A growing number of companies are using “dynamic” pricing

Schumpeter: Flexible figures.  as printed in The Economist Jan 30, 2016

chameleon

 

A growing number of companies are using “dynamic” pricing

IF A cynic is someone who knows the price of everything and the value of nothing, as Lord Darlington observes in Oscar Wilde’s “Lady Windermere’s Fan”, then it is getting progressively harder to be a cynic. A growing number of companies keep their prices in a constant state of flux—moving them up or down in response to an ever-shifting multitude of variables.

Businesses have always offered different prices to different groups of customers. They offer “matinée specials” for afternoon cinema-goers or “happy hours” for early-evening drinkers. They offer steep discounts to students or pensioners. Some put the same product into more than one type of packaging, each marketed to a different income group.

Dynamic pricing takes all this to a new level—changing prices by the minute and sometimes tailoring them to whatever is known about the income, location and spending history of individual buyers. The practice goes back to the early 1980s when American Airlines began to vary the price of tickets to fight competition from discounters such as People’s Express. It spread to other airlines, and thence to hotels, railways and car-rental firms. But it only became the rage with the arrival of e-commerce.

The price of goods and services sold online can be varied constantly and effortlessly, in accordance with the numbers and characteristics of those making purchases, and factors such as the weather. Competitors can be monitored constantly, and their prices matched. Amazon updates its price list every ten minutes on average, based on data it is constantly collecting, according to Econsultancy, a research and consulting firm.

The practice is spreading to physical retailers, which are installing electronic price displays and borrowing pricing models from e-retailers. Kohl’s, with nearly 1,200 stores in America, now holds sales that last for hours rather than days, pinpointing the brief periods when discounts are most needed. Cintra, a Spanish infrastructure firm, has opened several toll roads in Texas that change prices every five minutes, to try to keep traffic moving at more than 50mph (80kph). Sports teams, concert organisers and even zookeepers have embraced dynamic pricing to exploit demand for hot tickets and stimulate appetite for unwanted ones.

The dynamic-pricing revolution provides plenty of benefits for businesses. Besides helping them smooth demand (which can spare them the cost of maintaining extra capacity for peak times), it makes it easier for them to squeeze more out of richer customers. Travel websites have experimented with steering users of Apple computers—assumed to be better-off than Windows PC users—towards more expensive options. Airlines have been caught charging loyal travellers more for a ticket than infrequent travellers, on the assumption that they are more likely to be on a work trip, so their employer will probably be paying. The technology is far from perfect: ever since buying a coffee machine online your columnist (who is not good at newfangled tasks such as clearing browser cookies) has been inundated with offers for coffee machines, as if the purchase was proof not of a need that had been satisfied but of an insatiable desire.

Even if the technology becomes more sophisticated, there are two risks for businesses with dynamic pricing. The first is psychological resistance: companies’ reputations can suffer if they offend customers’ sense of fairness. Uber encountered a backlash when it increased its prices eightfold during storms in New York in 2013. Such “surge” pricing makes perfect economic sense: drivers are more likely to go out in hostile conditions if they get paid more; and many customers would prefer a high-priced ride to no ride at all. But these arguments cut little ice when prices run counter to people’s sense of equity. So, in this week’s snowstorms in New York, Uber capped its surge prices for its regular taxis at just 3.5 times the normal fare.

Psychological resistance can be fierce when companies use data collected from their customers to charge them more. That is why, in 2000, Amazon quickly dropped a scheme to charge some customers more for DVDs based on their personal profiles, and why it has trodden carefully since. Customers are learning to play the game. Some are searching for flights from an internet café instead of their living-rooms, to get lower fares. Others are piling goods into their online baskets and then failing to click “buy”, hoping this will prompt the seller to offer a better deal.

Price-fixation

The second risk with dynamic pricing is that it ends in a race to the bottom. Companies that sell online have long been caught up in a war for the top slot on price-comparison sites: even being cheaper by a penny can make all the difference. Physical retailers are being caught in the same logic: those adopting dynamic pricing are mostly doing so to avoid being turned into mere showrooms by customers who inspect the goods but then buy online. The Nebraska Furniture Mart constantly watches what competitors such as Amazon and Best Buy are charging, and updates its in-store electronic displays each morning to meet its guarantee of offering the lowest price. This is obviously good for customers. But getting fixated on prices can distract businesses from seeking ways to make their products and services so attractive that customers will be less fussy about their cost, as the most successful purveyors of luxury items, from Ferraris to Hermès scarves, do.

