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
This question was asked by a startup company this past week. They have the majority of a pretty broad software application already completed. How do they decide what to cut or add when determining the good, better, and best offerings?
Here are three steps to get them there:
1. Identify all pricing levers. This is a brainstorming exercise. Of course you can add or delete features to create the different levels, but don’t stop there. Which features can you decrease or increase? Can you alter the number of users? Alter the speed or memory? Control the number of uses per week? You get the idea. Think of every way you could create different products. Don’t worry about how valuable they are in this step. Just brainstorm.
2. Go talk to your market. Create (or mock up) a product and find out what they value. What do they not value? Start by asking open ended questions and then ask specific questions concerning the levers you identified in step 1.
You should also ask which features are required to make a useful product? You’re looking for the smallest set of functionality that someone would still consider useful.
Finally, you need an estimate of what they would be willing to pay. Ask the question this way: “What do you think is the most that other companies like yours would pay for something like this?” You can interpret the answer to this question as how much they would be willing to pay.
3. Look for correlations between how much customers are willing to pay and which of the pricing levers they value. You are looking for the levers that are not highly valued by those with low WTP (Willingness to Pay) but are highly valued by those who are WTP more. Obviously, your good, better, best products are created such that the good has the lowest capability but is still useful to those with very low WTP. Then add capabilities based on the amount of value they have for the better and best categories.
Of course it’s never this simple, but it’s not that hard. Remember your goal in creating good, better, best packages is to create a good that is good enough, and then add enough additional value that those with higher WTP choose to buy the better and best.
Photo by Flowizm
Pragmatic Marketing is sponsoring a lunch and learn event on pricing in Scottsdale on November 13. The lunch starts at 11:30 and the learning starts at noon.
If you’re in the area, come learn about value based pricing, price segmentation and pricing a product portfolio. There will be time for Q&A where you may have the opportunity to have your toughest pricing questions addressed.
Space is limited, so please register early at www.pragmaticmarketing.com/luncheon
Wednesday, November 13th from 11:30 to 1:00pm
Arizona Ballroom at Hyatt Gainey Ranch
7500 E. Doubletree Ranch Road
Scottsdale, AZ 85258
What KPI’s (Key Performance Indicators) do you track in your company? You are probably monitoring revenue, profit, certain expenses, and hopefully more. Do you use price as a KPI? If not, you should consider it.
Your marketing and development team created a product, built in value, and set a price to capture that value. Your sales department does their best to sell at that price. But what happens over time, as new competitors and technologies come into the market, the value our customers perceive relative to the alternative declines. They become willing to pay less.
If we are tracking our ASP (Average Selling Price) over time, we will likely see that it declines. When it declines too much, that is likely an indicator that market conditions have changed. Small decreases in ASP may be noise in the market or measurement, or they may be early indicators that the market is changing.
Another great use of price as a KPI, measure the average discount each salesperson uses. (You may want adjustments for volume, industry, segment or other factors.) This is an indicator of who is selling value and who is selling on price. Can you get one group to train the other? Better yet, publish the results internally. Salespeople are highly competitive and nobody wants to be on the bottom of that list. They will find a way to move their own ASPs up.
Other price metrics you may want to monitor include gross margin, pocket price (realized price after all discounts and considerations), level of variance in quotes, and more. Think hard enough about price and you’ll find that using pricing metrics can be a great measure of the health of your business.
Mark Stiving, Ph.D.
Photo by wwarby
The underlying sentiment is positively spot-on. We should set prices based on what our customers are willing to pay, not based on our costs. However, what is “the market” and how much “will it bear”?
The problem with this statement is markets are made up of companies and/or people. Each one is different. Each has a different willingness to pay. “Charge what the market will bear” implies a single price for a large group of companies or people.
If you price low enough, this single price may capture the whole market. However, you will be giving many customers a much lower price than they are willing to pay.
If you price high to capture the profit from those who will pay the most, you will be missing out on profitable business at the lower end.
Of course you can choose somewhere between as a compromise, so you give up some at the low end and some at the high end.
Which price, low, high or middle, is what the market will bear? Regardless, whichever you answer it is not the price that maximizes profit. The best answer is price segmentation. Create smaller segments that consist of customers with similar willingness to pay.
Next time you hear someone say “We should charge what the market will bear,” smile and know they have good intentions, but then dig deeper and set prices and pricing strategy based on much smaller segments. You will be much more profitable.
