e-Hail the Price Mechanism for your next App

Most people use a multitude of website, tablets and smart phone apps for free. Three in four readers of this column will probably use what a friend of mine calls “Facebook for Suits”, or LinkedIn, for free. Email, Skype and Viber, Search Engines, Instant Messaging and YouTube are further examples: the list goes on and on.

Businesses call this “leaving money on the table”. Economists call it “the consumer surplus”.

A couple of years back, McKinsey surveyed 4,500 web users across Europe and the USA in an attempt to quantify the size of the Internet’s consumer surplus. They asked them what they would be prepared to pay for various online activities that they were currently receiving for free. The figure they landed on was a staggering €100 billion!

That a lot of Euro’s and Dollars being left on the table. But that's unlikely to be the case with a couple of Chinese apps to “e-hail” a taxi, a space that is currently getting very crowded and competitive here in Australia.

No matter which way you look at it, these apps provide value to taxi drivers, whether it’s by increasing their revenue (more fares), reducing the costs associated with driving around looking for a fare, and by facilitating the payment of the fare, they also minimize risk.

In, China, the two big players are Didi Dache and Kuadi Dache. The former operates in Beijing, Guangzhou, Shenzen and Hangzou, and boast 30,000 registered taxi drivers. Kuadi Dache operates in Hangzhou and Shanghai, and has 300,000 users, 30,000 registered taxis, and is facilitating about 20,000 transactions per day.

But the two Chinese apps do something very clever. They recognise that each passengers’ need for a taxi differs, and so does their willingness to pay for it. So when they are e-hailing their cab, passengers can specify that they are willing to wait 10 or 30 minutes in return for a RMB5, RMB10 or RMB20 tip.

So not only are these apps a win-win solution for the taxi driver. The passenger wins as well, as the apps makes clever use of the price mechanism to discover who is prepared to pay more. Less money is being left on the table. The consumer surplus is being minimised. All this in a country where tipping taxi drivers is not common practice.

This clever use of the price mechanism, which has applications beyond just taxi services, has attracted the attention of the two Chinese Internet giants: Baidu in the case of Didi Dache, and Alibaba in the case of Kuadi Dache. So perhaps James Packer et al taking an interest in local taxi app company goCatch isn’t that much of a surprise after all?

How Should Accountants Count their Beans?

A month or two ago, I was interviewed for a forthcoming article on how accountants should price their services. Here’s a sneak preview of my response, which should appear in the October edition of “Public Accountant” magazine.

Q: Accountants know about finances, but price setting is perhaps another matter entirely. What advice would you give them when it comes to deciding how to approach setting a price for their service and products (i.e., what questions should they ask themselves)?

A: Many professional services firms (accountants, lawyers, etc.) are under so much pressure these days to stop charging by the hour (which are their inputs, their costs), and to start charging for the outputs or value they provide. To do this, Accountants and their clients need to understand that they are not an expense, but part of a value creation process. There are four categories of questions accountants will need to ask themselves and their clients if they are to move towards a value-based approach to pricing:

1. What sort of client am I dealing with? Are they a price buyer? Are they a value buyer? Are they a relationship buyer or are they a Poker Player? Each respond differently to a vendor of services: there's no point trying to sell a price buyer value-added services, for example. They are only interested in the cheapest possible price!
2. Secondly, work out what the value of the services you will provide are to the client: what the end result or deliverables look like. Accountants (or anyone for that matter) do not know what this is, because value is in the eyes of the beholder (i.e. the customer). In general, there are three sources of value: an increase in the clients revenue, a reduction in their expenses or a minimisation of their risk, all of which can be quantified, and your pricing shares in that quantified value;
3. What processes do I need to complete to provide this value, to achieve this end result or deliverable (e.g., do I need to obtain a private ruling for the client?);
4. And finally, what inputs do I need for those processes and deliverables (resources, people, data, etc.)

Q: What steps should an accountant put in place when raising prices to minimise any client loss?

A: There are a couple of things worth thinking about here:

1.     Tell the customer upfront of any price changes (not after you've done the work for them); 

2.     If you're in a very competitive marketplace, announce the price change in advance to give the competition time to respond;

3.     Explain why you are increasing prices (and don't blame it on costs – clients don't care what it costs you to run your Audi or to rent your office. They care about the value they receive, not your costs).

4.     Always offer choices (e.g. a small, medium and large alternative) each at different price points. The client then thinks "which one do I buy?" rather than "do I give my work to this firm?"

5.     Don't implement across-the-board price increases. Price increases in many industries these days are more "laser guided missiles" than "carpet bombs". Some customers / segments may take a greater price increase, others customers / segments a smaller increase.


Q: Can you briefly explain the difference between time-based and fee-for-service pricing models, and the advantages/disadvantages of both? 


A: Time-based pricing, as I touched on earlier, is where a client is charged on the basis of hours worked multiplied by an hourly rate. The advantages of this approach are that it is simple, every one understand it, it works regardless of the type and volume of the work being performed for the client, and your can put the question of "what value am I providing?" in the too hard basket.