The oldest form of dynamic pricing was practised in ancient bazaars, where merchants would size up their customers before the haggling began. Those retailers might not have been able to compute as many different variables as today’s algorithms. But they still have something to teach today’s dynamic pricers about the importance of establishing trust and playing on desire. Cynical as it sounds, to understand a customer’s underlying willingness to part with their money you need to pay a good deal of attention to values.

SQUARING THE CIRCLE

SQUARING THE CIRCLE: Consumer Choice and Consumer Segments

square peg

I have been reading about market segmentation and choice. Howard Moskowitz’s research into tomato sauce as retold by Malcom Gladwell on the TED talks led to a big increase in sales by Prego.The company added new varieties to its lineup of sauces – chunky, garlicky, mushroom, and saw a big jump in sales.(http://www.ted.com/talks/malcolm_gladwell_on_spaghetti_sauce?language=en  Moskowitz’s conclusion was that consumers are not one great monolithic entity with one taste in tomato sauce. Therefore, the company needed to offer more varieties and in so doing dug deep into the market.

But merely offering lots of choice leads to lower sales. In Terry O’Reilly’s CBC Radio programme, Under the Influence, (http://www.cbc.ca/radio/undertheinfluence/limited-edition-brands-1.3021076) Terry recounted a test marketing of jam. When consumers were offered dozens of varieties and even inducements, like coupons, sales were still less than where consumers were offered limited choice. It seems that our human brain cannot cope with too much choice. Too much choice causes us to walk away shaking our heads.

How can we square the circle of too much choice simultaneously increasing sales and killing sales?

The companies that have been successful in adding choice already have a market presence. Reebok introduced its soft leather dance shoe in 1982, but gradually offered tennis shoes, basketball and then children’s shoes. There was a time lag as Reebok built its brand and consumer awareness of the benefits of supple leather footwear. Introduced all at once to the market, it could have been hard to sell a monolithic idea to a splintered group of people with altogether different needs and tastes. We are not all the same and so we all do not need the same product.

So how is it done? First create a presence in the market for 1 product or service that is the best or suits your target market the best. Dominate your market. Like the pub in the sitcom, Cheers, Everyone Knows Your Name. This is brand creation. Offer limited choice in that product or service. If you are offering more than 3 or 4 choices, trim. Only when you have some significant market share (you are measuring your market penetration, right?) can you start slowly adding other related versions to the original idea. Even after marketing leather shoes to dancers, Reebok is still best known for…  running shoes.

WHY DON’T SCHOOLS TEACH BUSINESS HOPEFULS TO USE CASH FLOW TOOLS?

Gallery

This gallery contains 1 photo.

Imagine a business, if you would, that shows decent margins, low debt, and slowly growing sales. Bankers examine the financial statements declare that the company is in good shape. “Carry on and keep up the good work,” they say. But … Continue reading

Results Based Pricing for Professionals

I have just read an article from November of 2013 (Managing Partner, published in New Zealand) about pricing for professionals. When surveyed about how they charge, most professionals shrug and admit that they charge what everyone else charges. It has reminded me to put value and choice at the very top of the list of how to devise winning pricing strategy that will increase profits.

shrugPricing professional services is a big problem for lawyers, accountants and anyone selling services. Professionals deal in results, but they charge for effort. The easy route is to charge by the hour but that makes it easy for a potential client to compare apples to apples. AB charges $125 per hour. BC charges $250 per hour. Therefore, AB is the best buy. But is that true?

So, would you buy a house based solely on price? House F is small, rundown, needs a roof and is in the middle of a rough neighborhood. It is listed for $229,000. House G is much larger and in a nice neighbourhood. It is occupancy ready and most importantly, your wife likes it. But its list price is $400,000. Which house has value?

In order to place value on a service for hire, the trick is to comprehend that the customer does not care about the amount of time, effort and sweat you expend. They want results. And what is the result they want? Do you ever ask? Where will the customer place the most value? Speed of service? Accuracy? No jail time? Or will  they respect the weekends you spent on their file, the late nights and the cost of years of schooling?

