April 30th, 2010

Is Pricing Your Friend or Foe (Part 2)?

In the last blog entry, we examined the roles of commodity vs. differentiated products, elasticity of demand, and relative market share play in pricing strategy. Now I would like to look at three more areas – your sustainable price premium, the use of product configurations, and participating in relevant price bands.

Your Sustainable Price Premium

Your ability to use pricing to your advantage is tied to what people are ultimately going to pay for your products. If you are highly differentiated, have a premium brand, deliver a great product, customer experience, etc., you should be able to charge a price premium for your products. The opposite is true as well. Technology examples of premium priced products include HP printers, Apple PCs, and Intel chips. Now let’s look the opposite situation. You can’t charge a price premium. In fact, you may even have to discount your products relative to average market prices. Can Kia charge as much a Toyota? Can Budweiser charge as much as Heineken? Can Lexmark charge more than HP? Even in the best situations, charging more than 10-20% higher than your nearest competitors (as a share leader and/or premium brand) is extremely difficult. There are notable exceptions. If you are a market niche player or luxury product with extreme product differentiation, and control distribution you may be able to sustain more substantial price premiums. Examples include Bose, Louie Vuitton, and exotic cars like Maserati and Ferrari.

The Use of Product Configurations

As a supplier of a product or service, your goal is to get the highest price per unit the customer is willing to pay. In technology marketing, products with attractive low base prices and options (multiple configurations) that contain additional features and accessories bundled together are typically used. The option prices are set up so that the sum of the parts of the bundle are less expensive to buy than buying them individually or are otherwise unobtainable features (if you don’t buy it in a bundle you can’t upgrade your product later for that feature).

See these two examples:  

Apple’s iPad Pricing

HP’s M4345 Multi-Function Product Pricing

It is an art to decide what features should be included in the base product vs. the options. Customer-centered marketing insights will lead you to the right answer. But the net goal is to have attractive, entry-level price points on the base products then build such an attractive portfolio of options that people, based on their needs, will more than likely purchase a more expensive option.  In addition to this product/pricing approach, there need to be compelling up-sell and sell across marketing communication, tools, and promotions to wring out these higher average selling prices.

Participating in Relevant Price Bands

Based on the above, you should be able to triangulate on your pricing, relative to industry averages and nearest competitors. It is helpful to calculate average selling prices or revenue per unit and compare your performance to that of the competition. Many third party companies track this data (like IDC or GfK for printers and PCs). Equally important is the concept of price bands.

 As a company, you ideally want to sell products at all relevant market price bands (or customer- appreciated price points) – whether they are higher or lower. Why? As mentioned earlier, participating in more price bands opens up broader market access. Over time as a product category matures, lower price bands grow faster than higher price bands and there is a mix shift to lower price bands. This follows the trend of classic technology productlife cycles. This becomes important when you are managing your market share. For example, let’s say 50% of your market is priced over $300 per unit and 50% if your market is below $300 per unit. You don’t currently play in the less than $300 market because it is less profitable, cheapens your brand, etc. Let’s say you have 50% market share in that >$300 market.  That would give you 25% market share in the total market (50% x 50%). Let’s assume you are gaining one share point of market share every year in the >$300 market and the <$300 market is growing 2X faster than the >$300 market. In this scenario, even if you gain market share in your traditional segments of the market, you are losing market share in the overall market. That may or may not be OK, depending on your business strategy. If you are the market share leader for the price bands you participate in as well as the overall market, chances are you will want to hold on to your share and keep prices as high as possible. But as new price (probably lower) price bands emerge, you will need to decide how to respond to them. There are ways to respond (but that will be another blog entry).

Equally important to this conversation is to develop the appropriate tracking mechanisms to measure and respond to your industry’s unique pricing dynamics. Appropriate measures can include revenue share, unit share, price premiums vs. average selling prices, market leadership indicators, brand metrics, and coverage of market price points and bands. Looking at these factors and carefully considering your pricing approach will yield better decisions and help you make marketing a more strategic, value-added function.

Often times, companies will make broad statements – that they would like to grow revenues, profits, and market share – all at the same time. Unless you are starting from nothing, this is almost impossible. At best, only two out of the three variables in play can be optimized. You need to make sure you wisely chose the best ones for your business.

So is pricing your friend or foe? It is you friend if it helps you grow revenues, has neutral or positive effect on market share, and helps you manage your overall profitability to goals. It is your foe if pricing decisions drag down your revenues, gross margins, profits, and market prices. While there are no easy answers to pricing decisions, a framework like this will greatly increase your odds that you are making excellent pricing decisions.

Print

Email

Rss

5 Comments

Posted By Vince Ferraro

April 23rd, 2010

Is Pricing Your Friend or Foe (Part 1)?

