Fixing Mistakes in Your Pricing Structure: 2 Examples

You analyze reams of data. You carefully evaluate potential pricing policies. You select what you think is the best one. And then your users tell you that they hate it. And not just because no one likes to spend money unnecessarily. They actually have good reasons. Had you known them at the beginning, you would have priced differently. So what do you do now?

Zoho, makers of popular online applications for CRM and office productivity applications, apologized on their blog and revamped their pricing. Essentially, they had not understood how some of their customers actually used their Creator application. The pricing policy had forced customers to trade off between buying a lot of things they didn't need to get a few features that they did need, or going without. Pricing is about capturing value, but the initial policy failed to give free and low-cost editions the capabilities that Zoho wanted them to feature. So they tried again. Perhaps it's a bit embarrassing to write a blog post like that, but it's much better than pretending everything is fine, or queitly making a change and sweeping your mistakes under the rug.

Zoho is lucky in some ways. They can change prices easily because they sell Software as a Service (SaaS). They don't have to deal with catalogues, price tags, contracts, and other overhead that goes with a price change at many other companies.

Dell is infamous for having different prices for essentially the same computer depending on which part of the website you visit. This is because during its breakneck growth, Dell organized around segments (Small Business, Home, Student, Government, etc). Segment leaders maintained control of their pricing, leading to inconsistencies. It got worse, as different promotional policies could result in the same machine in the same segment showing different prices. Customers complained on Dell's IdeaStorm online feedback forum. Now Dell is touting consistent pricing for their Vostro laptops for small business. It's a good start.

While these approaches draw attention to past missteps, they build a better relationship with customers than the typical press release-style price changes, where everything is spun to sound wonderful.

When Buying Larger Quantities is a Worse Deal

When you buy in bulk, you typically get a better deal. On a per-unit basis, it's cheaper to buy a 32-pack of Coca Cola at Costco than a single can in a convenience store. The same concept applies in industrial manufacturing, software licensing, and other industries. Sometimes, however, the buying more will cost you more, even on a per-unit basis.

This makes economic sense if what you are buying is in short supply, and rather than letting the price float with the market, the seller wants to allocate the supply to a number of buyers, perhaps due to contractual obligations. If you want more than your allotment, you pay the market price, not the contract price.

In some situations, it just seems like a tax on the mathematically disinclined. Take this example from an airport massage lounge.



Sorry about the blurry image. Here's what the sign says, plus an additional column that indicates the $/minute of massage.

Minutes	$	$/minute
10	$12	$1.20
15	$17	$1.13
20	$22	$1.10
30	$35	$1.17

I can get a 10 minute massage and a 20 minute massage for $34, $1 less than just getting a 30 minute massage. It probably says something about the way my brain is wired that this jumped out at me as I walked by. I asked the therapist on duty why this was the case. She said it had to do with the way they got reimbursed.

When pricing is compromised by internal alignment issues, it's usually easier to fix the alignment issues (as hard as that may be) than change the market.

Let's suppose they can't fix the alignment issues and they have to price this way. What should they do? I'm not an expert when it comes to massage, but I'm guessing that you could offer a "30 Minute Deep Tissue Massage" or some other value-added offering that you simply can't provide in less time. Maybe you add a foot massage. Then you raise the price to $40. And break it out separately from the per-minute massages on the board.

Differentiating Commodities

Pricing power comes from differential value. If you offer more value, you can charge more. Value is perceived by the customer, however, so while you can suggest the value of your offering, the customer ultimately decides.

Often, attributes that some customers value highly are irrelevant to other customers. For example, automakers sell more four-wheel-drive sedans in places where snow is a regular occurrence compared to Florida and Arizona.

Small businesses can often differentiate themselves from much larger competitors by serving a market or geographic niche much better than the larger firm. Product companies can differentiate themselves based on their service. Some companies might offer faster delivery time, while another offers more comprehensive engineering services, while another bundles in maintenance. Notice that the differentiators are not necessarily mutually exclusive, but companies that value certain differentiators will choose the vendor that offers the best fit.

In a crowded, competitive market place where every vendor says they are "better" and every customer says they care about low price, providing "difference cues" helps to remind people of how you are different. Apple, known both for great design and hefty price premiums, provided a great difference cue when they launched their iPod. MP3 players were relatively new to the market. They were like the Walkmen of yore and the portable CD players that had recently become popular-- useful to listen to your music on the go, but clunky. On subways, in gyms and buses and offices, people wore black or grey headphones to listen to their music. So Apple made their headphones white with white wires. It was different from everything else on the market. (Someone will probably name a counterexample, but I can't think of one off the top of my head.) It also advertised the product. The player itself might be hidden in a bag or a pocket, but the headphones were visible. It's a subtle point, but back when rational people (I like to include myself) thought that a $400 music player was a really dumb idea, the difference cue enhanced the iPod's value as a status symbol. Not only did you have a really cool music player, but everyone knew it.

