Archive for 1. Pricing Fundamentals
Pragmatic Marketing’s December activity/box of the month is Referrals and References. What does this have to do with pricing? Plenty.
If you are systematically executing the activity of creating and collecting referrals and references, then you probably have a formalized program on turning customers into valuable marketing tools. If you don’t then you are hopefully collecting and organizing data about customers who like you, at least when they fall in your lap.
We gather referrals and references to help us sell more product. Referrals help us find new customers while references help us close deals. But here’s where pricing comes in:
Referrals and References increase new customers’ willingness to pay.
Since pricing is all about creating and capturing value (i.e. customers’ willingness to pay) then anything we can do to create value helps us win at higher prices.
Think about your own decisions. You are thinking about buying a new kitchen appliance, say a panini press. You haven’t shopped yet, but in a conversation with a friend he tells you about the one he has, brand X, and how it makes great sandwiches. He is extremely happy with it. Now once you decide to buy a panini press, wouldn’t you pay a few dollars more for brand X over brand Y just because your friend has it and loves it?
Just like you would pay a little more because one brand comes highly recommended from a friend, so will your customers. Think of a referral as one more “feature” your product has that your competition does not. Your customers value that feature and would pay a little more to have it, all else being equal.
When we put together a program to systematically collect and use referrals and references, we increase both the volume of sales and the price at which we can win. Sure seems like a win-win for us.
This article in the International Business Times reports that Walmart may match lower prices from on line retailers. Walmart already price matches other retailers, but so far has not ventured so deep to match prices with Amazon. Is this a wise decision or not?
First, the key reason companies should offer price matching is to reduce price competition. When one company says they will match competitors prices, then there is no incentive for competitors to lower their prices. As a general rule these clauses reduce incentives to compete on price resulting in higher industry profits.
However, it seems highly unlikely that Walmart is thinking this. Even a behemoth like Walmart surely can’t think they can influence Amazon’s pricing strategy. So there must be another explanation.
This is more understandable when we break the market into segments.
1. There are a group of people who believe Walmart has great prices and just shops and buys without comparing to online prices.
2. There are a group of people who will buy online and won’t even consider shopping at Walmart.
3. There are a group of people who shop at Walmart, but still check Internet prices to see that they are getting a good deal.
Segment 1 will purchase at the regular price. No discounts needed to win their business so the price match makes no difference. Segment 2 will not buy from Walmart so the price match makes no difference.
The big question is what happens with segment 3. If Walmart doesn’t price match, then these guys will not buy from Walmart if they find the same product cheaper on line. By offering price matching, Walmart wins customers they wouldn’t have won otherwise. These customers may purchase at prices lower than Walmart wants, but they are likely still profitable.
So, without price matching, Walmart wins segment 1 at full price. They probably don’t win segment 3. With price matching Walmart wins segment 1 at full price AND they win segment 3 at lower prices. Overall Walmart makes higher revenue and higher profits, but a lower average gross margin.
The article says that Best Buy recently offered price matching with Amazon and their margins went down by 4%. The article implied this is bad. However, this could be a positive because Best Buy is really winning customers they wouldn’t have won otherwise, those in segment 3. This result is the same result Walmart should expect if they offer price matching. Margins will go down a little.
The article provided another big reason Walmart may want to offer price matching. Walmart has an image of the low price leader, but this image can be damaged if buyers can consistently purchase on line at prices lower than Walmart’s. Price matching helps Walmart maintain their low price brand.
Price matching, at least for Walmart, seems to make sense. What about your company? Presented here were three reasons you might consider offering a price match: reduce price competition, win new market segments, and enhance your image as a low price leader.
The question: Does price matching make sense for you?
Pragmatic Marketing’s October highlighted activity is personas. So how does this relate to pricing? In many ways, but let’s split this topic in two’s, buyer and user personas. Recall that in general, we build products to solve problems for user personas and we market our products to buyer personas.
But before we start pricing for personas, remember the general rule, Charge what our customers are willing to pay.
User Personas and Pricing – Different user personas have different willingnesses to pay. This is logical because different users have different problems they are solving which drives a different value proposition.
For instance, imagine we are selling lawn care products to two different personas, a homeowner and the greenskeeper of a high end country club. The expectations of results are very different. The homeowner’s problem is to keep the lawn green enough that the neighbors don’t complain. The greenskeeper on the other hand needs the lawn to look perfect so new members will join and current members will not go find a better place. Two different user personas, two very different problems, two extremely different willingnesses to pay.
The solution to charging homeowners and greenskeepers two different prices is usually to create two different products. This is one reason why in many industries we see the “handyman” versions and the “pro” versions of products.