Here is the scenario. It is the end of the quarter and your company is not making its numbers. With one month left in the quarter, your VP of Sales calls you up and pitches to you that the quickest way to recover sales is to cut the price of your most popular selling unit. Why not? After all of all, of the available marketing P’s, pricing is certainly the easiest lever to pull when time is short. Sure you can manipulate the other elements of the marketing mix – product, promotion, distribution, etc. But successful implementation of all of these other marketing levers takes time. No wonder many companies spend more time driving pricing decisions than all of the other elements of marketing mix combined.

While pricing is certainly a powerful motivator of demand, it is not always a good predictor of success. In order to successfully execute the pricing lever, there are a number of factors that need to be considered. I am not talking about specific pricing strategies, but factors to consider as you deploy your chosen pricing strategy.

Commodity or Differentiated Product

If you are selling commodities (say a bushel of corn), your ability to differentiate your pricing is severely limited. Typically, commodities will differentiate their prices based on grade or scarcity. For example, let’s look at food products. If you sell eggs, you can differentiate your prices based on grade and size or some other differentiating factor (free range, organic). If you sell maple syrup, you differentiate on grades based on the color of the syrup (medium amber, dark amber) and perhaps where it was produced (i.e. Vermont). If you are not a commodity product, then presumably you are in a market that has a product with some ability to differentiate. It may be a lot or a little depending on the type of product or industry.

Elasticity of Demand

To borrow an economic phrase, if you cut the price and you can increase demand, presumably there is elasticity of demand. If you have a differentiated product, one assumes that some incremental demand will be realized with lower prices. What is important here is that the price change generates incremental revenues. If you cut prices by 10% and your demand goes up by 5%, you will see decreased revenues and profitability. Demand is rather inelastic. If you cut prices by 10% and volume goes up 15% demand is elastic. Growth and new categories often show more elasticity of demand than mature product categories.

The formula is PEoD = (% Change in Quantity Demanded)/(% Change in Price)

In mature product categories, growth is mature and the only way to drive incremental demand is to take market share from a competitor, which is difficult to do. Often times, marketers will try to work the margin, meaning holding the standard price constant and offering discounts or rebates for incremental demand. Bid deal (bid desk pricing) pricing follows this approach. This is easier said than done. Many companies cut price only to find that they cut revenues as well.

Relative Market Share

If you have a product with low market share, “buying” market share by aggressively lowering prices (vs. prevailing competition) is a successful strategy for growth. Dell did it in PCs, Samsung did it in printers, and AMD did it in microprocessors. It is a strategy that can work. You “buy” market share because it is all upside. If you are a legitimate brand and have 0% share and you price aggressively, it is likely you will get some share. You “pay” for it with aggressive pricing. On the other hand, if you have higher market share, your goal is to keep it. To keep it, you have to fend off aggressive competitors who want to take it from you. If you have relative market share of 3-5X the market share of your nearest competitor, you can bask in the fact that you have true market leadership and that responding to competitors’ aggressive pricing must be very specific and surgical. You don’t want to take market and street prices down and trash your revenues and profits just because an aggressive competitor is coming after you.  If you have less than 2X the market share of the nearest competitor or you are not the market share leader (less than 1X), a more aggressive pricing response may be needed to drive/sustain share. When looking at market share, it is important to look at both unit market share and revenue market share. Rarely are the two the same. Revenue share is often a measure of channel clout. If you sell to Best Buy – what would be the best position to be in as a vendor that sells to them?  25% unit share and 50% revenue share, 25% revenue share and 50% unit share, or 50% revenues and 50% share?

It is important to note that an aggressive competitor can create new (usually lower) price bands that will expand the market size. Depending on your pricing strategy you may or may not choose to participate in these price bands. For example, if the price range of a given product is $200-500, what is likely to happen if a respected company decides to compete with a decent product at $100? Two things will probably happen. First, the market will expand overall. Second, it is likely that some customers that bought a $200 product will be happy with the $100 product, so a mix shift in pricing (and share) will occur. This happened when PC manufactures introduced the net book as an alternative to the notebook PC. When Asus introduced a net book in 2007, it created a whole new product category. Notebooks became more affordable so global demand for portable PCs went up but product mix skewed more to lower price points as people who previously bought more expensive notebooks found their needs satisfied by net books. The same thing is going to happen with e-readers and next generation tablet PCs.

In Part 2, we will examine the roles that price premiums, product configurations, and price bands play in pricing and how pricing can be your friend or foe.

