon to go along with it, and crushed it on Black Friday. It’s interesting because it got additional press, which probably drove more eyeballs, but people knew that the next day it would be $5 cheaper and they still purchased it.
From a pricing perspective, could this be repeated? I’m guessing people felt ok about paying more because it was “fun”.
First Ryan, thank you for the nice comments about Pragmatic Pricing.
The lesson I glean from this successful “experiment” is that when a company can create something fun or funny or surprising (in a positive way) about their offering that makes the conversation go viral, it has a great chance of boosting short term sales. In this case, the company, Cards Against Humanity, was able to turn the Black Friday sales tradition on its head and charged more. This was so unusual and outrageous that it went viral. Then some of this extra attention turned into sales.
It is interesting that many people purchased at the higher price on Black Friday instead of waiting and purchasing the next day for $5 less. Maybe they didn’t pay close attention and assumed it was a discount, when in fact it was the opposite. Maybe some did voluntarily pay a little more just because it was fun. I tend to favor the explanation that they weren’t aware. (How often do we just assume certain things are true when we make purchase decisions?)
However, note that a lot more people purchased the day after black Friday. Some of these may have been aware of the gag and waited. Some of them may not have heard of the stunt until Saturday. Regardless, the attention of this outrageous pricing scheme is undoubtedly what drove the sales.
To answer Ryan’s question, could this be repeated? I would say yes, but not too many more times. I would guess that even though it made a big splash, only a small percentage of the population heard about it. There are still millions of people whose attention has not yet been grabbed by this shocking pricing strategy.
That said, there are possibly other pricing strategies that may grab people’s attention. A few years ago we wrote about the Subway $5 footlong, which we believed was successful because it was both surprising and memorable. Keep watching and we will surely see more.
The following excerpt from the November 20, 2013 Wall Street Journal article titled “Price War Looms For Electronics” screamed out at me that there is a lesson here to be learned about trying to avoid a price war. First, read the excerpt.
Best Buy Co. shares plunged 11% Tuesday, after the electronics chain warned investors that it was prepared to sharply cut prices—even at the risk of its profit margins—to keep up with competitors that are aggressively discounting to win market share. Chief among those rivals is Wal-Mart Stores Inc., which last week stated bluntly that it will turn to even more price cuts to boost its stagnant sales.
I’m especially enamored with the comment that Best Buy warned “that it was prepared to sharply cut prices to keep up with competitors.” Think about what this statement says.
Maybe it’s completely truthful and it means exactly what it says. They are ready and willing to fight any price war that comes along.
However, think deeper. What it could mean is: “I’m warning you competitors to not start a price war because it won’t end in you gaining share, only in lower profits for all. We are committed to maintaining our share even at lower prices. Since lowering prices won’t gain you share, you might as well not try.” The statement could be an attempt to stop the price war from ever beginning.
Economists call this “cheap talk” and would take the logic even further. They point out that it is costless for Best Buy to make this statement. And, if Wal-Mart aggressively lowers prices, there is no gun to Best Buy’s head forcing them to fight a price war. Hence it may simply be an idle threat to keep competitors from lowering prices. The logical conclusion is that competitors should not believe this threat is credible.
Although economists are usually right in theory, this doesn’t feel like the best explanation. Since Best Buy made the statement to their investors, they are essentially committing to a course of action. Yet surely they are hopeful that announcing these intentions, their competitors will choose to not compete so aggressively. This holds industry profits up for all.
Regardless of the truth of Best Buy’s intentions, we can learn a lesson from this. Threats of aggressive retaliation often keeps competitors from using price to compete. That has the potential to keep profits, yours and the industries, higher. The lesson, be strong and threaten retaliation in a price war. After all, the threat doesn’t cost you anything and it just may work.
Think about supply and demand. Years ago I wrote a blog post on how supply and demand aren’t typically related to pricing because supply is usually abundant. Implicit collusion, not supply and demand holds prices above costs.
Today, let’s think about when supply is limited. We see this for consultants who have more business than available hours. We see this for airlines and hotels during the holidays and other busy times. Each year, some toy will become the hot, unattainable plaything that every kid clamors for.
In each of these cases, demand exceeds supply. This means ideal pricing is driven by supply and demand. Excess demand is an opportunity to increase price.
We see that airlines and hotels charge higher prices during their busy times, when demand exceeds supply. Savvy consultants do the same. Ticket scalpers for sold-out events are taking advantage of excess demand while new dynamic pricing methods are trying to capture more of that profit for the venue and promoter.
Constraints don’t mean you have to raise prices, but it is an opportunity.
Remember when Volkswagon re-launched their Beetle. It was a huge hit and there were long waiting lists to purchase one. However, VW did not raise their prices. Notice that because VW didn’t increase prices, some entrepreneurial people were able to buy a Beetle off the showroom floor and then sell it aftermarket for a profit.
The same is true for the new video game consoles when they are first released. Usually there is a temporary “used” market at prices higher than what the manufacturer charges. Of course this market goes away once the supply constraints go away.
Constraints can drive higher prices even if you are constrained and your competition isn’t. Since the constraint means you can’t completely serve all of your customers, you may choose to only serve those with the highest willingness to pay. This often means raising prices. Of course, be clear about what may happen when your constraints diminish and you try to win back lost customers.
Now apply this concept to your business. What constraints can you foresee? Are there super busy times, or a lack of supply of a critical component, or not enough hours in the day? Plan now what you will do when these constraints arise. It is much easier to make these decisions logically when customers aren’t screaming for more.
Constraints often look like challenges, but pricing power is frequently a silver lining
If you think of any other constraints I haven’t mentioned, please share with the community.
Photo by Hanna