As we enter a recession that probably will be long and deep, smart companies fight back with - pricing!

Many companies feel the need to improve their “competitiveness” in a downturn, and they think the best way to do so is to drop their prices. Wrong! Sure, in a recession your sales will drop, but if you also drop your prices, your contribution margin will drop even further, making your company less profitable and possibly resulting in a loss of profitability altogether. If you do, it means you have given up, and taken the easy road. You need to fight back. You need to utilize the recession as a way to improve your long term business results. Pricing champions do!

Pricing champions find ways to increase their prices, or increase their price realization. They fight back. They become even more successful and they increase their competitiveness by adding cash to their war chest, and improve and invest in product and market development.

Let’s take a look at two price champions:

Dow Chemicals, one of the largest chemical companies in the world, reported Q3 revenues that where up 13%, while volume went down 9%. In anticipation of the recession, the company increased prices by an average of 22% across the board.

Here is what Andrew Liveris, chairman and chief executive said:

“The company's ability to take protective measures has helped the company ward off the effects of the current economic downturn. The company has initiated two broad-based price increases and implemented aggressive cost controls.”

Dow is not giving up. They planned for the recession and they used pricing as a strategic weapon for that purpose.

The second pricing champion is a relatively unknown company called Parker-Hannifin, a diverse manufacturer and number 279 on the Fortune 500 list – probably the largest company people haven’t heard of. On October 16th they reported last quarters’ results - a 10% increase in sales over the previous quarter, and a 9% increase in profitability compared to a year ago.

So let’s see why. Here is what Timothy K. Pistell, EVP, CFO said in the prior earnings call, July 31, 2008

“Part of our “Win Strategy” is strategic pricing. We think we have done a very good job through this last fiscal year. The fact is that the gross profit margin improved in ’08 over ’07. Right now, we forecast our price increases will stay on pace with our cost increases.”

What they both have in common is that they do not drop their prices in a recession. They plan for price increases and cost control. They don’t give up. Certainly, they see a recession as a difficult time, but, they also realize that these difficult times are what weed out the long-term winners from the losers.

So you have a choice. You can follow the lead of the pricing champions, and use this economic downturn to your advantage or you can give up. What will you do? What long-term effect will strategic pricing have on your business? What will you do with all that extra profitability?

Again, the choice is yours.

With positive and "do-the-right-thing" regards,

Per Sjofors
Founder, Managing Partner
Atenga Inc
www.atenga.com
per@atenga.com

The AppStore, a microcosmos for understanding price elasticity

On a number of technology blogs, a bit of grumbling has started over the price of software bought from Apple’s AppStore. So let me just explain what this is.

I’m sure you are aware of the iPhone, one of the hottest consumer electronics products in the last 12 months. About a month and a half ago, Apple introduced an updated version of the product, the iPhone 3G. As the phone is basically a small portable computer, Apple also introduced what they call the AppStore, a section of iTunes where iPhone users can download small software applications. The AppStore has been a huge success, with hundreds of these iPhone applications available, selling more then $30m worth of software in the first month despite the fact that a majority of the apps are available for free.

Each developer set his or her own application price, or decides to give the app away for free, though most chargeable apps sell for $2.99 – $9.99. And on various technology blogs, I'm starting to hear about one of the world’s most common pricing mistakes. Developers are complaining, to whomever wants to listen, saying things like “I used my gut feel to price my app at $9.99 and it did not sell very well, so I dropped the price to $2.99 and sure I’m selling more but I’m getting less revenue”. This is a classic example of the perils of price elasticity. Price elasticity is a fancy name for how the demand of a product or service changes with the price. If the demand changes little with the price, then the price elasticity is low (or inelastic); if it changes a lot, price elasticity is high (elastic).

Once the elasticity curve is known, it is easy to generate a revenue curve. The revenue curve points out the best or optimum price, where the combination of price and demand generates the maximum revenue. If your market is elastic, and most markets are, selling your product at the optimum price point is crucial for the business results of your company, and can easily mean the difference between market leadership and marginalization.

These AppStore developers have a very unique advantage in the way they can discover the price elasticity curve for their product by simple trial and error. An advantage virtually no other company has. They sell software, so revenue max is also profitability max, they promote their product to a “closed” marketplace as they only compete with other software companies in the AppStore, and they can change the price as often as they wish.

So an AppStore developer can start with a price of, say, $9.99, wait a month, note the demand, change the price to $6,99, wait a month, note the demand, change the price to $4.99, wait a month note the demand and so forth. After plotting 5 to 6 demand points, all with prices taken out of thin air, it will be easy to set the optimum price, the price that will give the developer maximum revenue and profits. Of course, during this process, the company is losing revenue; leaving money on the table to define the lower-than-optimum demand points and forsaking sales volume to define the higher-than-optimum demand points.