Coincidentally, Sony had done something similar a decade earlier when they introduced their "Sports" line of Walkmen, which were built to withstand sweat, rain, and even water. Sony made the players and the headsets bright yellow to accenturate the difference from the regular "non-ruggedized" portable cassette players on the market, which helped justify the $50-100 prices.

So what did Bose do when they wanted to introduce earbud headphones? Bose had traditionally sold large, over-the-ear headphones, which gave them the ability to print "Bose" prominently. With the smaller earbuds, they needed a different approach. They didn't want to just have a black buds-- that would be so pre-iPod. They didn't want to just use white, because that wouldn't differentiate them from the (lousy-sounding) headphones that come with the iPod. So they created a twisted white and black pattern on the wires. I don't know if I like the asthetics, but you can immediately tell that they are different.

There are ways to differentiate just about everything. Here's a 1 slide animated PowerPoint with a great example of differentiating a "commodity." (Click on the image to open or save the file.)

PPS Spring Conference

We're at the Professional Pricing Society Spring Conference, with over 500 other pricing folks.

The best comment I've heard so far came from someone who stopped by our booth this morning. He had spent 9 years in sales and recently moved into pricing, so he understands how to make pricing work in the field. He said that sales is really important, but "this [pricing] is the s#$%!"

Luxury Pricing: Top This!

Although I've said before that with luxury items, the price is the value, I'm still occasionally astounded. Now along comes one of the most absurd items I've ever seen. Swiss watchmaker Romain Jerome created a watch they call "Night & Day." Why do they call it that? I'm glad you asked. Because it doesn't actually tell time. It just tells you whether it's day time or night time. How much would you pay for this? If you offered less than $300,000, you wouldn't have got one, because they sold out within 48 hours.

Other luxury goods typically make a pretense that they offer some kind of functionality to justify their price. Ferraris are fast. Fine, rare wines are supposed to taste good-- even if you're not really supposed to drink them. Fancy jewelry is supposed to look nice. Even luxury watches, which are no more accurate than $10 digital watches, have complex mechanisms to tell you the phase of the moon or some other piece of not really useful information. But a watch that doesn't even pretend to tell you the time?!?

As a pricing person, this is brilliant. This is about the story that you tell when someone asks you about your $300,000 watch. I imagine it goes something like this:

Nice watch. How do you read it?

See here? This means it's day. If it was over here, it would be night.

Oh, I see.

Yes, it's extremely useful when I'm in the media room of my yacht and I just really want to know whether it's day or night, and my VCR is still flashing 12:00, so I just look at my watch.

Why don't you just ask your butler?

Usually I do, but sometimes I've just sent him to get a bottle of that Chateau Lafite that you're really not supposed to drink, but I've never understood senseless luxury, you know?

That's great. Chronographic technology has come so far since man looked at the sky. I can never keep up with the time zone changes when I'm in my yacht. I should get one of those.

Sorry, they're all sold out.

So can anyone come up with a luxury item to top this?

Not Free! Why $0.00 Is Not the Future of Business

Wired editor-in-chief Chris Anderson recently wrote a provocatively-titled article called Free! Why $0.00 Is the Future of Business. Anderson argues that the economics of computing on the net, where storage and bandwidth costs fall even faster than the cost of processing power, will drive the price of many services to the marginal cost-- in other words, $0.00.

Anderson starts by recounting the story of King Gillette, whose disposal razors laid the foundation for a multi-billion dollar industry. Now some companies have "razor blade" strategies. Think Hewlett Packard printers and cartridges, commoditized industrial products and high-margin services, Xbox video game consoles and games. The loss leader products in these examples have substantial marginal cost, which, along with antidumping laws, prevents companies from giving them away for free.

On the web, however, marginal costs are often close enough to zero to be zero for practical purposes. Anderson notes:

Not too cheap to meter, as Atomic Energy Commission chief Lewis Strauss said in a different context, but too cheap to matter…

From the consumer's perspective, though, there is a huge difference between cheap and free. Give a product away and it can go viral. Charge a single cent for it and you're in an entirely different business, one of clawing and scratching for every customer. The psychology of "free" is powerful indeed, as any marketer will tell you.

This difference between cheap and free is what venture capitalist Josh Kopelman calls the "penny gap." People think demand is elastic and that volume falls in a straight line as price rises, but the truth is that zero is one market and any other price is another. In many cases, that's the difference between a great market and none at all.

