Pragmatic Pricing

Peter Waldman published an article “Why Baby Costs Less Down the Road in Silicon Valley” describing how different hospitals charge significantly different rates for the exact same procedures.

The point of the article was to discuss monopoly pricing or market power by large hospital conglomerates, but let’s learn a different lesson.

Health care is a service that we all need.  It’s an industry where much is written on lowering costs, where major insurance companies have incentives to drive down prices.  And yet, we see such a difference in pricing between hospitals.  Even in an industry with such strong pressure on costs and prices, we do not see prices driven to commodity levels or even to parity.

What makes it possible to have this pricing disparity?  Let’s answer with a question.  When was the last time you used price to decide where you were going to have a medical procedure done?  When was the last time you even knew the price of the service before going in?

OK, we don’t know prices because our insurance covers the cost … but not really.  Don’t we have co-pays?  Even a 10% co-pay on $1,000 is $100.  Isn’t it worth $100 to find the best deal for a procedure?  So most of us have financial incentives to shop around for price, but we don’t.  Hmmmm.

There’s the lesson.  Many customers do not shop around for price.  Think carefully about your industry.  Of course you have customers who haggle on price and blatantly compare your price to your competitor’s.  But how many customers do you have that don’t even shop around for price?  Is it possible that you can make more money by focusing on the customers who don’t shop for price and foregoing the price buyers?  Can you put programs in place that allow the “price-buyers” to get a discount, while those that aren’t worried so much about price do not?

Action:  Which of your customers are price-buyers?  Can you describe a common characteristic?  More importantly, can you describe the characteristics of a customer that doesn’t even know the price but still buys?

Seth Godin blogged on pricing the other day, which of course requires a response.

Seth’s position is that for more expensive goods, where a customer is relatively loyal, you should give that customer your best price so that he or she doesn’t leave you when they suddenly find you have been overcharging them.  He closed his post with the following:

“You might leave money on the table if you reward people for being loyal (and don’t make them shop around each time). I think it’s money well spent, because loyalty is worth more than a little more margin. If you train your partners to shop around, expect them to shop around.”

In many situations, Seth is right.  However, I ran into a company the other day that was in the garbage collection business.  In that business a company had to price very aggressively in order to win a contract, and then year after year they would raise their prices without the contract going out to bid again.  They tend to keep a customer for about 10 years, enough time to get that customer to pay 2 to 3 times what they will pay when they go out to bid again.

The trick to this business is that it is a small enough piece of the companies expenses (even though it is a big number) that they don’t focus on it every year.  Loyalty may appear to be very high, but it’s really just inertia.

The lesson to take away is that Seth is right in a lot of (most) cases – where the price is relatively large, the customers buy from you multiple times, and it is not too difficult to switch vendors.  If you have an offering with these characteristics, absolutely positively consider his words.  Consider giving your most loyal customers your best prices.  However, like we say every time we try to make a pricing generalization, it depends.  But then if pricing were easy, it wouldn’t be fun, would it?

Mark Stiving

Pricing is not a strategy.

A strategy is the big picture of how you compete in the market.  Your strategy should be based on how your product or service is different from your competition.  That could be features, that could be location, that could be marketing, that could be breadth or focus of offering, but it shouldn’t be pricing.

The only way that pricing can be your strategy is if you are always known for the lowest price.  That’s Wal-Mart.  If you take this as your strategy, then your business must be continually focused on lowering and controlling costs, just like Wal-Mart.  You are attracting the price buyers, the customers who are not loyal, but are looking for the lowest price.  Once a competitor figures out how to produce a similar product for less, they will charge lower prices and you will struggle.  If another company figures out how to sell products for less than Wal-Mart, Wal-Mart will be in trouble.  Wal-Mart has a laser focus on keeping costs down to make sure that doesn’t happen.  If you make low price your strategy, you have to be like Wal-Mart, laser focused on low costs.

You may be thinking about a different price strategy.  “My product is as good as a Lexus, but less expensive.  I’m going to make that my strategy.”  Don’t do it.  You may be able to have that product positioning for a short period of time, but it’s not sustainable.  The market will morph and your position may or may not exist in a few years. You have competitors on both side of you, above and below, either of which may be able to steal your position, because it’s just price.  A better strategy would be to position yourself relative to a Toyota, differentiate yourself, then price to the market.

This is not to say that you can’t have a pricing strategy.  Actually, you MUST have a pricing strategy.  Your pricing strategy is different from your corporate strategy.  Your pricing strategy is a big picture view of how you set your prices.  There are three pricing strategies:  penetration, skimming, and neutral.

Neutral pricing is setting a price that is similar to your competition, taking into account any difference in value offered.  Penetration pricing is charging much lower prices in an effort to grow the market or steal market share.  Skimming is charging higher prices, usually in an effort to segment the market.  In a future post we will discuss when each of these strategies is most appropriate.

Action:  Write down your corporate strategy.  What is your sustainable competitive advantage?  Did you mention the word price?  If so, try to rewrite them without using price.

Mark Stiving

During May and June, I collected airline prices to see if I could figure out when the best time to purchase might be.

I also did this so I could create a Toastmasters speech, which was recorded in a TV studio.  Please watch the video if you’d like to hear the story about whether or not Tuesday is the best day to buy tickets.  (My speech starts 15 minutes in if you don’t want to watch the whole Toastmasters meeting.)  The speech also describes the data and how it was collected.

The results … there wasn’t an obvious day of the week to buy tickets.  However, there were some surprises.  I was surprised that Southwest wasn’t cheapest and the amount of day to day variance was pretty high.  It seems the best technique to buy a ticket is to check daily, and buy when the price drops.  And if it isn’t obvious, use a site like Orbitz that aggregates prices.

Although the data doesn’t prove this, it appears that airlines have a schedule of how many seats on a  flight should be sold depending on how many days until the flight departs.  If they have sold fewer seats than what’s on the schedule, they lower their prices.  If they have sold more, they raise the prices.  This is very rational behavior if you have a lot data to figure out what the best schedule should be.  Most of us don’t.

This post doesn’t have a great moral or lesson, but I found it interesting and thought you might as well.  Please feel free to share your comments.

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I will happily share the data with anyone that would like to play with it.  All I ask is that you attribute Mark Stiving of PragmaticPricing.com if you publish any observations or results, and you also copy me so I can read them.  To request the data please send an email to Mark@PragmaticPricing.com with “Airline pricing data” in the subject and I will send the excel file to you.