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Last month I wrote a post Dealing with Customer Complaints in which I mentioned some personal dealings with Verizon that were unsatisfactory. In the post I wrote that it felt like playing Hunt the Wumpus. I also refer to it as a Where’s Waldo pricing strategy. I know Waldo is in there, in the form of something I won’t like, and I just have to find him. Unfortunately, if that is your reputation for pricing, you are going to have unhappy customers.
With Where’s Waldo Pricing, the reality of value you receive for the price you pay does not match perception. With Verizon, the misdirection happened multiple times.
A somewhat popular tactic of companies looking to improve their margins is to identify their low-margin customers and fire them. They don’t go Donald Trump on their customers and say “You’re fired.” Instead the companies jack up the prices of those customers to either drive them away or make them profitable. Some companies even erroneously think that is a pricing strategy. But is that really a profitable tactic? In our view, that tactic is often more harmful than helpful. The real answer is you need to understand much more about what the customers are buying, why the margins are low, and their incremental impact on profitability before changing their prices.
Often times the suggestion to fire customers comes from the finance team as a result of an analytical review. In particular, it is fairly common for finance teams to look at the top and bottom 10% of customers in terms of gross margin or margin percent. It is easy to isolate the bottom customers and develop a plan to “fix them or fire them.” It is also common to review rate-volume-mix reports and identify customers with a product mix-shift to lower margin products, who are then candidates to be fired. A third source of targets for attention comes from looking at customer profitability reports generated by activity based costing (ABC) systems, and identifying the negative profit customers. All of these sources are worth looking at as starting points, but by themselves should never be a reason to increase prices.
If customers complain about your pricing, should you do something? A few things have occurred recently that have prompted me to write this post. In early March a bill was introduced in the Senate, Forbidding Airlines from Imposing Ridiculous Fees (FAIR) Act. A few days later I overheard two guys in the gym complaining about being charged for paper statements on their brokerage accounts. And a week after that, my personal dealings with Verizon for TV and internet felt like playing a game of Hunt the Wumpus. (Due to space, I will write more about this in a future post.) The issues are slightly different, but all are related to customers complaining about pricing strategies. Complaints about differentiated prices for differentiated service are natural and should not cause changes in your pricing structures. On the other hand, if your pricing is deceptive rather than aligned with different value profiles, you should fix it.
Senators Ed Markey (Dem., MA) and Richard Blumenthal (Ind., CT) have decided that separate fees for checking bags, changing or canceling a flight, and selecting better seats are somehow unfair and should be prohibited; and that led them to introduce the FAIR Act. Certainly some customers have complained about those fees, which lends support to the senators’ view. However neither the complaining customers nor the senators are recognizing the benefit of those add-on fees. Customers are not all the same. They have different budgets, different needs on planes, and different abilities to plan their schedules. The airlines have appropriately recognized these different customer segments and created offers that can appeal to each.
In discussions with clients or prospective clients, we are often asked if our work is driven from monitoring competitor prices. In our view, an understanding of competitor pricing strategies and competitor behaviors is a helpful piece of the puzzle, but it is far from a complete answer. Competitive analysis is information that supplements insights from your own data and understanding of your strengths and weaknesses, and it contributes to an understanding of how you can compete and win in your chosen markets. However competitive analysis and competitor price monitoring are not strategies.
Customers decide what to buy and where to buy based on a number of factors, only one of which is price. I was reminded of this on a recent trip to Florida during which I observed a wide range of gas prices at service stations within a small area. In fact the highest price I observed was 30% higher than the lowest price and 9% higher than the median. And in spite of those price differences it appeared that all of the service stations were busy. So matching prices would not have helped the high-priced guys.
Price monitoring software and services are widely available today, particularly for retailers. The tools are sophisticated and enable the users to track a wide variety of competitors and products. The theory behind the tools is many customers use the internet to compare prices, and if your prices are too high, you will lose sales. My car even has a travel link app that supposedly will tell me gasoline prices in the area. (Unfortunately it must not refresh often enough because it was not accurate on my Florida trip.) But even with that price transparency, customers are not buying solely on price. If they were buying only on price, higher-priced retailers and the Florida gas station with the 30% premium would quickly go out of business.
How confident are you that the prices you have set are the optimal prices? If your prices were higher, would you make more money or perhaps cause customers not to buy? If you lowered your prices, would you get enough extra volume to increase your profitability? These are common questions asked within companies every day, but most often are not answered. Companies worry about their pricing strategy, but frequently just hope they got it right — or good enough. There is a better way. It is possible to move beyond hope as a strategy and build confidence in your pricing by regularly using A/B testing.