So we establish, state and then highlight the value on the table, first, right? But now what?

In order to get your price, though, you must offer choice. Like Goldilocks , the choices must be few- not too high, not too low and just right. Choice in pricing will allow you to take clients and customers with all kinds of budgets and thickness of wallet, without discounting. The platinum package will have the largest assortment of bells and whistles. The gold package has fewer bells and only one whistle but has a lower price tag. The workmanship is still present, but the results are fewer. The bronze package is the budget offering with the lowest price and the fewest bells and no whistles at all.

Want to be more profitable? Be brave and get a better pricing strategy.

Exiting your Business with a Barrelful of Money

 

How to Super-Size the Cheque the Buyer will give you.

With the baby boomers reaching retirement age, a large number of companies will likely change hands in the coming years. Right now, 20% of small businesses are for sale. Within 10 years that percentage will double to 40% and within 15 years that number will rise again to 70%. Kelowna and the Okanagan, being an older demographic are at least 5 years ahead of that supply curve.

soldWhat will be the fate of small businesses when the owners retire?

According to TD Waterhouse’s early October Business Succession Poll of 609 small business owners, only 24 per cent of small business owners surveyed said they had a succession plan worked out for retirement.

Of those polled, whether they had a formal plan or not, 23 per cent said they would simply close their business when it came time to retire; 20 per cent planned to sell their business to a third party; 18 per cent expected to transfer it to a family member; 12 per cent said they’d sell to a partner or employee; and 27 per cent said they were not yet sure what they’d do with their business.

td waterhouse survey

 

 

 

 

And what will be the likely impact on personal wealth?

When you sell to a family member or employee, there are typically fewer dollars on the table, because the company will be heavily discounted.

Closing the doors means zero return for years of business building.

The people answering “not sure” are likely faced with a Freedom 85 Plan, wherein the owner works until he/she can no longer work- and not by choice.

Of course, if the owners salted money away and used the cash flow diligently to build personal assets, then the owners may have enough for a comfortable retirement, allowing them simply to close the doors.

This article, however, is about those who are relying on the sale of their business to fund their retirement and how to find the retirement money they need.

Simple economics dictate that in forthcoming years, supply will exceed demand and many companies will just be left on the shelf as buyers cherry pick the best. But since the beginning of the recession in 2008 many businesses have faced falling sales and increasing debt. This situation has eroded value in many businesses.

So how can an owner stand out from the rest in a crowded bidding war for a buyer? What will buyers pay top dollar for? Investors look for a return on their investment and will not buy indebted companies with falling market share and paper thin margins. Most of all, they will not buy a business that depends entirely upon the owner to make it work.

  1. Is there good return on equity – today, not some hypothetical future?
  2. Does the company have high profit margins?
  3. What fixable factors mean that the business will be purchased at a significant discount to its value?
  4. Are there systems in place for the owner not to have to work 12 hours per day?
  5. What factors will help a buyer get financing from his financial Institution?

If an owner answers NO to any of these questions, then something needs to be done, starting today.

What to do?

  1. Pay for a third party valuation and ask what factors are holding back the value.
  2. Pay down debt, starting with the most dangerous debts
  3. Build tangible assets that hold their value and are essential to the business
  4. Increase profits and cash flow with a better pricing strategy
  5. Increase sales with a modern marketing plan
  6. Create a credible exit plan that identifies to whom you will sell the company and at what price and when.
  7. Talk to a good accountant about the tax implications of your plan
  8. Build a solid 3 year plan to make this happen
  9. Work the plan
  10. Do something, do anything. Remember that even a dead fish can float downstream.

By Andrew Gregson, Senior Partner at Floodlight Business Solutions LLP, a consultancy focusing on rebuilding sales, rebuilding finances and creating value. call today if you need a guest speaker on this topic www.floodlight.ca.

Email: agregson@floodlight.ca                        Ph: 888-959-0752

Innovate, Don’t Ape – How to Survive the Recession

Aside

apeThirty years ago, according to a recent article in the Economist, the bosses of America’s car industry were shocked to discover that Japan had overtaken them to become the largest car manufacturers on the planet. The bosses blamed this success on cheap labour and government subsidies.