As you’ve read here in previous blogs, you really should segment your pricing. You want to charge different customers different prices based on their willingness to pay. What was unique about Brian’s pricing strategy is he used a different pricing strategy (not just a different price) based on who the customer is. Brian combined a normal fee for service model with pay as you wish.
Pay as you wish is a pricing strategy where you don’t even mention a price. Instead, you simply ask people to pay what they think the product is worth. This strategy became more widely known in 2007 when RadioHead (a music group) released an entire album on line and aked people to pay what they wanted. RadioHead claimed it was wildly successful. (However, their next album they did not use pay as you wish.) (You can read more details on pay as you wish in my book Impact Pricing.)
Pay as you wish works best when you have low (or zero) variable costs and when you have a relationship with your customers. In the RadioHead example, their mp3′s had essentially no variable cost and their fans surely had a positive relationship with the band, a good fit for pay as you wish.
In Brian’s business, he provides a service which includes hardware as well as his time and expertise. Since most of his customers are regulars, he makes friends with many of them. Also, many of his customers are relatively well off. When Brian finishes providing his service, the customer typically asks, “How much do I owe you?” Brian responds one of two ways:
1. He hands them an invoice which includes the price of the parts and his service.
2. He hands them an invoice which only includes the price of the parts. No service charge. He says something like, “The parts come to $147.84.”
As you might imagine, when he uses technique 2 for his wealthy “friends”, his customers tend to pay him more for the service than if he had given them a price. One thing I love about Brian’s overall strategy is he can try this technique with any customer. If they don’t pay him more than he would have charged, then the next transaction with that customer he invoices for the service component as well. The customers are completely unaware that Brian is choosing which pricing strategy to use based on his expectations of their payment behavior. After all, both of these pricing strategies are extremely fair.
What is your lesson for today? Think creatively. Think about many different customers and determine the optimal pricing strategy for each customer. If you find you have more than one pricing strategy, then try to think of a way to legitimately use different pricing strategies for different customers.
Special thanks to Brian for providing another example of how fun pricing is.
Mark Stiving, Ph.D.
Bicycle dealers are passionate about their businesses. They walk their talk. Their hobby is their job. Unfortunately, it appears that manufacturers take advantage of them. The problem is, many bicycle dealers love bikes more than they love business. Many don’t know what they should be doing. They don’t know how other industries work.
Don’t blame the manufacturers though. They are getting product to the market at the lowest possible prices because the dealers don’t pressure them.
Here’s what’s great though. If a large portion of the bike dealer network started making decisions in their own business interest, manufacturers would quickly follow suit. Dealers should do their best to choose brands who:
1. Don’t compete with them on the Internet
2. Enforce MAP
3. Enable higher margins at higher prices
1. Manufacturers want to take advantage of the high expertise of the Independent Bike Dealers, but they also want to sell through mass merchants or on-line. These are conflicting desires. Nothing is more frustrating to a dealer than to spend a lot of time educating a customer and then having that customer leave and buy the item from Amazon at a lower price. The solution? Dealers shouldn’t carry brands who also sell through mass merchant channels. Several manufacturers are getting the hint and only sell through the independent bike dealers. They forego the rewards of mass merchants to help the independents succeed. Dealers, reward these brands with your business. Let them know why you chose them.
2. Many manufacturers set a Minimum Advertised Price (MAP) but then don’t enforce it. To be fair, enforcing MAP is very difficult. Sometimes there is excess inventory. There is often a gray market. Some large retailers refuse to sign MAP agreements, and the manufacturers still sell to them because they wield so much power. Regardless, dealers should reward those manufacturers who do the hard work of policing and enforcing MAP. Do you want to know whether a manufacturer enforces MAP? Simply go online and search for the best price for that brand. If you find it below market price, that manufacturer is probably not doing a good enough job.
3. One thing I learned that surprised me: manufacturers expect retailers to take lower margins when they sell higher priced products. This is ridiculous. The whole approach to good, better, best is that we take the lowest price, the lowest margin at “good” because those are the most price sensitive customers. However, customers who buy “best” are much less price sensitive. We should be making higher margins from these sales. I’ll bet that the manufacturers make higher margin selling “best”. (If they don’t they should talk to me.) How can they expect the retailers to make a lower margin on these high end products? The justification is “it takes just as much effort to sell a $3,000 bike as a $1,000 bike”. So what! That may be partially true (what about financial risk, inventory costs, potential returns, amount of service required to meet higher customer expectations, etc.) but it’s irrelevant. Price should be based on customers’ willingness to pay. When manufacturers set an MSRP so low the dealers have to take a lower margin, they are taking advantage of the dealer. Dealers, do yourselves a favor, try to find brands who don’t set MSRP. If they do, make sure they are sharing the upside with you.