The basic concept behind A/B testing is to change the value of a single variable in an offer to consumers, and measure the results to determine which offer was superior. In the case of setting prices, A/B testing is simple. The test is to offer the same product to similar customers, but at different price points. At the end of the test period, measure the number of customers who bought the product or service at each price point, along with the total revenue, margin, and operating income. Then use the price that delivered the best results.
Heraclitus, the Greek philosopher, has been cited as the original source of the statement, “The only thing that is constant is change.” Whether that is his actual statement or is a reasonable variation, it is generally accepted as a truism. However, John Kotter reported in his book Leading Change that 70% of attempts at business transformation fail. One of the reasons for failure is insufficient leadership. There have been a number of change management models developed for use by organizations, but at the heart of all of them is the need for leadership. And in all of the models, the greater the transformation, the greater the need for leadership. Changing an organization’s pricing strategies and processes is no different – real leadership is required.
There are five elements of leadership needed in change management:
Create the vision
Inspire the organization
Align people around the goals
Enable the resources
Lead by example
I recently had a conversation with an executive of a B2B company who said they want to price more strategically. The company currently sets prices using a cost plus methodology, and they have heard repeatedly there is a better way. When we discussed some of the implications of pricing strategically, including pricing to value rather than cost, and setting different prices for different segments and customers, the executive worried aloud that he might make matters worse rather than better. I explained that when developing more strategic prices, he would identify the customers, products, and situations in which the probability of successfully selling a higher price would be greater. However, I also reminded the executive that in order to be successful, he would need to have the courage to actually charge the higher prices.
Unfortunately we often run into companies who determine where they could price more strategically, but then lack the courage of their convictions. These companies do the work to identify underpriced customers and products, but then refrain from properly increasing those prices. “I can’t raise that price 10% in an environment where inflation is less than 2%.” “I can’t charge small customers more.” Well why not? If you have really done the work to determine that the value to a customer or segment is much higher than you have been charging, or you have identified the customers who are less price-sensitive and more service-sensitive, why can’t you charge them appropriately? If your work is accurate, the customers will not leave you for making reasonable corrections.
Late last month there was an article in the Wall Street Journal, Smaller Sizes Add Pop to Soda Sales, describing the attempts by Coke and Pepsi to sell more soda in smaller cans. The article further points out that the price per ounce is higher for the small cans than for larger cans. If that is a surprise to anyone, it shouldn’t be. The real message should be that these actions are not pricing tricks, they are adaptations to customer needs. The things valued by customers are changing, and Coke and Pepsi are simply trying to address those changes. They are being smart about it, and the rest of us should pay attention.
Late last month there was an article in the Wall Street Journal, Smaller Sizes Add Pop to Soda Sales, describing the attempts by Coke and Pepsi to sell more soda in smaller cans. The article further points out that the price per ounce is higher for the small cans than for larger cans. If that is a surprise to anyone, it shouldn’t be. The real message should be that these actions are not pricing tricks, they are adaptations to customer needs. The things valued by customers are changing, and Coke and Pepsi are simply trying to address those changes. They are being smart about it, and the rest of us should pay attention.
Everyone realizes markets are constantly changing. Customer tastes evolve, new competitors enter the markets, new products are introduced, the economy expands, the economy contracts, cost structures change, etc. Each of those market changes can affect the market participants, and how the participants deal with the changes has implications for whether or not the business thrives. Too often, weaker or poorly managed businesses react out of fear and damage their long-term profitability. In this example, Coke and Pepsi are not being fearful, they are being thoughtful.
Time and again I hear people lament that their competitors’ products are just as good as their own, and prices have to be low to win sales. The general assumption is that price is the most important factor to the customer. That assumption is usually wrong. Earlier this month there was a series of posts on Facebook that showed customers decide first on the product that meets their needs, and they are relatively loyal once they have made that decision.
Earlier in 2015 my niece began running a weekly poll of sorts among her Facebook friends. She calls it Philosophical Friday and asks a single question each week, which friends can answer however they please. Last week the question posed was, “What is the one common item that you just can’t bring yourself to buy the off-brand/cheapest option? Household items, food, clothing, shoes…whatever. The answers were mostly focused on consumer products, many of which people might consider to be commodities.
There were 39 different products mentioned, the top 10 (in terms of frequency) were:
arlier this month there was an article in the Wall Street Journal, Why Gadget Warranties Are (Almost) Never Worth It, pointing out the disadvantageous math behind most extended warranties and chastising sellers for offering them. From my perspective extended warranties are good examples of when multi-part pricing makes sense, and they can be a win for both buyers and sellers. Conversely there are times when the better option for your pricing strategy is to create a bundled price, and it is worth discussing when each option makes sense.
