Pragmatic Pricing

The recession is over.  Even if it isn’t, inflation is starting to grow.  Either way, you are likely wondering how you’re going to raise prices.

One truth of pricing is that customers HATE price increases.  We hate them both as consumers and as businesspeople who now have to find a way to pass them on, or make less profit.  How can you make up for your increased costs while minimizing the negative impact on your customers?  Shrink your candy bar.

“Inflation makes balloons larger and candy bars smaller”  said David L. Kurtz, business author.

Likely you’ve noticed or heard about how candy manufacturers handle this situation.  When costs increase, instead of raising the price of the candy bar, they simply shrink how much candy bar you receive.  They don’t change the package size, and the only real change on the label is the new net weight.

I’d like to tell you the story of how when I was a kid we’d ride our bikes down to the apothecary and spend a quarter on a candy bar.  Then one day, seemingly just like any other, I arrived with my quarter in hand, starving for a Snickers bar.  I purchased one, gobbled it down, but was still hungry.  They gave me less Snickers in my bar.  I was upset!  I had been cheated!!!  I stormed up to the counter guy and screamed “WHERE IS THE REST OF MY SNICKERS BAR?” … I said I’d like to tell you this story but you see it isn’t true.  Throughout my entire childhood I bought Snicker’s for a quarter and never noticed that they continued to shrink the candy bar.  And that’s the point.  I never noticed.  And neither will many or most of your customers.

By shrinking the candy bar, we don’t notice the change as much as we would if they had simply raised the price.

What does this mean for you?  Is there something you can do to lower your costs that your customers are likely to not notice or care a lot about.  You can even de-bundle the feature or service and offer it as an option the way the airlines have de-bundled checked baggage service.  If you currently offer free shipping, can you de-bundle that?  Can you slow down the speed of your free shipping to save some costs?

Undoubtedly you’ve known about shrinking candy bars before this blog, but have you ever thought about how to apply this concept to your business?  Now is the time.  Good ideas won’t come easy so you’ll have to think.  Then again, nothing worthwhile is ever easy.

This is but one tactic to raise prices without really raising prices.  More to follow.

How was your health care in 1994?  From what I remember, it wasn’t bad.  In fact, it was very good.

Normally this blog takes a news item or pricing concept and explains it.  This time we’re going to use a pricing concept to propose a “fix” to the health care system in the U.S.   Be sure to read to the end to get the pricing lesson.

The price of health care is out of control.  It is growing much faster than inflation.  There are many reasons for this, including that the patient doesn’t pay directly for services, which confounds normal market dynamics, and doctors practice defensive medicine for fear of being sued.  Another big reason is innovation.  This article discusses innovation.

The cost of developing new drugs, products, or procedures is exorbitant, and companies rightly charge very high prices to maximize their profits and increase the chance they cover their development costs for both winners and losers.  But who should pay for these new products?  If you get sick, how much should your insurance company (or the government) have to pay to help you?  What if there is a new pill that costs a trillion dollars to make, but it will save your life?  Is the insurance company obligated to buy it for you?  If they are, then they will go out of business instantly and won’t be able to offer insurance to anyone else.

Obviously, insurance companies (and the government with Medicare and Medicaid) only cover certain treatments.  And yet, drug companies continue to develop new treatments.  Partially due to the cost of development, they only develop drugs which they believe will have a huge return, to mitigate the high costs and the risks of failure.   And they charge high prices because they can.  They have a patent.  All is right with the world of innovation, except that our health care costs keep going up.

Back to the opening question.  How was your health care in 1994?   The patents on every product and procedure used in 1994 is now expired.  This means competitors are allowed to copy these.  Competition drives down prices.  It is likely that if we had 1994 health care today in 2011, with no innovations in the interim, the cost of providing that health care would have decreased dramatically by now.  Think about that for a second.  It would cost less to pay for insurance today than it did in 1994.  Wow.

Of course we don’t want firms to stop innovating.  So instead, we have companies continuing to innovate (thankfully) and finding ways to get insurance companies and governments to pay their patent protected prices for often marginally better products.

