Sunday, February 02, 2014

What a Couple of Blokes Learnt About Pricing...

Enjoying some Kirin Special Lager and Pilsner Urquel (a Czech beer), I recently joined @sportsgeek (aka @seancallanan), @joshrowe, @shortbatch (aka @scottkilmartin), and later @mrjamesnoble, to record an episode of Beers, Blokes & Business on the topic of pricing.

Like any good pricing discussion, the recording only touched the surface of this huge topic. So the blokes asked me to pull together a summary of the key lessons and take-always from the podcast. Here goes...

1.     All Value is Subjective
This may come as a surprise to some, but the value a customer gets from a product or service is not determined by you. Value is subjective and is determined by the customer. Take private health insurance as an example (a product dear to the heart of @joshrowe). The features of a private health insurance policy can include optometry, dental, physiotherapy and the like. The benefits may include $800 of coverage or claims. Both features and benefits are determined by the private health insurance provider.

But ask consumers what they value in a private health insurance policy, and you'll get answers such as "piece if mind", "I get out of the public health system" or "I can get back to work or normal life quicker". What one customer values can differ from what another values, and this will be reflected in what they are prepared to pay for a product or service.

2.     All Pricing is Contextual
The good news is that you can help shape that value because all pricing is contextual. Take a look at the YouTube video for the Wicked Sick Project above.

A couple of guys buy a BMX bike on eBay for $27.50. They do nothing at all to the bike, other than put it back on eBay with a much better description, and the bike ends up selling for $134.50. All they did was change the context, and they got a higher price.

3.     Offer Customers Three Choices
You should always offer customers three choices (think "Small, Medium, Large" or "Good, Better, Best". Here's why: If you offer customers one option, they either buy or they don't. You have a 50:50 chance of closing the sale. If you offer customers two choices, you are putting them in a position when they are making a price-based decision.

But if you offer them three choices, you are forcing them to make a value-based decision. In fact, customer often think to themselves "which one do I buy from this vendor?", rather than "do I buy from this vendor at all?"

4.     WTF (in laymans terms) is Price Elasticity?
Scott McNealy, former CEO at Sun Microsystems, once famously said "Pricing [is] confusing to us too. In the whole history of Sun, we have never known what demand is, what elasticities are, or what the right prices are for our equipment".

Put simply, price elasticity is the ratio of the percentage change in sales volume as a result of a percentage change in price. Sounds simple enough, but for many companies the complications arise from factors such as not having data at a product level, or at a customer level, quantifying non-price impacts (e.g., did an advertising campaign affect sales volumes), and given that these calculations will be performed on historical data, do the calculations yield long term or short term elasticities and will they apply to future sales. These are just some of the reasons why price elasticity is like the abominable snowman: no one's really sure if they've seen it or not.

We also received a couple of questions on Twitter which we didn't have time to address during the recording. One of the other blokes, @jimboot, asked "when should you raise prices?" Most companies, because they tend to adopt cost-plus pricing, think the answer is when your costs increase. The problem is, customers don't care about your costs. They care about the value you receive.

That means changing prices when you add more value to what you sell, when there is a change in the competitive landscape (eg a new entrant, a merger or acquisition), when there is a major technological break-through in your industry, when a key business process is outsourced and even when a recall or safety warning in launched.

@DarrylvanRooy though a more interesting question is not when to raise prices, but how? My recommendation is to be honest and open with customers. Look at what Netflix is doing in the US at the moment. They've told the press they are looking at their pricing, and it's got so much media coverage, that you'd think they had already implemented the price increase. The market is certainly conditioned for the price increase...when it eventually comes

As I'm sure you'll discover when you listen to the recording, there's more to pricing than just setting a price, crossing your fingers and hoping someone pays. Feel free to contact me if you'd like to discuss any other aspect of pricing not raised in the podcast.