Print

Email

Rss

Comments

Posted By Vince Ferraro

January 30th, 2010

This week Apple announced their much-anticipated iPad, a tablet-like device which has been described as a supersized iPhone, a shrunk down (or new form factor) notebook, or a competitive product with Amazon’s Kindle and other e-readers. At a base price of $499, the iPad has hit a price point to give people who want to purchase an e-reader time to ponder their purchase decision. From a market perspective, I believe their timing was excellent. There was a good article in the Washington Post , Top 10 Reasons The Apple iPad Will Put Amazon’s Kindle Out of Business that has more fact than fiction in it. Truth be told, Apple is going to revolutionize yet another category and give many a competitor angst and a run for consumers’ purchasing dollars.

As a pundit of the high technology marketing, I would be remiss if I did not try to look at this and break down some of the key things that make Apple’s entry into new market so formidable. So I am going to comment on a few marketing strategies I have observed that make this such an interesting case study.

1. Great Pricing Strategy. Everybody knows that Apple has a premium pricing strategy. At $499, Apple surprised the market and priced the iPad $10 higher than the Kindle DX. For $10 more of course you would want to buy the Apple over the Kindle. Why not? Well to begin with the iPad display is color while the Kindle is monochrome.  Think it will cost you $499 over its lifetime? Think again. If you want 3G wireless, it will cost you an additional $130. More memory – an extra $100. Want a data service to run the 3G network capability and connect to the internet beyond basic Wi-Fi connectivity? That could easy cost you $500 a year. So the total cost of ownership (TCO) of the iPad is going to be pretty high – probably over a $1000 for the first year. And don’t forget the e-books at $9.95 each. The point is that Apple has created a pricing strategy that will lure buyers in. With desirable extra features and services, many buyers will leave a few hundreds of dollars poorer than they expected. Will customers be unhappy? No, because they will have created as product that has delivered an excellent customer experience vs. what the competition can offer.
2. Excellent Customer Experience. Much of Apple success can be attributed to developing products that are game changing – not first to market. Did Apple develop the first e-reader, smart phone, or MP3 player? No they did not. What Apple is brilliant at doing is creating a unique product experience that is so engaging and fun, that they can significantly differentiate themselves from any other competitor. Michael Porter, in his book, Competitive Advantage, would call this a differentiated advantage. Differentiation advantage is aimed at the broad market that involves the creation of a product or services that is perceived throughout its industry as unique. The company or business unit may then charge a premium for its product. This specialty can be associated with design, brand image, technology, features, dealers, network, or customer service. With Apple, this differentiated experience comes in the form of its industrial design, cool factor, brand name, Apple retail stores, software user interface, application widgets, iTunes/App store and synching software. In addition, Apple has figured out how to wrap a business model around it and make money as well! There are many models on how customer experiences can be defined and delivered. HP used a model called ACOILUSD and it will be the subject of a future post. By delivering an excellent product experience, Apple hopes to increase customer loyalty and preference for its products – now and in the future.
3. If First You Don’t Succeed, Copy. If I was an executive at Apple, I would enjoy watching how the competition responds to my new products. In fact, most companies that compete with Apple just try to copy the features and capabilities of the Apple product, in hopes that it will make them a closer compare to the Apple device (and most likely sold at a lower price) at the time of purchase. Now this can be a respectable strategy when applied properly. After all, Microsoft has Zune, Samsung introduced its Galaxy i7500 Android phone, and RIM announced widget support for its Blackberry. To be honest, I would find new marketing executives in these companies, if that is the best they can do. Instead of trying to up the ante and create better, alternative, and differentiated experiences that delight customers, these vendors decide that following Apple is better than trying to beat them the old fashioned way – by developing and delivering innovative new customer experiences and products.  Have they conceded to Apple? Don’t have any better ideas? Do they believe following/copy cat strategy is better than the status quo? I have no idea, but there must be a better way. The question is which company can do it? Take Apple to the mat, to use a wrestling metaphor.
4. Scarcity of Value. Probably the most important idea here is that Apple depends on a “scarcity of their products” in markets of high demand. What does this mean? What I am trying to say is that when Apple goes into a new market, the markets are relatively big, can be big, or converging into a big market. The scarcity of supply simple means is that there are no other competitors out there delivering a comparable product value or customer experience. Using MP3 players as an example, this means you will pay more to enjoy the Apple experience vs. the competition – even in a market where there is tons of competition. Because there is not a direct replacement product – hence scarcity! The best examples of this concept are people who bought another brand of product, perhaps due to budgetary constraints, and wished they had bought the Apple product instead!

Taking a high road product and pricing strategy is not the only strategy a company can deploy. If you are not in a commodity market, most markets are stratified into different price points and volumes. A company can build a value proposition in the low end, the middle or top end of a market. I think what the Apple example illustrates is how delivering great marketing through excellent product value and customer experiences, a company can become a dominant market force and game changer in the market, even though they might not always be the volume leader.

Print

Email

Rss

6 Comments

Posted By Vince Ferraro