The lost art of raising prices

For many years, as inflation was low, corporate gains in efficiency, cost cutting and outsourcing exercises made it possible to maintain or increase dollar-for-dollar profitability. Unfortunately, under current economic conditions, this is no longer possible. Amidst a rise in inflation, the cost of raw materials, and the cost of transport and energy, companies face, for the first time in many years, the dread of increasing their prices.

• Sales people dread price increases because they forgot how to defend them a long time ago. And as their customers are no longer accustomed to “the annual price increase”, sales people believe they will face strong resistance.
• Executives dread the price increases because they think their competitiveness will suffer.

But there are several positive aspects of price increases.

Share price:
For example, yesterday, Chemtura Corp., a global producer of specialty chemicals and polymer products announced a price increase of approximately 15%. The result – shares immediately gained 2.8%, and have continued to raise today.

You deliver results:
Furthermore, your customers are doing business with you because you deliver results. Your product or service provides value to your customers, and the vast majority of your customers want to continue to do business with you. They want you to take care of your business so they can continue to gain value from what you deliver to them.

Stronger customer relationships:
Announcing a price increase also gives you the opportunity to remind your customers about the value you provide, and have provided for a long time. And, by telling customers all the things you’ve done to avoid price increases until now, your relationship can grow stronger. But this is a message your salespeople are not used to delivering, and they will need the right ammunition and training to do so effectively and successfully.

Revisit your pricing strategy:
As you revise your pricelist, it is also a good idea to look for methods through which you can tweak your prices in such a way as to drive customers to buy more profitable products or services from you -- ways in which you can change the product mix you are selling to become more profitable overall.

So there are several aspects to a price increase – and when it comes down to it, they are mostly positive. But a successful price increase needs to be carefully planned; salespeople need the appropriate training and you need to ensure you plan thoroughly to convert the looming price increase into a positive opportunity for your company to gain further profitability.

With warm summer regards,

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

Update on Dell and Apple - Drop your margin 3% and lose $14b!

I thought it is appropriate with a update on my Dell and Apple story from July 22. See below.

Dell on Thursday reported a fiscal second-quarter profit of $616 million, or 31 cents a share, on $16.43 billion in revenue. During the same period a year ago, Dell earned 33 cents a share on revenue of $14.77 billion. The result was an immediate -1.8% drop in share price.

Per Sjofors

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

A shrink for your pricing?

The other day I started a book by Peter Jenkins called “A walk across America”. It is about Jenkins who, as a young disillusioned man, in a post-Vietnam, post-Woodstock era, sought to find himself during a coast-to-coast soul-searching walk together with his dog.

It is an old book, first published in 1979.

Jenkins does not just take off; he prepares meticulously, he exercises, he talks to other people with experience from ultra long walks, and he carefully plans the equipment he will need to carry as he walks from upstate N.Y. to California. It is with his preparation where this story connects with pricing. Jenkins, with very limited funds, says that he selected one brand of tent, backpack, sleeping bag and so forth, because “There were more expensive companies, but this was the best I could afford”.

Thus, what Jenkins demonstrated was one of the cornerstones of value pricing and pricing psychology. He believed that the price of the goods he needed was directly correlated to the “bestness”; in his case the comfort, quality, durability and weight of the product. The higher the price, the more “bestness”.

While in many cases there are correlations between price and “bestness”, this correlation is not certain, linear nor exact. It could well have been that a different brand, 15% less costly had a better “bestness”, that a brand, at the same price, or maybe 10% higher was twice as good, or half as good. In fact, the book explains how Jenkins made the brand decisions primarily from reading catalogues. He based his value perceptions solely on the marketing messages of the various brands. Thus, he selected a brand based on its messages and his derived perception of its value The basis of his choice was the perception of “bestness” these messages inferred, rather then the actual “bestness” of the product. In the end, however, the products met his expectation, he was a happy customer, and we cannot know the true facts on how these products really would stack up.

Another example of the psychology of pricing, this time from Atenga’s case files, is this company that came up with a new and innovative nail-gun. The nail-gun could be used by DIY homeowners and professionals; construction workers. The company had initially priced the product at $172; it was a price taken out of thin air, but the management team all felt was “the right price”. In fact, it was higher then the assumed price used in their financial plans, so their business plan numbers looked better then everybody had hoped. The product is a true innovation and does not have serious competition, and the company had a good PR agent. So they were rather well publicized in newspapers and magazines for both DYI folks and professionals. Yet, the business was just not going anywhere.