Buyer Personas and Pricing – To price well for buyers, we must understand their buying process. Different buyers use different processes. Although it is very difficult to generalize on this topic, here is one of my favorite examples.
Imagine buyers at two different companies, a huge multinational conglomerate and a small company. If you were to ask which one is more price sensitive, the answer may surprise you. The huge company hires purchasing agents that are brutal negotiators. They get the best deals possible on everything that matters. Note the last three words, “everything that matters”. For large volumes and large dollar values, the huge company is very price sensitive and will undoubtedly get the best price possible.
However, for small volumes, huge companies are horrible at negotiating and finding the best deals. It’s barely worth their time. Yet, for small volumes, our smaller company cares a lot about the price, because they only buy in small volumes. The small company will shop around for the best price, stock up on cheap inventory, anything they can to keep their costs lower.
When you understand the buying process each buyer persona uses, you have the opportunity to capture higher prices. In PragmaticPricing history you will find many posts on how price segmentation works. These are the techniques we need to employ to charge different buyers different prices.
To summarize, knowing your user and buyer personas will effect your pricing decisions. We frequently create different products (at different prices) for different user personas and we should use price segmentation techniques to charge different buyer personas different prices.
Photo by marketing facts
A friend and fellow pricing expert, Jon Manning, posted this article, “Comedy club charges customers per laugh” in the Pricing Propheteers LinkedIn group. If you click on the link and scroll to the bottom of the article, you’ll see a video that describes it well.
To summarize, they hooked up cameras to the seat back in front of each patron and used that camera to count laughs based on facial expressions. The show was free to enter, but entrants were charged approximately 30 cents per laugh up to a maximum of 24 Euros.
Imagine you run a theater company and when you decide how to price it, the most logical choice is to set a price for the seat. After all, it’s common. We see that pricing model in other shows, in movie theaters, in airplanes. We are used to charging and paying by the seat. It’s easy. If you run a theater of course you are going to charge by the seat.
But these guys went way beyond what was obvious and answered the question, what are people really buying? Patrons are buying the entertainment, not the seat. That’s what they charged for, the entertainment, not the seat.
What about your company? Most companies do what is obvious. Charge for the product. Charge by the seat (in software). These are obvious and it’s what your customer expects. But what if you could charge directly for the value?
What are your customers really buying? Do they really buy the right to use your product or software? Probably not. They are probably buying some function, some result. Their value comes from that function or result, not from the right to use your product.
Now the hard question: Can you find a way to price your product based on the value your customers receive instead of simply taking the easy way? Think hard. Be creative. If a theater company can charge by the laugh, surely you can come up with something too.
Last week I attended the Train the Trainer class put on by Ed Tate and Darren LaCroix of the World Champions Edge. Great class. There is always something new to learn, but that’s not the point of this blog.
They had arranged a special rate of only $49 a night for a room at the Palms Resort. What a great price. As a very frequent traveler, I haven’t paid $49 in years. And the Palms is a nice resort. My room was as spacious and clean as any 4 star hotel.
When I checked in the agent told me they had a $25 resort fee. Wow! A 50% up charge as a fee! The below is from the Palms website www.palms.com/faqs
The resort fee is a daily fee of $25.00 (plus applicable tax) that is charged at the end of your stay. This is a standard practice at the majority of the hotels in Las Vegas, we promise.
The resort fee includes:
Complimentary In-Room High speed internet service (faster rates available for additional fee)
Complimentary access to Palms Cardio Center & Palms Place Fitness Center
Shuttle Service to and from the Forum Shops 11AM-8PM Daily [please note hours may adjust some]
Daily Newspaper (available at select locations)
Unlimited local and toll-free calls
Airline Boarding Pass printing
Copies and faxes at the Front Desk and Concierge (does not include color and large print jobs)
Many of us at the event joked that we paid $25 for “Complementary WiFi.”
I’m not complaining. $74 a night is still a great price, but notice how well the Palms understands their customers decisions. The room rate is critical in that decision so the Palms works hard to keep that as low as possible. Then, once they have you on location, they try to make as much as possible, not only from their “resort fee” but also from food, gambling, and more.
I ate in the resort the entire time, because it was convenient and there weren’t any restaurants within easy walking distance. Their restaurants were a little pricey, but not ridiculous. My breakfasts were about $15, one lunch was about the same, and one dinner was well over $100 at their steak place. The food was good so again I’m not complaining. Just pointing out their pricing strategy.
Don’t forget the gambling. Of course they want you to gamble. I played a little video poker. Won $6 the first night and lost $20 the second, so they got another $14 from me.
There are many other ways they can get your money that I didn’t experience. For example, they had a spa, a shopping area and even a fortune teller.