Any company can do the same. Whether you are selling farm equipment, data storage, shovels, or boxed software the process is identical, but, because you don’t have the advantages of easily changing your prices on a platform like the AppStore, the process will be longer – probably a few years. And chances are that by the time you are done, your marketplace will have changed so much it will be time to start the process all over again. Not to mention that in the process, you will give up millions in lost revenues and margin.

So when you priced your product, did you use some combination of “gut feel”, “I know exactly what the market will bear”, or the all-too-frequent “our cost plus x % markup”? If you did, what are the chances that by sheer luck you will hit the optimum price point? If you were one of the very few who found that price point by luck, you probably have revenues beyond your wildest dreams. But if not, chances are much higher you are struggling to meet the numbers. If your company is like 99% of companies out there, you can easily gain 10% – 20% in revenue, double your growth rate, and double profitability by knowing the price elasticity of your product, and optimizing your price accordingly. Think about it. What would price optimization mean for your company?

And if experimenting with different price levels and seeing how they affect demand is not a realistic possibility at your company, as the cost in lost business is too high, how will you be able to define the optimum price?

With warm summer regards,

Per Sjofors
Founder & Managing Partner
Atenga Inc
www.atenga.com

Tivoli Radio: Sweet Sound, Steep Price

There is a great pricing story that I ran across at TheStreet.com today. For those of you who are not familiar with TheStreet.com, it is a website for financial news and investment advice, and, as with many other publications of its ilk, it also covers topics like life style and technology.

Gary Krakow is TheStreet.com’s senior technology correspondent, and today he wrote about the Tivoli Internet radio. Tivoli Audio has been around for only a few years, but entered this fledgling market with a great pedigree – its founders are legends in the higher end of the home audio industry.

So the story is about this Tivoli Internet radio and what Gary is saying is that it is darn expensive – and worth every penny! In addition to this Internet radio, Tivoli sells a range of tabletop radios and music systems. None of them are cheap. So what Tivoli has done is to monetize its pedigree, to provide products with a perceived value higher than other tabletop radios and tabletop music systems and price them higher as a result. A quick web search shows that the Tivoli Internet radio costs two to three times more than other similar products, yet, according to Gary, it is worth the extra expense. So let’s expand on why that is so.

Firstly, it is likely that experiences of the founders of Tivoli ensure that the product exceeds the actual quality of other products in the category; it may be better designed, better built and may use higher quality components. Secondly, the price of a product is part of the marketing mix and the messages the company communicates to its prospective customers. Thus, the higher price causes the customer to expect a higher quality, better product, something that Tivoli can deliver on. But, as pricing also drives the perception of value, the psychology of pricing says that the customer of the premium product are more likely to be satisfied with his or her purchase. For as simple a reason as paying the premium price, they come to expect a premium experience. And where it gets interesting psychologically, is that regardless of the actual quality, many times the customers will convince themselves they have had a premium experience – resulting in high customer satisfaction.

Thinks about how you communicate with your customers and how your pricing fits you’re your overall message. Also think about how you can leverage the psychology of pricing for your company. What messages can you deliver to your customers that increase their perception of value, that you can then capture in pricing actions to increase your profits?

For those who like to read the article here is a link: http://www.thestreet.com/story/10430699/1/tivoli-radio-sweet-sound-steep-price.html

With warm summer regards,

Per Sjofors
Founder, Managing Partner
Atenga Inc
www.atenga.com

Drop your margin 3% and lose $14b!

Apple Inc. (NASDAQ:APPL) is a price champion. It provides products that, while really being commodities, command higher margins and higher prices than any other computer maker. Apple never sells on "low price" and never discounts. Instead, Apple relentlessly works with its marketing and messaging to increase the perception of value of its customers, and in sales, to capture that higher perceived of value. With higher perception of value comes higher prices and higher margins.

Yesterday, however, Apple announced an unspecified product transition for the next quarter, indicating that its average margin will drop as low as 30%. Compare this with 33% in last quarter. As a result, shares dropped around 10%, shaving $14b of its market cap, but are now recovering slowly.

Then consider Dell (NASDAQ:DELL), who focuses all its marketing on the "low price, value for money" value. Dell operates at a 5.4% margin.

The consequence of these vastly different strategies is that Dell has revenues 2 1/2 times that of Apple, yet, the company has a market cap roughly one third of Apple’s! ($47b for Dell vs $134b for Apple).

Nearly every business faces these same choices. The company can be a value brand (Dell) or be a premium brand (Apple). The premium brand always has a higher valuation, but it take a concerted corporate effort to get there; to know and leverage customers value perceptions, to know how to build value in marketing as well as design, development and sales, to make the effort to learn their customers’ willingness to pay, and to optimize prices accordingly. Apple is doing a spectacular job of this - even after the coming slight margin decline.

Think about it - even if you are in a different industry you must choose your mindset and execute it relentlessly. Do you have the Apple or Dell mindset? What will it mean for your shareholders?

With warm summer regards,

Per Sjofors
Founder, Managing Partner
Atenga Inc
www.atenga.com