But the progressive bosses went to Japan and discovered that Honda and Toyota had raced ahead of them by virtue of a combination of innovation and inspiration. The American manufacturers quickly dubbed the methods of production “lean manufacturing”. This approach to manufacturing was in fact an American idea that was fully developed in Japan and ignored in America. The inspiration was to listen to customers who – echoing today’s demands- were looking for cars that were cheap on gas but still a quality product.

The moral of the story is that if Japan had merely aped American car manufacturers, their car industry would not have thrived. Today’s emerging economies are growing in part on cheap labour but mostly because they have innovated faster than rich countries. Kenya, for example, is the world leader in money-transfer by cell phone. Frugal innovation in the emerging world has created the $3000 car and the $300 laptop. These products were re-designed to eliminate costly steps in the manufacturing process.

The lesson for today’s businesses is an old one. Innovate don’t ape. If everyone else is offering sale priced goods on senior’s Tuesdays, and they are not making any money, why would you want to copy them? If everyone else offers the same burgers, the same landscaping service, the same financial solutions, the same furniture, then, to compete you must drop your prices in order to gain customers.

 In a conversation last week with a manufacturer in Vancouver, the owner told me that his approach during this recession had been a total reversal of the approach in the recession 10 years ago. A decade ago, the company chose to ride the storm and drop prices. This time they cut costs and left prices intact. The result: fewer sales but more cash in the bank.

 So, the question is how to innovate. Can you make your product or service better in some way than is currently offered? Will the change be a gimmick and easily copied by your competitors or can you offer something your competitors cannot?

 Overwhelmed by the thought of what to do? Do you think your business has no room to innovate? Consider this. Water and flour are commodities traded on the world markets on price alone. When mixed together, they ought to produce another commodity. However, this product has over 1000 market niches with prices that reflect not the cost of materials or the taste of this food product, but the shape of the food. I am speaking, of course, about pasta.

This is brilliant marketing to create a market based upon the shape of a food product while everyone else focused on flavour or fast food.

5 keys to profitability – part 1

keysA profitable business is a saleable business. A profitable business is easier to manage and to operate. Everyone loves to do business with probable businesses because they all know the invoices will get paid. The best employees want to work for profitable companies because they know their paycheques will not bounce or get delayed.

Profit is the reason entrepreneurs get into business in the first instance; but how to keep a company profitable is sometimes a trial. Here is how, with the first of our 5 keys to profitability.

Attention to cash flow

Most business owners focus on price and margins forgetting an important element in running a successful business – cash flow. What does this mean and how does it work?

Let us consider for a moment that you are selling loose tea. You pay 1 dollar per kilo for the tea. You sell the tea for $1.50 per kilo giving you a margin of 33%. Monthly you can sell 100 kilos to 100 different customers. So every time you sell one kilo of tea you profit by 50 cents.

At $1.50 per kilo you can sell 100 kilos per month but experiments have shown that by dropping the price to $1.29 per kilo you sell 150 kilos per month to 150 different customers. That generates a margin of 22%.  So every time you sell one kilo of tea you profit by 29 cents.

Most business owners will focus on sales and price believing that dropping the price will increase sales and the sun will shine. But will that reasoning help your profits?

In the first example the cash flow is $50 per month. In the second the cash flow is $43.50. So dropping the price and selling even more tea has damaged the bottom line. In terms of cash flow, increasing the sales with a lower price has not been a good decision.

But if you focus on the cash flow figure, you can also improve profits, as follows. Suppose that you are now selling tea for the sale price of $1.29 per kilo. But instead of selling one kilo at a time, now the buyer must buy a minimum  of 2 kilos. As before, 150 customers come in and buy tea and the margin remains the same at 29 cents per kilo. But this time the contribution to the bottom line is $87. And you did not have to work any harder for that profit.

What this example tells us, is to focus on the dollar contribution and not margins or even the price. Dollars pay the rent, employees and taxes.

Written by Andrew Gregson, Senior Partner at Floodlight Business Solutions and author of Pricing Strategies for Small Business (2008).  1-888-959-0752  www.floodlight.ca. Floodlight Business Solutions, where we help you drive profits.

