Strategic Pricer Blog

We all know more than a few people who bought Apple iPhones the first day they were available, June 29th.  Some people feverishly called around their city to find stores that had them.  Others stood in line at AT&T stores.  But all of those people paid premium prices for the phones, which have a cool, user-friendly interface.  Those people, our friends and colleagues, are early adopters.  Anyone who has taken a marketing course knows - early adopters frequently pay a premium price compared to others who buy a product after it has been around awhile.  The question in this case is whether that premium, which now appears to be $200, was too much.

Each individual purchaser can decide that answer on his or her own, but from my perspective Apple was smart to charge such a high initial price.  Here’s why.

Each prospective purchaser of a phone forms an opinion of the value of the phone to him or her.  That value depends on many things including, the specific functions available in the phone and how easy it is to use them, the frequency with which specific features would be used, the quality of the phone signal, and the data transmission speeds versus the need for fast transmission.  The value perception of each person also depends on the prices of alternatives in the market, the personal value of having a new toy to play with, and the value of being perceived as hip.  With all those variables, each person is likely to come up with a unique perception of value.  If we could learn all of those individual value perceptions, we could actually draw a value curve. 

Apple’s shareholders would want the management to capture as much of that value curve as possible.  That is something the airlines have been doing for quite some time, using statistical models to predict where those different value points are, then setting prices targeted at the individuals who fit various points on the curve.  Unfortunately the retail environment cannot easily tailor each price to each buyer.  The value curve is really a demand curve, and sellers select price points on the demand curve and offer their products to all buyers at a single price (at least for awhile).  One way sellers maximize their take from the demand curve is by setting higher prices initially to capture the demand at the higher prices, then lowering prices over time to capture incremental demand.  That is exactly what Apple has done. 

We see this behavior all the time in consumer electronic products.  It is generally written that the reason prices on electronics drop over time, is the manufacturers are spreading their fixed costs over higher volumes, additional capacity is coming into the market, and new products are available with more features.  All of those statements may be true, but they don’t fully explain why manufacturers don’t try to capture more volume earlier by setting lower prices that will attract more buyers earlier.  Well, the reason they don’t do that is because there are plenty of early adopters out there who are willing to pay more to get the newest product.  If Apple and other manufacturers don’t price their products high initially, they leave all that money on the table.

I suppose the danger in this type of situation is that of angering the early adopters with too high a price premium.  In this case, it appears that Apple has run the risk of that by dropping the iPhone price by 33% after only 6 weeks.  That strikes me as pretty aggressive, and I have seen a few customer quotes venting their anger.  I would bet any anger will all blow over, though.  Apple has been very good at understanding their customer base and has consistently offered premium-priced products.  My guess is they understand them well this time too, and the $100 credit they are offering will mollify the vast majority of the early adopters.  It will also entice them to spend some more money on other Apple products and services.  Use your iPhone, and send a response if you don’t agree.

[Originally published in June] 

I recently read the paper “An Economist Sells Bagels: A Case Study in Profit Maximization” by Steven D. Levitt, author of Freakonomics and economics professor at the University of Chicago. (Pardon me for not typing the full text of his title). The link to the article is attached. http://www.chicagogsb.edu/capideas/may07/5.aspx

As usual for Dr. Levitt, the paper is very well written in a way most people can understand. The paper’s most important point was the necessity of feedback on prices. In his paper, Dr. Levitt describes how an economist turned bagel salesman captured and evaluated significant details regarding the volumes and types of bagels and donuts that were sold. He was getting daily feedback on volumes. An opportunity to evaluate the effect of pricing decisions (by looking at the impact of price changes) appears to have been ignored, resulting in missed opportunities to maximize profits by raising prices.

It seems to me that the bagel economist’s allocation of effort, lots of analysis on volume and much less on pricing effectiveness, occurs at other companies all the time. Because it is difficult, too often companies avoid capturing and analyzing the important feedback on their prices. Instead they rely on anecdotes, gut feel, and rules of thumb for margins to set their prices.

So if it is hard, how should companies get the feedback on their prices? This is a very simplistic response, but:
1. First they need to make sure someone’s job responsibilities include measuring pricing effectiveness.
2. Next that person(s) needs to appropriately segment their customer base. It is important to have peer groups (segments) to look at, because when individual product volumes change, they will want to see if the volume changes are common within a peer group or not.
3. Third, they need to measure as much as they can at the most granular levels they can handle. So that means the companies must build analyses to isolate price as a variable impacting volumes, as opposed to lumping it in with all other variables. Transaction-level details in appropriate segments will help get there.
4. Last (in this simplistic answer), companies need to experiment. Make small price changes in certain customer groups or products or customer/products and evaluate the impact. Try to determine how elastic or inelastic those customers or products are in the tests, and build confidence for broader price moves.

Obviously the world is complicated and those four points are fairly simple. But companies can and should take some steps to get and evaluate feedback on their pricing. If a firm finds that on average 20% of its products are under-priced by 5% because they relied on anecdotes rather than getting empirical feedback, there is a 100 basis point improvement in margin just waiting to be earned. Perhaps that is worth considering over a bagel.

[Originally published in April]

On March 27th an article in the Wall Street Journal highlighted the moves by Parker Hannifin over the past few years to improve the strategic dimension of their pricing practices.

The transformation at Parker during the past 5 years has been outstanding, and has improved operating income by $200 million. The company segmented their customers better, focused on identifying who was most price sensitive and on which products, better identified the values of their products, and eliminated much of the previous cost-plus mentality. The question is - should the CEO, Donald Washkewicz, have given a much detail as he did?

From my perspective, Parker disclosed too much. It seems perfectly fine to tell your shareholders, customers, and competitors that you view pricing as a critical competency and that you intend to move to pricing based on value. It also seems acceptable to tell those same parties that you expect your margins to increase as a result of eliminating wasteful practices. Shareholders and competitors will applaud those moves, and most customers will probably perceive that the comments apply to other customers. (”We do a very good job of benchmarking prices and getting the lowest price”). That is as far as I would go, though. Once a customer is told exactly how prices have been changed, the risk is that they will look much more closely at how their purchases line up against your specific price moves and get angry.

Now, it is likely that most of the moves Parker made were justified. They undoubtedly found products whose prices were too low compared to the alternatives their customers had. They were simply correcting those wastefully low prices. But, part of the pricing equation is the emotion of it all - how the customer perceives your company and your price. Parker seems to have recognized that their customers do business with them because they like the company, the products, the people, etc, but not simply because they like the prices. Parker also recognized that most customers don’t have the time or inclination to check prices on every item. If the customer is paying a little more for some lower volume items, it is not a big deal.

That emotion can work both ways, though. When the customer sees that you are raising prices on specialty items more than 25%, just because it is a specialty item, how likely are they to get angry? What if the customer thought he was paying a fair price or a high price already? The customer may very well still be paying a fair price, but the risk is that now conversations with the customer center much more on price and on whether he/she has been screwed, whereas before publishing the article the conversations were around the value delivered to the customer.

Don’t misinterpret me. I applaud the pricing moves by Parker and would hold them up as good examples of strategic pricing. I just worry that they may have kicked some sleeping dogs.