In a recent conversation with my son, he observed that New York’s MTA charges $2.75 for each subway ride, but the options for card refills are generally not divisible by that amount. In his view, this practice is not very customer-friendly and is likely harmful to the business. I agreed it is not customer-friendly, but I suspect it does improve the MTA’s financials. More importantly, it reminded me of the principles behind non-core pricing, or long-tail pricing.
Non-core pricing is a simple concept. Customers are more sensitive to the prices and price changes of items they buy frequently, or on which they spend a lot of money. Consider those as core items. Conversely, customers are less sensitive to the prices on low-value, infrequently purchased (non-core) items. So, when you are selling core and non-core items, price them differently. Try to capture higher margins and higher price increases on the non-core items.
This concept is sometimes referred to as long-tail pricing. If you create a pareto chart of your sales or your industry sales by product, you will usually see the vast majority of sales comprised of few products. See Exhibit 1 below, where the products on the left side have substantially greater sales than those on the right. The products with low sales are part of the long tail.
As an example, consider a hardware store. They are likely to sell high volumes of tools, paint, light bulbs, batteries, etc. They probably sell many fewer units of compressors, generators, gas grills, and the like, but the price for each is high, so sales dollars will be high. Those high-dollar and high-volume products will tend to be on the left side of the chart. On the other hand, hardware stores also sell nuts, bolts, washers, picture hooks, etc. They sell them infrequently and each unit does not cost much; and these items are part of the long tail.
If you are buying paint, which might be $20 – $30 per gallon, you might compare prices at multiple stores. Similarly, if you are buying a power drill or a power washer, you will probably compare prices (even if you pick the most convenient store or your preferred brand). What if you just need to buy some picture hooks, or some ¼ x 20 bolts? Are you really going to spend much time trying to save a few pennies on these? The answer is no. You will buy what you need, and not waste precious time on an inconsequential decision.
Unfortunately, too many companies ignore this simple concept and set prices in a sub-optimal way. Companies that take their cost and add a “fair” margin, have an easy time setting prices; however, they would make more money by setting higher margins on non-core or long-tail items. Similarly, companies that simply pass on their cost increases from year to year or increase prices by the same percentage on all categories miss an opportunity. They could potentially increase prices by a greater amount on long-tail items with little or no risk of customer defection.
At this point, you may wonder what this has to do with MTA metro cards. It is not exactly non-core pricing, but it is an example of capitalizing on low price sensitivity. Although all MTA customers could lose or destroy cards with unused credit, the percentage lost is low for frequent riders, the core customers. Regular riders will refill their cards often, and even if the amounts are not divisible by $2.75, leaving a couple dollars on the card is a very low percentage when spread over a bunch of rides.
Tourists and visitors who use the subway infrequently are much more likely to buy a card but not be able to use all the value, because the refill amounts do not correspond to any number of rides. These visitors are the long tail of MTA riders. When standing at the machine buying and filling a card, these non-core users don’t want to do the math to try to figure out how many rides they are likely to take and how to minimize value that may get left on the card. In other words, they are willing to pay for the convenience of not figuring it out.
In this MTA example, cards that are not divisible by the price of a ride is not very customer friendly, however, it is profitable. Core riders spread the overpayment over the cost of many rides, so they don’t care much. Non-core riders are less price sensitive because they are visiting, and it is not worth their time. MTA capitalizes on those areas of low sensitivity and makes a bit more money.
Each business is different, but most can include some form of non-core or long-tail pricing. Figure out which products or services you sell are part of the long tail and get more aggressive on how you price them. It’s a simple way to improve your profitability.
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