But there are huge disadvantages including it is inefficient (not all hours of the day are equal in value), it undermines customer relationships, customers get invoice shock, administration queries increase, the client perceives the professional service firm to be acting in self-interests rather than their interests, and there is also evidence of high levels of depression and substance abuse in industries where the billable hour dominates.

Fee-for-Service is where you charge (preferably a value-based) fee to deliver a particular service, perhaps best illustrated by an example: a financial plan for a client under a fee-for-service model would be (say $2,000. Under time-based pricing, it might be $200 an hour. This illustrates one of the key advantages of fee-for-service: the client knows what they are going to be paying. They don't under time-based pricing.

There are many other advantages and disadvantages, many of which are the converse to those mentioned above for time-based pricing.

How to Grow Your Pricing Capabilities as Your Grow Your Business

Any business owner that has come into contract with a marketing book, consultant, or has attended some sort of marketing course, will probably have been introduced to the concept of the “product life cycle”.

Over time, products move through various stages: firstly, there is development and launch. Assuming that stage is successful, the next period is one of growth, which is then followed by maturity and finally (but hopefully not), decline.  

In many industries, these product life cycles are getting shorter and shorter. Pricing strategies that maximize revenue, profit and the business owners’ return on investment across all stages of the lifecycle are therefore critical.

In this article, I’m going to discuss six pricing tips to help your business during this growth phase, a period during which, as customers become more familiar with your products and services, their price sensitivity tends to increase as well.

1.    Analytics

Not only is good data (converted to analytical and informative information) vital for several of the tips that follow, there is also another reason that it cannot be ignored.

It is fair to say you can’t believe anything that customers tell you, about half of what you see them do, but almost everything your sales data says they’ve done.

In industry after industry, the days of across-the-board price increases are disappearing or long gone. Today, business owners need to be firing laser-guided missiles, rather than carpet bombs, and good quality data and analytics is the key to finding hidden pricing opportunities.

2.    Segment your customers and your products

The range of products offered by companies tends to expand during the growth phase, and so too does the number and variety of customers.

Now that you’ve got a good grip on your data (See Tip 1), you are now in a position to segment your customers, not into “warm and fuzzy” general descriptions, but into actionable segments of customers who share similar demographic, firm-o-graphic and price sensitivity characteristics.

But don’t just stop with segmenting your customers: smart companies today, especially those with a broad product portfolio are also segmenting their products. Zara, one of the most innovative and devastating retailers in the world (according to LVMH), segments its products into one of three categories, ‘Classics’, ‘Fashions’ and ‘Trends’, each with their own respective pricing strategies.

3.    Use Gamification & Behavioural Economics

Fast fashion is not the only industry that has witnessed an explosion of choices in recent years. Walk down any supermarket aisle and look at how many different types of toothpaste, hair care or bakery products there are today. At any one time, there are thought to be over 1,000 mobile phone calling plans available in Australia.

By offering choices, the decision for the customer changes from “do I buy from this vendor?” to “which one do I purchase?”

Strategies drawn from Gamification and Behavioural Economics, where you ‘nudge’ customers towards your most popular product, or the product best suited to the customer, can help you “move more product”. For an extreme example of Gamification strategies, check out the website HumbleBundle.com

4.    Challenge Industry Norms and Conventions

Businesses in growth mode shouldn’t be afraid to challenge industry norms and conventions, particularly when it comes to Pricing. One such convention existed in the pharmaceuticals industry, where the norm was that a fledgling drug should be priced 10% below that of an incumbent.

When GlaxoSmithKline launched its ulcer medication drug Zantac several years ago, it did so at a 50% price premium over the incumbent. The company realised the new drug provided more value to customers than the alternative (smaller dosages, fewer side effects), and a price premium was warranted (and successfully obtained).

5.    Offer a Choice of Pricing Models too.

There is no rule that says you should only have one pricing model. By offering your product(s) under two (or more) pricing models, you can significantly expand you customer base.

Many software packages can be sold using a traditional licence pricing model, as well as on a pay-for-performance basis. Aircraft jet engines manufactured by the likes of Rolls Royce and GE can be sold to airlines, but are more commonly rented to them today on “power by the hour” contracts.

6.    Focus on Value and Outputs, not Costs and Inputs

One of the attractions of “power by the hour” contracts is that they are focused on the outputs and the value the customer receives, rather than costs and inputs associated with you manufacturing a good or providing a service. Look at it from the airlines perspective: they are only charged for the engine when the aircraft is in the air and earning the airline revenue.

The development of such Value-Based Pricing models during the growth phase will help sustain your business during the maturity phase of the product life cycle. It doesn’t matter what industry you are in, from professional services to manufacturing, your customers don’t care about what “it” costs you. They care about the value they get from your product or service.

The growth phase is an exciting period for business owners, and one where optimal pricing strategies can set your business up for long term success. The key is to think of your prices, not as a cost or an expense to your customers, but an investment in the creation of value in their business.