Thinking twice about price

WHEN bosses promise to make their companies more profitable they usually say they will do so by increasing sales or cutting costs. But a third road to profits is rarely mentioned: putting prices up. Managers often fail to ask how they might do better at plucking the goose to obtain the most feathers with the least hissing. The spiel from the management consultants who advise companies on pricing—whether specialists like Simon-Kucher or giant generalists like PWC—is that it is now more vital than ever to be smart at it. In today’s austere age many businesses cannot depend on rising sales volumes to lift their profits. As for cutting costs, most have already pared them to the bone. Prices are all that is left. And a business can do a lot with clever pricing, to boost its share of the limited spending-power that is out there.

Makers of high-tech products such as smartphones can opt to add whizzy new features and push up prices. In the case of luxury goods, their exclusivity is a large part of their appeal, and this in turn is a function of their price, so firms usually have scope for limiting supply and charging more: Ferrari, a sports-car maker, and Mulberry, a purveyor of posh bags, have both recently signalled that they plan to do just that. But raising prices by making products better or more exclusive is a strategic decision, open to only a few types of business. For all sorts of mundane goods and services there is much that can be done tactically, the consultants say, to charge more for the same thing.

Second, companies need to remember that, as the late Peter Drucker, a management guru, once put it, customers do not buy products, they buy the benefits that these products and their suppliers offer to them. So, businesses that fail to identify what benefits they are offering each type of customer are likely to be undercharging some of them. Equipment-makers who sell to other businesses can be especially prone to a “cost-plus” mentality, in which they charge the same margin to everyone instead of identifying those that are less price-sensitive and finding ways to earn more from them. Oil companies, for example, can suffer huge costs in lost drilling time if a pump goes down, so pump-makers could charge them a premium for guaranteed same-day dispatch of spares.

Airlines have learned to “unbundle” their product, charging separately for baggage and meals and increasing their overall takings. But industrial suppliers may still charge the same to customers who never call their technical helpline as to those who ring it daily. Makers of everything from aircraft engines to lorry tyres have gone further in selling benefits rather than products, by offering “power by the hour” contracts in which customers only pay when they use their goods. The suppliers earn more overall, while their customers preserve scarce capital.

A third route to charging more is to manage customers’ expectations better. In the early 2000s executives at General Motors were told to wear badges with “29” on their lapels, as part of a disastrous plan to get back to a 29% market share in America. This merely reinforced car-buyers’ assumption that GM would offer them whatever discounts it took to shift its metal off the forecourts, putting the firm on the road to bankruptcy. (Last year its market share fell to 17.5%, its lowest since the 1920s.) Once customers know that a firm’s price list is a work of fiction and that it will resort to discounts as soon as sales dip, it will be a long haul to get them used to paying full price, let alone accepting increases. Simon-Kucher’s consultants praise DHL, a logistics firm, which spent years drilling into its customers that whatever the economic conditions there will be a rate rise each year.

You’ve been framed

Fourth, there are lots of simple presentational tricks that almost everyone is wise to but which still, miraculously, work. Restaurants add some overpriced wines lower down the menu to make the ones at the top seem reasonable. Makers of ice cream offer “33% extra free” rather than “25% off” the cost of the regular size, even though these are arithmetically the same thing. Buyers at big industrial firms are just as susceptible to such “framing” when reviewing a list of widget prices.

The pricing experts make it sound so easy. But there are of course limits to how far firms can go in tailoring their prices to the customer without appearing sneaky. Last year Orbitz, an online travel agency, was criticised for offering a costlier selection of hotels to people browsing its site on an Apple Mac because it assumed they were richer than PC users. Although a firm’s customers may not notice the odd price rise slipped in here and there, they will eventually notice if their overall bill starts to swell: Tesco, Britain’s biggest grocer, is now having to offer expensive discounts to win back a damaged reputation for value.

And sticking to a pricing strategy takes guts. The irony, confides a senior management consultant, is that firms like his have such a taboo against letting go of a client that they are the worst at taking their own advice to be fearless in asking for more, and walking away if they do not get it.

Economist.com/blogs/schumpeter

Pricing Lessons – How to Sell more Healthy Food

broccoliI am extracting the pertinent information on pricing food, from a learned article by two INSEAD  researchers called “Does food marketing need to make  us fat?” ,.

