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“The market sets the price!” We have all heard that statement and many treat it as axiomatic. After all, there are limits to prices on every product or service, and you can’t “charge more than the market will bear”. So I am not terribly surprised when someone tells me their strategy is to match the market prices. However, I am also quick to tell them “The market sets the price” is not a strategy. Taking that approach is really a choice to not think much about prices, and let competitors and customers lead you.
If the market sets the price, how does that happen? Is there some wizard hiding behind a curtain determining what the prices ought to be? Or is there some giant computer somewhere figuring out the answer to what the right prices are? Of course, neither of those things are true.
The market includes your company, your competitors, existing customers and potential customers. How does that market set a price? Do your competitors know something you don’t know that enables them to set a price? If not, how do they do it? And if you are simply reacting to prices your competitors set, then the market isn’t setting the price, your competitors are.
Last weekend there was an article in the Wall Street Journal, How Not to Be Mislead by Data. The point of the article was people will use a number as evidence of whatever point they are trying to make, and use it to end an argument. After all, if the number supports your story, what is left to debate? The problem is, the number cited is often one which sounds dramatic but is not really representative of a complete picture, is an isolated case, or is meaningless. The first example in the article was New York’s Governor Andrew Cuomo bragging that unemployment in New York had decreased, and the state was “on the move”, even though New York’s rate was moving at the same speed as the whole country. He is not alone; many politicians like to cite unemployment figures as evidence of their success. However, they fail to mention that the percentage of the population actually working is lower than it has been in 10 years. Which number is more important? It is not just politicians who will mislead their audience with numbers. Dubious statements occur in many (if not most) companies when discussing pricing. It is important for all of us to be aware of the potential for misleading statistics and be thorough in our analyses.
You know inherently that customers are not all the same. I have written in the past about the importance of segmenting your customers and working to understand the needs of each segment so you can identify how much they might value your product (or not). A recent example in the car market illustrated that failure to understand customer needs can result not only in incorrectly pricing products, it can result in losing sales completely.
In prior blog posts, I have discussed the strong brand preferences of certain car buyers, specifically those who occasionally take their cars to the racetrack. At a track event last month, one particular Corvette aficionado (let’s call him Ike) was very pleased to report he had put down a deposit on a new 2015 Corvette Z06, with 650 horsepower and an 8-speed paddle-shift/automatic transmission. The price of the car was a little over $90,000. Ike was expecting delivery in early June. Interestingly, he ended up not buying that car, because the dealer either did not understand his needs, or did not understand which Corvette best met those needs.
There was a recent article in the Wall Street Journal, First Class Fares Get Affordable, reporting the major US airlines have quietly lowered their prices of first class tickets. As is often the case, the airlines are providing some pricing lessons with these moves. I see three main principles we can all take away:
1. They have done the math to learn they will gain more revenue and profit from selling more of their first class seats than they will sacrifice from lower prices to customers who have always bought first class tickets
2. The competitive risks are manageable and lower first-class fares will not cause a price war
3. They have built confidence to make these moves by testing other gradual pricing changes over the past few years
Earlier this month, Hertz announced they would be raising the price of most on-airport car rentals by $5 per day Hertz to Raise Car-Rental Rates. There is some risk to Hertz, because the rental car market is already quite competitive, and new options from Lyft and Uber add to the competition. However, I view it as a good move, demonstrating price leadership. In all markets, someone has to lead. In healthy markets with rational competitors, that leadership often benefits all competitors.
All companies would prefer to sell at higher prices. Even companies who compete on the basis of offering the lowest prices would prefer their lowest prices in the market to be higher. Similarly those who try to stimulate higher demand and lower their production costs by offering lower prices would prefer that those market-clearing prices be higher. The reason is they make more money. And the more money they make, the more they can invest in R&D, additional capacity, or other profitable alternatives. Despite that overwhelming preference for higher prices, market participants are often fearful of raising prices. The fear is that demand will go down, or a competitor will take business away because of the price differences. That cognitive dissonance can paralyze market participants so nobody acts.
Two weeks ago I wrote a blog Race for Better Service, Not Lower Prices, in which I discussed sports-car owners changing service garages because of poor service. This past weekend I participated in a driving event with car enthusiasts at Watkins Glen International which reminded me that many consumers really don’t like to switch products or providers. Apologies to Bryan Caplan for blatantly copying his title, but he pointed out in The Myth of the Rational Voter that voters often pick a candidate early and then stick with that candidate. They find it is not worth their time to do detailed research on candidates and the implication of candidate policies. Also, by sticking with their initial choice, voters never have to conclude they made a bad choice. Car owners, and indeed many consumers, behave in exactly the same way.
I often participate in Friday morning breakfast meetings with a group of local executives from a variety of industries. Discussion topics include the local business environment, performing versus non-performing entities, politics, and our hobbies. During our most recent meeting, a discussion of a common hobby and the performance of a local business reiterated that quality service is much more important than price, and customers will pay for better service.
One hobby several of the executives have in common is we own sports cars. Some of us participate in track days, wherein we drive our cars on race tracks at high speeds. When we do that, it is critical that our cars perform at their peak. So it is important to each of us to work with a service business we can rely on to maintain our vehicles at a high standard. I learned this past week that one service garage had disappointed three of us in the past few years, and had lost all our business.
At the end of March, Walmart announced its intention to recapture and reiterate its position as the low-price leader in retail: Walmart Ratchets Up Pressure on Suppliers to Cut Prices. Although they have always pressured suppliers to cut costs and enable low prices, Walmart is increasing the pressure. Company executives are telling suppliers to lower their spending on promotions, and other marketing initiatives, and pass the savings to Walmart in the form of lower prices to the retailer. Walmart would then pass the savings on to the consumers. Consumer products suppliers have some difficult choices to make, but in the process they can test some concepts that might enable better future decisions.
This past weekend my wife and I decided to go to dinner someplace where we could watch March Madness on TV. We picked a restaurant with plenty of TVs easily visible from most any table, a well-stocked bar, and a typically casual menu. There were salads, burgers, chicken, pork, steaks and seafood available. After each of us ordered baby back ribs, I observed what a great marketing and pricing success story ribs and chicken wings have been. Products that were essentially unwanted years ago are now in high demand and command premium prices.
We were reviewing the results of some analyses with a client recently, and the client observed they had raised the price of one of their biggest selling products and volume had decreased. Our client concluded the demand for their products was very price elastic. Certainly the classic calculation (the percentage change in quantity sold divided by the percentage change in price) would provide an answer that demand was elastic. However, the demand for a product can change for many non-price reasons and it is important to know the differences before adjusting your prices or pricing strategy. To understand those differences we want to look at the source of the demand, the behavior of customers across a range of products, the fit of the products with changing customer needs, and our service levels.