Of course there are brands that you can’t live without. They break every one of these rules but you still need them. Thankfully that’s not true for every product category. Work hard to move as many product categories as possible to brands that follow these rules, at least rules 1 and 2. It’s in your best interest. You will make more money with less price competition. What’s really nice though, as more dealers select brands that follow these rules, more manufacturers will start following these rules.
Mark Stiving, Ph.D.
Photo by thezartorialist.com
First, pricing can be very destructive. When you lower your prices, that certainly hurts your competitors. When they retaliate, and they almost certainly will, that will hurt you as well. In the end, the most likely result is lower industry profits, including yours.
Second, you can’t un-explode a nuclear bomb. Similarly, it is extremely difficult to raise prices again once a price war begins. Companies rarely want to unilaterally raise prices and risk giving up market share to their competitors. Coordinating price increases in an industry is challenging; and it’s illegal if done through direct communication.
Third, pricing can be considered a a deterrent. Your competitors are much less likely to lower prices if they believe you are going to follow suit and not let them easily take your market share. The real trick to this is to monitor and control your costs. You never want to be in the position where a competitor can price below your cost of doing business.
When it comes to doing battle with your competitors over market share, pricing should be the last weapon you pull out, if ever. Just like all nuclear equipped countries don’t use them aggressively, you too should avoid using your most powerful weapon aggressively. Feel free to chase market share with branding, marketing, sales, features, advertising … anything but pricing.
Photo by The Official CTBTO Photostream
Do your salespeople discount … too much? Too often? Too quickly? Many companies answer these three questions: Yes! Yes! Yes!
For such a universal and blatant problem, why does it still happen? Why can’t salespeople just do their job and stop discounting?
The answer: it probably isn’t sales’ fault (completely). After all, they are just trying to close deals, to bring revenue into the company. Instead of blaming sales, here are four reasons that sales offers discounts that we may be able to address.
1. Our price really is too high
Sometimes we love our products so much, we put high price tags on them. After all, we built a quality product and price is an indicator of quality. However, if we are lying to ourselves about how good we are and over-price our product, sales will only pound their head so many times. Eventually they will figure out the true worth of our product and sell at that price. This means they discount to get us to a reasonable price.
The same effect happens when we offer one product with one price to two different market segments, each with differing willingness to pay. We set a higher price targeting the less price sensitive segment, but then have to discount to win the more price sensitive customers.
Measure what proportion of your deals are discounted and what the average discount is. This could serve as an indicator that you have set your prices too high.
2. We haven’t communicated value
Customers make choices between our products and our competitors’ products. If we expect to earn premium pricing, we MUST communicate why our product is better. How does that manifest as value to the customer? Turn feature differentiation into benefits. Communicate those benefits in terms of financial and emotional well being. If we haven’t delivered the tools to sales to help them communicate our value, then how can we expect them to do this well?
3. Lack of confidence
We may have solved both of the above issues, created a great product and priced it high, but intelligently so. Some salespeople still may not believe they can win at full price. They aren’t confident in either our price or our value. To combat this we need to share wins that other salespeople have. One effective tool is to regularly rank salespeople by their average discount and publish the rankings. Those at the bottom of the list may realize that other salespeople can sell without large discounts. They may become more confident. Share best practices.
4. Negotiation skills
A fourth reason may be we haven’t trained our salespeople in negotiation. Purchasing agents are well trained negotiators and are constantly battling for a better price. Have we given our salespeople the knowledge and skills to negotiate? Negotiation is all about gives and gets, understanding what is most valuable to each side. Can we find more items (in addition to price) to give when asked for a discount. Do we ask for items, like commitments or bigger scope, when we have to give something? The more negotiation skills our salespeople have, the less they will need to discount.
Of course sometimes sales really needs to discount in order to close the deal. If we want the business we need to discount. However, this then becomes an easy excuse for why we discount every deal. If you want to reduce discounting by your salesforce, address these four issues: price fairly, communicate value, build confidence and offer negotiation training. Discounting will decrease, profits will go up.
Mark Stiving, Ph.D.
Photo by jlz