The key lesson here though, the Palms Resort clearly priced the room at a very low price to attract customers. The room rate was the factor that helped people choose the Palms over other locations. Then, once their customers check in, they find other ways to earn profit.
You should be thinking the exact same way. What product or service do your customers use to decide whether or not to engage with you? Consider pricing that product aggressively to attract more customers. Of course, that only makes sense if you have add-on products and services where you can make the profit you give up from your aggressive pricing tactics. If you don’t have additional means to make profit from your customers, then it’s very difficult to be aggressive with the price on the original product.
You may be thinking this is deceptive and you don’t want to do it. What happens to you if your competitors implement this strategy? If they have the ability to charge very low prices for the decision product, how will you compete? Maybe the owner of the Palms Resort doesn’t really like doing business this way, but the Rio and the Orleans resorts, both close by, use this pricing strategy. The Palms doesn’t really have a choice if they want to stay in business.
Think hard about how you can use a complementary pricing strategy.
Photo complements of Wikipedia
Usually when we use the phrase “the competitive landscape” we are looking to enter a market and trying to decide how it looks. Is this a market where we want to play or not?
Pricing offers a unique perspective on this question.
First, remember that costs are essentially irrelevant to pricing. What really matters is how much our customers are willing to pay. However, when deciding whether or not to enter a business, costs become extremely important, both fixed costs and variable costs play a role. Today we will focus only on the variable cost aspect.
A key component in looking at the competitive landscape is the margin your competitors are making. If they are selling an extremely high margin product, there may be room for competition. This is a strong indicator that competition isn’t driving the price down toward costs. Of course, when you enter, your competitors may choose to compete on price to hold their market share, but at least it doesn’t start that way.
If your competitors are selling at relatively low margins for the industry, and especially if they are low relative to what you are willing to accept, then you have to decide if you are adding enough extra value that you can charge higher prices. Alternatively, do you have a strong cost advantage, meaning you can manufacture at a much lower cost than your competitors? Something has to be different if you want to enter the market.
Before you enter the market, ask yourself, “what price will I be able to charge?” Use the value based pricing process to see how much your product will be worth relative to your competition. Then, if you plan to price lower than your competitor have a justifiable belief on how they will respond. Will they ignore you because you’re the new kid in the market? Will they aggressively compete to not lose any share? You need to predict your prices and your competitors responses. If they compete aggressively, will you have enough margin in your product to meet your corporation’s goals?
Although costs rarely matter when setting prices, they are critical in deciding whether or not you want to be in a business. Determine your pricing up front, including your competitor reactions, then decide if you want to enter this market.
Costs matter when deciding to enter a business. Knowing your pricing up front is necessary to predict profitability. Understanding pricing will help you understand your competitive landscape.
A Sharks season ticket holder wrote:
I was surprised to learn that the SJ Sharks are printing variable pricing on the tickets for the games. “This means that the price printed on your ticket will reflect the true market value based on the expected demand for each game.”
So if you are in a low priced (Tier 1) game, do you wear your old uniform?
It turns out that the Sharks are considering the opponent and the day of the week the game is scheduled to estimate demand and therefore price. This makes perfect sense for pricing individual games.
What didn’t instantly make sense though is why do this for season ticket holders, who pay for the season, not individual tickets. Why should the Sharks bother printing different prices on each paper ticket?
After a little digging you find that this behavior provides more value to their season ticket holders.
To make sense of this you need to know that the NHL hosts a site called NHL TicketExchange, which is where you can legally go to sell tickets to any game you might not be able to attend. However, you can only sell them for the face value of the ticket. This variable pricing allows the season ticket holders to sell the best games at higher prices.
Also, when you add up the prices of all of the individual games, you get a number larger than the price of the season ticket. This means if a season ticket holder could sell every ticket at face value, he or she would make a profit.
What is fascinating about this example is simply by changing the printed price on a paper ticket, the Sharks provided more value for their season ticket holder. Are you always on the lookout for ways to add value to your customers? It doesn’t have to be with the price label (and rarely will be). When we add value, we make happier, more loyal customers who will likely be willing to pay more.
I love to see unusual pricing behaviors. They are intriguing and often we can learn something interesting from them, even if it’s what not to do. Please send me any apparently inexplicable pricing you run into.
Those of us not in sales often make fun of salespeople, well … because it’s fun. Our first gut reaction says of course we can’t give pricing authority to sales. They will only sell on price and we’ll be giving huge discounts to too many clients. Unfortunately, a lot of salespeople do sell on price. Besides, every customer asks for a discount and it’s easiest for sales to give them one.
