Recently I had a conversation with a friend (let’s call her Helen) who wanted to buy a new iPhone, however she was frustrated that the iPhone 8 offers little in enhancements from her current iPhone 6. She was contemplating ordering an iPhone X. When I asked why Helen needed a new phone at all, she said her current battery would not hold a charge. When I said she could simply replace the battery, she responded, “I just want a new phone.” Although her current model has all the functionality she wants or needs, Helen is willing to pay something between $700 and $1,000 to upgrade. Our conversation got me thinking about the age-old problem of value pricing something that is very durable.
Earlier this year, my wife and I moved to Florida. With year-round nice weather, palm trees and white sandy beaches, it seems like Paradise. Last week Hurricane Irma came through and reminded us of the true price of paradise. It also reminded me that buyers make trade-offs in every purchase decision, and your pricing strategies should understand and quantify the values of those trade-offs.
All companies want to grow. The tough question is how to do it profitably and sustainably. A common approach for many manufacturers is to expand the number of channels through which their products are available to reach customers who otherwise might not try them. However, if that is not done with a proper understanding of segmentation (which customer segments buy in which channels), growth can be fleeting and potentially profit-killing in the long term.
Last week Andy Kessler wrote an article in the Wall Street Journal, The High Cost of Raising Prices, which might scare you into thinking you will ruin your business by raising prices. While I usually enjoy reading his articles and I found a few valid points, I mostly disagree with this article. Don’t fall for the scary stories and false correlations that could make you afraid to raise your prices. When the value you provide to your customers is greater than the price you are charging them, you can and should increase your prices to match the value.
The Atlanta Falcons have established a new concessions pricing strategy for the coming season, and they will have the lowest prices in the NFL. They are lowering most prices in an effort to be more fan friendly. I am not a scrooge, but I think it is a bad decision. At best, they will make less money. However, the fan experience may also be worse than they think.
Last week there was an article in the Wall Street Journal, So Long, Hamburger Helper: America’s Venerable Food Brands Are Struggling which discussed the declining market shares of some of the largest packaged food companies. It is not a surprise; the large CPG companies have been losing customers for the past few years on multiple fronts. Although many companies would interpret declining share as an indictment of their pricing strategy and would lower their prices, doing so would likely make the situation worse. It is much more important to understand what is happening with each customer segment and tailor their actions to the segments.
While there are surely more important things than crowd size for our politicians and news media to worry about, both groups have participated in a flurry of recent discussions of the expression “alternative facts”. While that is not a term often heard in negotiations, other erroneous statements are. You can improve your profitability by using the right tactics in responding to these alternative facts.
Remember that everyone, including your customer, operates in their own self interest. Often that means stretching the truth a bit. As evidence, consider how you behave as a buyer. Have you ever told a car salesman that another dealer offered the same car for a lower price, when it was not the exact same car? It happens all the time. That is why car sellers ask for documentation. Not all buyers are liars, but they are all looking out for themselves or their companies. Be ready to counter some of their claims during negotiations.
“Your products are exactly like your competitor’s “
First, don’t accept commoditization of your product. Your customer bought your product initially based on its value. Remind them of that. What are the differences in performance and durability? If your product lasts longer or performs better for the customer, they will realize cost reductions or revenue improvements from them. Even if you are selling the identical brand as your competitor, there are probably differences in service, delivery, reliability and availability. Make sure you identify these and sell the value of them. Make sure all your sales people understand these differences and are not trapped by the commodity mindset.
I seem to have received an extraordinary number of requests lately to complete customer satisfaction surveys. Some have been only one question and some have been 10-minute surveys. The goals of the companies requesting my survey participation are generally to improve their service delivery and build customer loyalty. Both are good goals. Unfortunately, if the surveys are not crafted and interpreted properly, they can kill the companies’ chances of achieving their goals.
In 2016 we saw several examples of companies raising prices rapidly and causing an uproar in the process. Classpass canceled their subscription to unlimited boutique fitness classes, What The Hell Is Going On With Classpass?. Also Mylan, Valeant, and Turing were all in the news for substantially raising the prices of popular drugs. In fact, they were all called to testify before Congress and were scolded for their actions. Their customers are and have been actively looking for alternatives. These few examples do not mean you should forego price increases or be timid about them; but they do mean you should be thoughtful in the process. Make sure your pricing strategy is multi-dimensional and includes steps to limit your risks when raising prices.
The first step in setting defendable price increases is to avoid having across-the-board common price increases. No matter what price increase percentage you pick, you run the risk of being too high for certain products, and you will definitely miss opportunities on other products. Other elements to consider include:
- How critical is the product to your customers’ business? For mission critical items, customers are less likely to switch to new unproven suppliers and they may tolerate slightly higher increases.
