Archive for 1. Pricing Fundamentals
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
We often think of pricing as putting a price on a product. This is true, but it’s so much bigger. Here are several examples.
Scope: When we sell one item, we can probably sell more. Think of this as complementary products. By pricing low on the products our buyers use to make the decision, we may be able to win the deal and then make real profit with complementary products.
Scope: When large companies negotiate with large companies there are usually multiple transactions happening at once. Imagine Dell and Intel. Dell buys from Intel. Intel buys from Dell. Dell could also buy AMD. Intel could also buy from Acer. Dell could purchase a multitude of different products from Intel. Intel could do the same. When purchasing for one company is negotiating a part and a price, they almost always make it bigger. More parts. Total spend.
Deal size: Sometimes our customers use more and more product over time. This is true with consumables and when selling parts to manufacturers. The bigger deal is to buy more, commit for a longer period of time. Sometimes buyers will offer to do this to get a better deal. Sometimes sellers will insist on this when buyers ask for discounts.
Deal size: We often see volume discounts. If a buyer is willing to commit to more, they can get a better per unit price. The game is bigger.
Loyalty: Think lifetime value of a customer. If you can gouge them today, you might lose them as a customer in the future. By maintaining loyalty they buy from you over the long term.
Strategic relationships: A purchasing agent might say, “If you give me a better price I’ll help you get designed into the next product.” Similarly, a salesperson might say, “I might be able to get you that discount you need if you can help me get designed into the next product.” Instead of the next product it could be a joint white paper, an introduction to another company, a referral, anything that’s strategic to the seller.
There are many more examples. The point is that it’s almost never simply one product and one price. There’s almost always a bigger game. Can you identify the bigger games you play? The goal is to play the big games as well if not better than you play the small ones.
Photo by Ytoyoda
The Pragmatic Marketing theme for this month is “Requirements”. As their pricing blogger I wanted to write on how pricing should help when defining product requirements. Here are my thoughts. What are yours?
Let’s start by defining “requirements” as what the product team gives the development organization to work on. These are the next features or products the company will develop. So when does pricing care about what development does? I’d say the answer is two-fold.
First, we’d rather development develop the attributes that have the most value in the market. Given a choice between two attributes, we’d prefer to develop the one that has the biggest return. That may be measured in number of new customers or the extra amount someone is willing to pay or a combination of these. Our knowledge of pricing should be able to help with these decisions. Possibly the most powerful tool to help with understanding the value of an individual attribute is Conjoint Analysis.
Second, we care a lot about the product portfolio. As product people knowledgable about pricing, we want good, better, best portfolios. Development won’t create them unless we write the requirements. It’s our job to define what goes in each version. The good product should be barely good enough so only buyers who can’t afford to buy up will purchase this. As an extreme example, in the late 1800’s, third class train service didn’t have a roof just to be sure that anyone who could afford it would buy second class. Your best product should be expensive and full featured, while the better product is what most of your buyers will buy.
Still on product portfolio, we want complementary products. Often we have to compete aggressively for business, achieving lower margins than we would like just to win. It would be great if we could have additional products we can sell to the customers we win so we can increase profitability and margins. Again, development won’t create complementary products unless we write the requirements.
In the end, the product team is responsible for deciding what development should develop. Should they build the next generation of your current product? Should they build good and better versions? Should they build complementary products? Using our knowledge of the market and our knowledge of pricing, we can guide them to build the most profitable products.
Photo courtesy of Pixabay.
This Motley Fool article nicely describes the what and the why of Chipotle’s price increase, but what lessons should you take away for your business?
Why are they raising prices? The article gave us three reasons: increasing costs, need to raise same-store revenue, and demand (because they can).
As the article pointed out, they are considering raising prices more than what is justified by the cost increases. However, increasing costs is the single best (if not the only) excuse your customers will accept for price increases. It should be part of every price increase strategy.
The second reason is they need to increase same-store revenue. Chipotle already serves such large portions to each customer it will be challenging to increase the amount or number of items a customer purchases. To increase in-store sales they need to find ways to raise the average purchase price over the current $9 per customer. One way to do this is through a price increase.
Although this is a reason, it’s not a very good one. This is based on inside-out thinking, meaning what does Chipotle need? This is not rooted in what the market is willing to pay. There is nothing wrong to set increasing same-store revenue as a corporate goal. However, it is not justification for a price increase. Price is just one tool they may use to achieve that goal.
Finally, the third reason is the best one: because they can. Chipotle has long lines at meal times and they feel it is very unlikely that they will lose many customers due to a price increase. This is pricing power, the ability to raise prices without a big hit on demand.
We should always base our pricing on what our customers are willing to pay. The high demand and long lines are indicators that Chipotle customers may be willing to pay more. Hartung, Chipotle’s CEO, said, “We’re currently reviewing our menu price on a market-by-market basis compared to competitors and based on our analysis.” This is the right way to think. Different markets likely have different willingnesses to pay.
Finally, here’s a piece of pricing advice for Chipotle (in addition to the general price increase). Offer a discount during off-peak hours. If they have long lines at lunch time but not dinner, offer 10% lower prices after 2:00. This way price sensitive buyers with flexibility will come after the peak time, making the lines a little shorter during peak hours so fewer people will see long lines and walk away.
Your 2 key takeaways:
1. Use cost increases to justify price increases.
2. Price based on willingness to pay, not internal corporate goals.