The solution – An insurance company should offer IP Free Health Insurance.  IP stands for Intellectual Property and in this case really means patents.  IP Free insurance only covers products and procedures where there is no patent. When there is no patent, multiple firms compete and prices go down.  So IP Free insurance will likely cost significantly less than other insurance plans.

IP Free insurance would include products and services where patents have expired (everything patented 1994 and earlier), where companies release their patents to the public domain, and where companies simply choose not to patent certain capabilities.

Think about it.  17 years ago was 1994.  Was health care bad back then?  Sure there have been advances, and many of us are willing to pay more to have access to them, but a very low cost health insurance plan can offer affordable health care to a much larger portion of the population.  This also solves the problem of deciding which treatments get covered and which ones don’t.

As the pool of people insured under IP Free insurance grow to a huge number, companies with new innovations will have more incentives to abandon their patents and make the technology available to competitors, just so they can sell to the masses.

What does this have to do with pricing?  This idea popped into my head while I was thinking about price segmentation, specifically versioning.  All markets have segments of people willing to pay more and others that are only willing to pay less.  How can an insurance company create versions of their products to attract the most price sensitive markets?

You may like the idea, you may hate it.  That’s OK.  The lesson to learn relative to pricing is that by focusing on our market segments we can find new and interesting ways to segment existing markets.

Finally, please do us both a favor.  Forward this to a friend.  If everyone asks for IP Free insurance, we just may get it.   This just seems … pragmatic.

Mark Stiving, Ph.D.

Customers hate price increases. It’s a visceral animosity that just comes naturally.  You want to be very careful when raising prices to avoid raising this ire.

For example, I’ve had the same company clean my house for several years now.  A little over a year ago, my cleaner raised my rate 5%.  I wasn’t happy.  I thought about finding a new cleaner but didn’t want to go through the hassle so I sucked it up.  A month ago, they raised my rates by another 5%.  They accompanied it with an explanation that their costs had gone up, fuel costs. Unhappy and unsatisfied with the explanation, I cancelled their service and began the search for a new cleaner.

It was only 5%.  The time I’ve spent time looking for a new cleaner is probably worth more than I’ll save.  But I did it anyway.  Ouch.  This was painful for me and probably more painful for the cleaning company.

What can we learn?  Customers hate price increases, so do your best to not increase them.  If I could advise my cleaner on their pricing it would be to not raise prices on existing customers, rather raise the rates for new customers coming in.  It’s not easy to find new customers and customer acquisition costs are high.  Once you have a customer happily paying, make sure you keep him or her happily paying.  Raising prices causes many customers to rethink their previously automatic purchase decisions.  Don’t do it unless you absolutely have to.

Here is another way to look at this.  When I first selected a house cleaner, I likely compared several cleaners, their reputations and their prices.  When I chose one, the decision was made.  If the price next week is the same as the price last week, well, I already made that decision.  Why revisit it.  However, if the price next week is higher, then maybe the decision I originally made should be changed.  Maybe I should revisit the topic.  Of course this is the rational explanation, but let me assure you that my decision was also emotional.

From the cleaner’s perspective, it is always possible I was a “bad” customer and my cleaner was happy to see me go.  In that case, he did the right thing by raising my price.  Either I pay more and he’s happier, or I leave and he’s OK with that.  If you have to raise prices, consider only raising prices on your “bad” customers, the ones you would not be unhappy to see leave.

My cleaner attempted to do one thing right, he blamed the price increase on rising costs.  Unfortunately in his case it wasn’t credible.  How do higher gas prices significantly effect the cost of cleaning my house?  After all I’m paying for the electricity they use to run the equipment.  Customers are more likely to accept price increases when you can justify that your costs have gone up.  The justification has to be believable.

All pricing situations are different.  If you have a situation where you have loyal customers that purchase over and over again, then here is a summary of the lessons to learn from this house cleaner situation.

1. Don’t raise prices
2. If you have to raise prices, do it selectively.  Consider raising prices for only new customers or “bad” customers.
3. If you still have to raise prices, justify it with increased costs.

The Pragmatic Pricer – Mark Stiving