Pragmatic Pricing

Markup vs. margin:  what’s the difference?  For you math whizzes, it’s all in the denominator.  For everyone else, it’s all in your perspective.

The Math (feel free to skip this part)

Start with price minus cost and call that margin dollars (per unit).  Markup is margin dollars divided by cost.  Margin is margin dollars divided by price.

Markup = (price – cost)/cost

Margin = (price – cost)/price

As an example, if you purchase something for $1.00 and sell it for $1.50, you have a 50% markup and a 33% margin.

The Perspective

Markups are commonly used in retail.  They buy something for a price and apply a standard markup to get to the price.  Since retailers buy thousands of items at different prices this seems to make sense.  BE AWARE – This is cost plus pricing.  Starting with a cost and adding a markup is the definition of cost plus pricing.  Hopefully by now you realize that cost plus pricing is not optimal.  It leaves money on the table.

Margins are what are reported on companies’ annual reports.  Margins represent what you actually realized from a price and cost perspective.  The implication is that margins are what materialized, not how to set the price.  If you use Value Based Pricing (as you should) then you are closely monitoring your margins, looking for areas of improvement, watching for indicators of decline.  Margins are a KPI (key performance indicator), not a means to drive pricing.

What are you using?  If your company commonly uses markup, you are almost certainly in the cost plus pricing mentality.  Throw that concept away and focus instead on margins.  If your company uses margins, it is not a guarantee that you use value based pricing, but at least it’s an enabler.

Use margin.

Mark Stiving, Ph.D. – Pricing expert, speaker, author

Photo by The Consumerist

I ordered the New iPad on the day it was released.  I never do this, but after watching Apple’s pricing over the years I’m confident they won’t be lowering their price for a year or so when they release the next version.  Why not buy immediately?  Apple has trained me what to expect.

An attendee in a presentation last night described her experience with Banana Republic.  She said, “I used to shop at Banana Republic and sometimes buy at full price.  However I signed up for their email list and I get coupons in the mail every few days.  Now I don’t buy anything there unless I get a discount.”  Banana Republic trained her to only buy with coupons.

JCPenney is trying very hard to retrain their customers.  Customers used to wait for sales.  JC Penney wants to give them good pricing every day and make their customers confident in these prices.

Here’s the point.  You are training your customers with your pricing behaviors.  Whatever you do frequently, your customers will come to expect.  Do you have frequent sales?  Do you hold price?  Your customers learn your behaviors and use that to help them make their best decisions.

This is not a bad thing.  It’s a fact.  You are training your customers.  The question is are you training them to behave in the manner you’d like?

Mark Stiving, Ph.D. – Pricing expert, speaker, author

Photo by skycaptaintwo

It’s no secret, pricing can signal quality. But why, and more importantly when, does it work? 

Think about the last time you went to your wine retailer, stood in front of the seemingly infinite choices of wines, and had to decide which one to purchase.  If you’re like me, you were probably thinking something like this:  “I’m going to a good friend’s house and they are making dinner.  The least I could do is bring a nice bottle.  I’ll spend about $40.”

We are all relatively clueless about how the wines taste, so we choose some price point and buy a wine at that price.  Here’s why it makes sense.  We are trusting that the manufacturer and the retailer both know how good this wine tastes, and they’ve decided that it’s worth $40.  We’re also hoping (or believing) many other consumers also know something about wine and if it wasn’t worth $40, they wouldn’t pay it, so the retailer wouldn’t charge it.

If only this were all true.

Let’s use something other than wine, something where we can determine quality if we try hard enough.  How about a new LCD TV?  If you are so inclined you could study all the features of a TV, figure out which ones you really need and then buy the one that just meets your requirements, without going overboard.  Another option is to look at the price range, and then buy one toward the middle of that range.  By doing this you are believing that other consumers, the manufacturers and the retailers all know what range is needed, and you are probably average so you get one in the middle.

These were two examples where we surely use price as an indicator of the quality of the choices.  But it doesn’t always work.  As consumers we use as many cues as possible to infer quality, and if some cues are off then a high price is not enough to make us believe the product is high quality.  Imagine a real estate agent pulling up to your house in an old beat up Chevy saying “I’m the most expensive because I’m worth it.”  You wouldn’t believe him.  Imagine your neighbor shows up at your door pulling a red wagon that holds several cases of unlabeled wine.  He tells you “This wine is a great bargain at only $50 per bottle.”  Do you believe him?  Of course not.

You see, price is one of many indicators of quality.  A high price alone will not make you look like high quality.  If you want to be seen as high quality, all indicators must point in that direction.

Mark Stiving, Ph.D. – Pricing expert, speaker, author

Picture by Sassoles

Remember Coke’s attempt to charge higher prices on hotter days?  It failed miserably.  Now Budweiser is taking a shot at pricing based on weather, but quite differently from Coke.

Kathryn Koegel reported in Ad Age: “Budweiser took on a huge challenge selling its brand in the suds-soaked Irish culture using the Bud Ice “Cold Index” campaign. Taking advantage of global warming and the fact that people with smartphones check weather insanely often, they built a dynamic pricing engine tied to a heat index. So the price of beer went down as the temperature went up. Every time someone checked their Bud Ice app in places like Galway, it told them what kind of discount they would get. If the temperature went above 18 degrees centigrade, they could show their phone to the nearest pubkeep, and the pour was on Bud. Game elements. Fundamental mobile functionality. Free stuff. User engagement. Bud iced the competition.”

This Ad Age video shows screen shots of the app and described how Budweiser was pleased with the outcome.  Why did this work when Coke’s attempt didn’t?

First and most importantly, Budweiser couched everything in terms of a discount off of the normal price.  Bud offered a lower price on hotter days. Coke would have been more successful if they had offered lower prices on colder days (which was their intent).  Instead, Coke offered higher prices on hotter days.

Second, Bud wasn’t attempting price segmentation (Coke was).  Bud’s objective was to generate trial and hopefully loyalty.  The low prices were on days when demand for beer is likely at its highest, hot days.  Also, beer seems to taste so much better on hot days, so this discount generated trial on days that put Budweiser in its best circumstance.

Third, the novelty of the program and the weather app for the iPhone generated attention.  Well executed.

What are the lessons you can learn from Budweiser’s success with this program?

1. Always position price segmentation as discounts from normal prices.  Never as price increases.

2. You can use price segmentation to generate trial as well.  It doesn’t always have to be about steady state sales.

3. You still have to break through the clutter to grab your customers’ attention.

Mark Stiving, Ph.D. – Pricing expert, speaker, author

Photo by Thomas Hawk