This concept is powerful and disruptive for problems that are amenable to web-based solutions. It's not so powerful if you need a giant locomotive to move goods across the country. However, if information can replace the physical goods, prepare for disruption.

Microsoft, whose Windows and Office software programs generate billions of dollars in profit every quarter, thought it was immune to the web-based threat. Microsoft thought that the web could never provide rich enough functionality for users, and users would never accept a solution that required a live internet connection. Funny thing. Google just introduced technology that allows people to use its Office-like applications without an internet connection. Meanwhile, when connected to the internet, users can share documents and work collaboratively more easily than with the more fully-featured Microsoft version. Cost for Microsoft Office? About $300 for an upgrade. Cost for Google's version? $0.00.

So where does the money come from? After all, a business is a business, and if it is to remain so, a fundamental inequality must hold true:

Value Provided to Customers > Price Paid by Customers > Cost to Provide Value

Leaving aside questions of value, the only way for a price to really be zero is if the cost is less than zero. While this may seem absurd, it's the magic behind Google. It's just that instead of serving customers for free, Google serves an audience to advertises for high margins. Anderson would like us to think that this is a fundamental change in the nature of business, but it's really as old as newspapers.

Free is not a pricing strategy. It's an advertising strategy (gather as large and valuable an audience as possible). It's a promotional strategy (offer free services to cross-sell or up-sell other offerings). It's a testing strategy (allow users to test your software for free, so that the premium version is more reliable).

Companies that take part in the "free" economy need to have a good strategy for monetizing what they giveaway at some point. And as Anderson points out, while we have more and more abundance in many aspects of our lives, our time and attention are scarcer than ever. The ability to offer something for nothing, even if the offering is valuable, is worthless if no one notices. Along with the abundance of the web, comes a strong network effect that Robert Frank and Philip Cook explored in The Winner Take All Society. In this global age, benefits accrue disproportionately to the "winners." Google makes billions from "free" search. A small group of other search companies combined makes less money than Google. But offering a free search service is unlikely to generate significant profits, unless you can find a valuable and underserved niche. Similarly, a handful of popular bloggers make good money by giving away their ideas for free, and charging for ads. I am not holding my breath for this strategy to work for pricing blogs.

So we still have to provide value to customers, whether they are users or advertisers. We better be able to charge more for this value than it costs us to provide it. Otherwise we will go out of business. Anderson is right that the cost side of inequality is changing rapidly and that this can have a disruptive effect on markets. But while $0.00 may make for a catchy headline, it is not the future of business.

(Anderson, who previously wrote The Long Tail, is developing a book based on this concept, titled FREE, which will arrive in 2009.)

Pricing Advice from the World's Oldest Profession

For many people watching the Elliot Spitzer scandal unfold, the shocking part of the story was not that a powerful politician went to a prostitute. That seems almost retro these days. What seemed jaw-dropping was the amount of money Spitzer was paying out. Well, it turns out that the world's oldest profession knows a thing or two about high end luxury pricing. (As Bill Mahr pointed out, there's a big difference between the high end call girls in Elliot Spitzer's circle and the vast majority of prostitutes who have few or no options and no pricing power.)

As we pointed out in the recent post "In Luxury Goods, Pricing Is Part of the Value", high prices for certain goods create a perception of high value in some markets. Brownwyn Fryer over at the Harvard Business Review Editors' Blog takes a much more practical, hands-on view of the experiment we discussed that doesn't involve MRI machines, but does require purchasing one bottle of expensive wine. (See "Are Your Prices High Enough?") Bronwyn herself left a comment on one of the other comments referencing a recent New York Times article called The Double Lives of High-Priced Call Girls.

And when it comes to price, Ms. Xi’an shared a secret. When someone pays her $1,250 an hour, he gets exactly what he would for $200, her rate when she started out. The difference is psychological, she explained: “The more somebody pays for you, the more they’ll respect you.”

“Tell a guy you’re $100 and they’ll treat you one way — tell them you’re $1,500 and they’ll treat you better,” Ms. Xi’an said in a telephone interview from her home on Long Island. “I’ve heard a lot of girls saying, ‘Is this girl getting $5,500 an hour because she’s more beautiful? Is she doing something I don’t?’ The answer is no. But that girl is able to look a guy in the eye and say, ‘This is what I’m worth, and this is what you have to pay if you want me.’ And you have to be able to do that, and believe it.”

This can be true for a lot of purchases. People who buy expensive, top-of-the-line offerings, whether they are stereo systems, software applications, wines, or other indulgences think more highly of their purchases and invest more heavily in them that those who purchase cheaper offerings.