Most food is still sold as a commodity which has brought with it a steady decline over the past 50 years in the relative cost of food. We spend less on food as a proportion of our income, certainly in North America, than previously. But does price or discounting influence purchasing?

The authors pursue a number of studies on the effect of price on purchase decisions that are important for the savvy businessman.

In the long term.

The average price elasticity of food consumption is low at -.78. We need to eat to survive! But, long term low retail prices for food, especially fast food, have resulted in people consuming more, as measured in the increasing rates of obesity.

But higher prices can lead to reduced consumption.  A 10% increase in the price of fast food leads to a statistically correlative reduction in obesity of 0.7%.

Pricing is a stronger motivator in a buying decision than nutritional labelling – a strategy that sometimes backfires because nutritional labelling is often associated with no flavour or just bad taste.

“The only exception to the rule that higher prices reduce consumption comes from a study showing that higher prices at an all-you-can-eat pizza restaurant led to higher consumption of pizza, probably because of the psychology of “sunk costs,” which leads people to try to eat “their money’s worth.”

In the short term

In the short term, significant price reductions can lead to measurable increases in consumption.

“Probably the best evidence of this comes from a randomized controlled field experiment involving 1,104 shoppers. This study found that a 12.5% temporary price discount on healthier foods increased the purchase volume of these foods by 11% among the low-income consumers who received the coupons. The effect persisted even 6 months after the promotion had been stopped. “

This is important because low income shoppers mind their pennies and are motivated to buy as many calories per dollar as they can.

Interestingly, “price deals can influence the speed of consumption even when the food has already been purchased. This should not, in theory, influence consumption because the cost cannot be recovered, no matter when, or how quickly, the food is consumed. Nevertheless, studies have found that people accelerate the consumption of products perceived to have been purchased at a lower price.”

Observation – quantity discounts lead to stockpiling which accelerates consumption. The quantity purchase of some foods displaces the purchase of other foods. Because it occupies shelf space, we eat more of it. This effect also persists even 6 months after the initial discount.

Recommendation – offer “buy 1 get 1 free”

*** However, the discounts on healthy food did not reduce purchases of “vice” or unhealthy food.

So, if you want people to buy healthy foods, do not discount unhealthy foods.

Observation – consumers prefer price discounts to bonus pack on “vice” foods, but prefer bonus packs to price discounts on healthy food.

Recommendation – offer “free quantity” promotions. That means Larger Package size on healthy foods like fruit and vegetables.

The points that are important to food retailers in order to increase sales and profits are:

  1. Keep the packaging of “vice” foods to smallest sizes and lower the price.
  2. Package healthy foods in larger quantities and keep the prices higher.

 

(Nutritional Reviews. 2012 October; 70(10): 571–593.  Published online 2012 October 4. doi:  10.1111/j.1753-4887.2012.00518.x PMCID: PMC3495296 Does food marketing need to make us fat? A review and solutions Pierre Chandon and Brian Wansink)

How to Price for Profit

How to Price for Profithow-to-price-for-profit

In the age of Black Friday megasales, ubiquitous smartphones and “big data” mining, the pricing wars have shifted onto an entirely different battlefield. And both shoppers and vendors are turning to high-tech weapons.

On the consumer side, buyers have access to apps and websites that give them real-time price comparisons, but companies such as Decide.com are taking that up a notch. By grinding up historical pricing data for electronics, appliances and other goods, the Seattle-based app maker enables users to game out the timing of their purchases to coincide with low-ebb periods (which, as it turns out, don’t necessarily occur during traditional sales blitzes).

Retailers like Wal-Mart and Target are responding by applying mathematical formulas to shopper psychology, luring us in with a $9.99 backpack but knowing we’ll also buy two shirts and a lunch Thermos for our child. Amazon.com, one of the sharpest players in this arena, taps so-called “dynamic pricing” algorithms that adjust list prices to individual buyers based on such factors as the value of their past purchases.

Where does this leave small companies? Having to raise their game significantly in how they set prices for their goods or services… for the full Profit Magazine, go to

http://www.profitguide.com/manage-grow/strategy-operations/how-to-price-for-profit-47906