Just as the example of the camping equipment, where Jenkins believed (as do most of us most of the time) that he price of a product is a good indicator of its quality, its “bestness”, so did the customers of the nail-gun. There are ways in which price specific market research accurately can assess the optimum price for a set number of attributes, a set quality, a set “bestness.” In this case, research showed that professionals said that the price of the device was much too low. They said that it was “too cheap – can’t be any good.” Thus, the price of $172 was to them a message of inferior quality. In fact, research showed that any price less than $205, would indicate to a majority of prospective professional customers that the product must have inferior quality and not be worth buying. This same research showed that at $288, the product would be too expensive, and the benefits it provided would not be worth the price. The optimum price for this product was $242. At that price, the majority of prospective buyers said that the product met their payment expectations, and the business took off; it generated a 40% increase in sales volume in only two months.

So what do we learn here? Well, we learn that the price of your product or your service is also part of your marketing mix, just as communicative and just as important as your marketing messages, and your positioning statements. Your pricing must all be congruent and relevant for the marketplace you have selected. In the case with the nail-gun, the marketing messages of the company built a value and expectation of price that the $172 price completely disrupted, also disrupting the buying process, and left the company struggling.

But this also means that you can affect the marketplace’ perception of value, perception of “bestness” and therefore their willingness to pay - many times without changing the product! The better you understand the psychology behind your customers’ purchasing decisions the better you can influence the perception of value your marketing message builds, the better you can increase the congruency in the marketing mix and the better your company will perform. Many companies, unfortunately, forget that price is part of your customer communication; it can communicate value, "bestness", or the lack thereof. The choice is yours. You need to, and you can, take control of price as part of your marketing mix. You need to understand the psychology of pricing for your company, your product or service, and for your marketplace. Be the pricing shrink! Enjoy!

With warm summer regards,

Per Sjofors

Founder, Managing Partner

Atenga Inc

www.atenga.com

Yield Management System Crashes Airline Industry

Being a very frequent flyer (several hundreds of thousands of miles flown every year for the last 30 or so years), I cannot help but to follow the woes of the airline industry. Unfortunately, I do this with some considerable amount of schadenfreude – they did it all to themselves!

Hailed at the time as the industry savior, the yield management systems of the mid and late 80’s provided a significant, but relatively short-term, revenue and profit boost. After a while, it completely commoditized their offering and drove profits deep into negative territory. Even before 9/11, airlines were in financial trouble. The consequent recovery (supported by dips into chapter 11, in many cases) was only temporary. The ongoing deterioration of the industry is just hastened by the current oil price shock. America Airlines' then-CEO, Robert Crandall called yield management “the single most important technical development in transportation management”. How, then could it be the most significant reason for the current industry problems? Well, here is why:

Yield management systems change the price of the airline seat based on the number of seats available. So, the simplified theory is that, say, 3 months before a flight, when there are many seats available, so the price per seat is low. As the plane fills up, the price of a seat increases. If sales of seats are slow, prices are kept low to increase demand. If there are still unsold seats near the date of departure, those seats are discounted heavily as, in the view of the airlines, at that point, every dollar is a good dollar. This sounds like a good theory, and it is, except for that little nagging fact the airlines forgot; they are transporting humans, not cattle, not pigs, not chickens, not packages, but people – people with the ability to think and to change behavior based on experiences and external inputs.

I’m sure you, the reader, have been seated with somebody paying a fraction of what you paid, for exactly the same uncomfortable, crammed seat with lousy service. Or maybe it was you who sat with me and bragged about your bargain ticket, 70% lower than what I paid! Thus, it did not take very long for travelers to be thoroughly trained by the airlines to exploit the theory and shortcomings of yield management systems. Because airlines offered no meaningful differentiation between themselves and between a cheap and expensive seat, passengers shopped around for the best price only; found the cheapest airline, regularly booked their flight earlier, or, if their schedule were flexible, they waited to the last minute. (Meaningful seat differentiation could possibly be: the cheap tickets are for the back of the plane, mid seats only, expensive seat in the font with extra legroom and a free drink - only consumer market research could find out.) The advent of the internet, with easy price comparison and ticket auction sites further accelerated the commoditization of airline seats to the point that no airline made any money on any flight (with a few exceptions).

So transposing this scenario to other businesses, what can be learned? The key words here are “meaningful differentiation” and “every dollar is a good dollar”.

If you are in an industry where your customers meet and talk, you cannot sustain a policy of selling your product or service to different customers at a different price unless there is “meaningful differentiation”. This means that you must be providing something meaningful, or valuable, to those who are paying more and not providing it to those who are paying less. When I say “meaningful”, I mean meaningful to your customer, and not necessarily to you.

Furthermore, the notion of “every dollar is a good dollar” must go away – even if you are in a commodity business with high fixed cost (like the airlines), you must keep firm on a cost based floor under which you will not sell your product or service. If you (like the airlines), train your customers that they can buy at pathologically low prices – they will – and your business will enter a death spiral from which recovery is almost impossible. The trick for you is to de-commoditize your offering, and find segments of your marketplace where you can add unique value and be meaningfully different than your competitors.

Warm summer regards,

Per Sjofors
Founder & Managing Partner
Atenga, Inc