However, who better to figure out how much a customer is willing to pay than sales? They have the relationship with the client. They have direct knowledge. If only we could find ways to keep salespeople from selling on price and instead use their close knowledge of the customer to discount when it’s needed.
The hard part is balancing these two opposing forces. The trick is to provide incentives and tools to help the sales people sell value instead of price. Here are four tips to help.
- Distribute authority throughout the sales hierarchy. You may give your salespeople the ability to discount 5%. Your sales managers can go to 10% and your sales directors down to 15%. Anything lower than 15% off has to be approved by headquarters. (The numbers are an example. Use what makes sense for your sales team.) The good thing about this is that one salesperson alone can’t do a lot of damage.
- Monitor, on a salesperson by salesperson basis, how much discount they tend to give away. Report it. No salesperson wants to be on the bottom of any list. Hopefully those salespeople who discount less can help the rest of the team learn how they do it.
- Talk to your sales team about NOT jumping to the maximum discount. Instead, start small. Every percentage can have a big impact on company profit.
- Create an incentive program that rewards the salespeople with the smallest discounts. We often hear the saying, “salespeople are coin operated” meaning they do what they are paid to do. Let’s pay them to not discount.
Finally, it is our responsibility to make sure sales has the right tools to be able to sell on value. Take a hard look at what you give your sales people and how that helps them sell value.
When we give sales the tools to sell value and the incentives to not discount too easily, we maximize our chances of winning business at the highest possible prices.
Picture by 92Five
This past Thursday I taught the first fully released pricing course for Pragmatic Marketing. The day was better than I could have hoped. The students were energized, asked great questions, contributed their own stories and I’d like to believe they all walked out with a smile on their face and several action items to help them in their pricing endeavors.
However, about three quarters of the way through the class, I put up a slide and to emphasize its importance said, “this is my favorite slide.” A lady in the front decided to make fun of me by asking, “how many favorite slides do you have?” Embarrassingly, I had to admit that I’d said that line many times during the day. And it’s kind of true. There are so many great concepts in pricing that can help companies be more profitable. So many concepts that aren’t obvious and produce aha’s in the students. Many of these concepts seem to be my favorite.
But it did prompt me to think, “what should be my favorite slide? What is the most important concept in pricing?”
The answer: The most important concept in pricing is to price based on what your customers are willing to pay, not your costs.
I teach that concept first thing in the morning. Companies must use Value Based Pricing. Charge what your customers are willing to pay, not costs. There is a little pushback at first, but soon everybody nods their head and has accepted the concept, almost. Throughout the day, students sometimes make reference to why they needed to use costs to price. Of course I’d have to correct them. By the afternoon, they were catching themselves whenever they were about to mention costs again. It’s amazing how ingrained pricing based on costs really is.
What about you? You may nod as you read this, agreeing with me, but then do you go talk to your company about costs and pricing? It is fascinating that pricing based on costs has penetrated us so deeply that it’s hard to let go. That’s one reason I think Value Based Pricing is the most important concept.
The other reason though, if you don’t accept value based pricing, then you lose the power of all of the pricing strategies that come with it. There’s no need to segment pricing based on willingness to pay if you only price based on cost. You can’t take full advantage of a good-better-best strategy if you only price on costs. There’s no reason to think of pricing portfolios if you only use costs.
Yes, value based pricing is without a doubt the most important concept in pricing. But that doesn’t mean I can’t have more “favorite” slides does it?
Photo by Valerie Everett
The ability to price higher than your competition comes from having differentiated products. Your products must be better than your competitors’.
When we think of positive differentiation, we usually think of what features can we build that our competitors don’t have (yet). However, one very powerful “attribute” of a product that can create positive differentiation is brand. If your brand name becomes synonymous with trust and quality in your industry, you have earned the ability to charge more. People pay more for well known brand names.
Here is one of my favorite examples:
Take a walk with me down the vodka aisle at your local liquor store. You will likely see something very similar to what I’ve seen at my local Beverages and More. Stolichnaya Elit Vodka is priced at $59.99 for 750 ml, Grey Goose Vodka is $26.98, and Nordic Star Vodka costs $7.99 for the same size. Three different brands, three different prices. We assume three different quality levels.
This doesn’t seem unusual until you read Section 5.22 of the U.S. government’s Standards of Identity for Distilled Spirits which defines vodka as “neutral spirits so distilled, or so treated after distillation with charcoal or other materials, as to be without distinctive char- acter, aroma, taste, or color.” In other words, by law you should not be able to tell one vodka from another. In this case (or bottle) it really may all be in the brand.
Brands are expensive and time consuming to build, but as you can see, they yield strong pricing power.
Photo by Hippietrail