- This answer could be different for each customer segment
- How much of your customers’ total budget is consumed by the product? Your customers will be much more sensitive to price increases on products that comprise a large percentage of your budget. Higher price increases will elicit more negative reactions.
- On the other hand, there is not much incentive for customers to look for alternatives to products that make up a small portion of their budget, and they will be less sensitive to price changes
- What is the price/value relationship of your product compared to competitors, i.e., where is it on the Value Equivalence Line? If your product delivers 20% greater value than competitors, is it priced 20% higher?
- If your price/value relationship is low, you can raise prices more aggressively. Conversely, if that relationship is already too high, increasing the price further could anger your customers
- How many competitors and available substitutes exist for the product? Customers will be more sensitive to price changes on commodity-like products with many competitors and substitutes.
- For more specialized products with few substitutes, customers will tolerate somewhat greater price changes
- How elastic have the purchases of the products been? If customers have historically been inelastic (price increases did not reduce volume), you can be a little bolder with your price increases.
- Be more cautious increasing prices where customers have a history of voting with their feet
Absent from the list above is the change in the cost to produce your product or service, because cost should not be the driver of prices. Having said that, there is no doubt that when customers know your costs are increasing, they are more tolerant of price changes. However, customers care more about how much they have to pay compared to the value they will receive; and those factors will have a much greater impact on their price sensitivity.
If you consider the dimensions above, you will be well on your way to setting product-specific price increases that enable you to capture more margin without too much risk. The last step is to communicate your price changes effectively. That discussion should always emphasize what you do for your customers and how that provides value to them. Be honest and direct about the price changes, and don’t apologize for them. If your prices are really aligned with value, the customers will accept them.
Make sure you give your customers a reasonable amount of notice. Nobody likes surprises, and an adequate notice period let’s your customers plan for the impact. It will also help your customers to offer alternatives. De-scoped products that offer a lower price, rebates for significant volume increases, incentives to order in larger quantities, and product/service bundles can help customers reduce the impact of price increases.
Although we have seen plenty of examples of companies angering their customers with price increases, that should not be the norm. It is clear that huge price increases can cause a backlash, but strategic price increases can improve your profitability without creating customer problems. Be thoughtful and vary your price changes according to the products and circumstances to maximize your upside and minimize your risks.
Last month I read an article, How Amazon’s Pricing Algorithm is Designed to Hurt Consumers, that implied Amazon is not as customer focused as they claim. The article said that the online retailer does not always have the lowest-priced item first in their results list, and therefore is trying to take advantage of their customers. I disagree. What Amazon is doing is aligning their merchandising and pricing strategies. They are trying to sell more products by delighting their customers, and they are trying to make more money in the process. Isn’t that the point of retail?
When you shop in any physical retail store, you can see the merchandising choices the retailer has made. The products that have the most prominent placement, which makes them most likely to be seen, are seldom the least expensive products. In simple terms, they are usually products that either drive more traffic or generate more gross margin per foot of space. The store layout is also designed to encourage customers to spend more. In some cases, that means moving high-demand items to the rear of the store so that customers flow through the aisles and are tempted by other items on the way. It can also mean spreading the most recognized brands widely within a section to encourage more browsing. Rarely does it mean putting the lowest-priced items closest to the doors.
In grocery stores, customers usually pass the produce and prepared foods first, engaging positive feelings from visually appealing displays and pleasant aromas. Research has shown customers spend more when they are hungry (which can be triggered from the nice smells) or enticed by the fresh vibrant colors of fresh produce. The stores do not start customers there because the lowest-priced items are there! In addition, within any aisle in a grocery store, the low-priced and generic brands are not often at eye level. That premium space is usually reserved for the premium brands.
Retail is an inherently low-margin business. (If you doubt it, just look at Amazon’s return on sales.) To survive, retailers use many tools to determine how they can sell more to customers and at higher prices. In recent years, data science has become a much more important part of the retail toolkit. By analyzing how customers make purchase decisions, which factors affect those decisions, and how customer selections affect profitability, retailers can make much more informed and effective merchandising choices. Those choices include having an array of products to serve multiple segments, including the more price-sensitive buyers, and providing a simple path for each segment to find the products they want. Those merchandising choices also mean presenting higher priced, higher value alternatives to customers.
When online retailing started, low prices were one of the primary competitive strategies of online retailers. However, Amazon and other online retailers have learned that customers care about more than just low prices. They value a broad portfolio of products, service, ease of use, and the ability to find what they are looking for. The retailers also understand that product placement in their search results is similar to product placement on physical store shelves. They can and should use a more scientific approach to making those merchandising decisions. The fact that Amazon is using their considerable data science capability to improve their profitability should be expected. After all, they are in business to serve customers and to make money.