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Newsletter: September 25, 2009

Pulling Pricing Back from the Brink | Conditions are Right for a Pricing Death Spiral | The Fairness of Fees | Good Reading!

Pulling Pricing Back from the Brink

By Dr. Reed Holden

This has been the worst recession in my lifetime. Activity in many business segments continues to be slow. While there are signs that we may be at the bottom (why is that suddenly a good thing?) unemployment continues to rise. Most companies are continuing in the survival mode. They're cutting expenses to the bone. Capital projects are on hold. Price discounting is used to keep the sales people busy or the plant active. Companies are cutting prices where they have to and trying to hold when they don't. We're all looking for the light at the end of the tunnel, but we aren't sure what it will look like or when it will come

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I honestly don't think the worst is over. Yes, the recession might be over, but there are a lot of companies out there, big and small, that are on the brink of extinction. They got there because they didn't move fast enough to cut costs and inventory going into the recession (think GM and Chrysler and lots of technology/capital goods companies). When the recession hit, cost cutting wasn't going to be enough, so they dramatically discounted their high-value products to grab the little market share that might still be there. Others, like United and the freight companies, implemented unreasonable fees and alienated their loyal customers. When the economy does grow again, these companies are going to quickly run out of cash and have a questionable business case with the banks and investors–an already skittish group.

There are companies that have survived during the downturn quite nicely. I wrote recently about Oracle, once the poster child of discounting. They've made quite a few good acquisitions at low prices and rebuilt their value and pricing power. And they've leveraged both with good success. Ford has gotten more customer focused and is beginning to see demand pick up in their popular models. Cisco has held prices, continued to innovate, and will be in fine shape when the global economy begins to rebound. Microsoft will do just fine–especially with their new pricing and product strategy rolling out in several weeks. They're introducing a value-priced flanking brand of Windows 7 and seem to have a good handle on getting customers to upgrade to the more functional suite of products.

A question for us all is: what should we do in anticipation of the upturn that everyone seems to be talking about? Here are a number of things to think about:

1. First, don't do anything until your business shows an uptick. That could be in a number of areas of the future business dashboard: inquiries, proposals (a very dangerous indicator), or actual booked orders to mention a few.
2. Now is a good time to review your strategy. Don't change it until you see the upturn. For markets that are suddenly growing, a penetration strategy might be appropriate. If you've been discounting the high-value products to survive, you should be preparing to stop that once the markets do turn. At least make sure you've identified the leading indicators we talked about above which would signal a change of strategy would be appropriate.
3. Review existing policies and pricing systems and ask yourself a few questions:
   
   • Are your pricing people disciplined about sticking to the process?
   • How well have your salespeople stuck to the rules and procedures?
   • If there is a disconnect—what warranted it?

If you're reading this and don't have any policies and procedures, now is a good time to begin to stitch them together. Don't worry about doing anything fancy here–just do something!

4. Be ready to expand capacity. Note I don't say to expand capacity. You should have a plan in place that identifies necessary resources to handle the increased demand when it comes. Don't jump the gun on this one. With good pricing information systems (See chapter 8 in Pricing with Confidence!) most steel producers had held prices, despite the dramatic drop in demand. When they saw the possibility of a turnaround, a number of them expanded capacity. But when the demand didn't materialize, prices dropped dramatically–go figure!

Good pricers and leaders look ahead in the business cycle. In upturns or in downturns, that's true. It's a bit like walking a tightrope–you have to be ready to react, but sometimes it's just good to stay in balance. If you don't, it's a heck of a fall.

Conditions are Right for a Pricing Death Spiral

Commentary By Mark Burton

From “The Great Trust Offensive,”BusinessWeek, September 28, 2009

In Pricing with Confidence, Rule 4 is focused on playing better poker with customers. In discussing Rule 4, we point out the critical role that trust plays with both relationship and value buyers. Our research found that there were two major drivers of price-buying behavior. The first is the size of the company. The second? The level of trust in both the selling company and salesperson. In short, if your customers don’t trust you, they are far more likely to engage in price-buying behaviors and be far more aggressive at the negotiating table.

The BusinessWeek article ominously points to some serious troubles for American business in the area of trust–and the implications for pricing power are significant.  “Polling in recent months shows that increasing numbers of consumers distrust not just the obvious suspects—the banks—but business as a whole. In a phone survey conducted from May 26 to July 3 by public relations firm Edelman, only 44% of Americans said they trusted business, down from 58% in the fall of 2007.”

While the research focused on consumers, you can bet that when these consumers put on their suits, go to work, and become your customers, their attitudes don’t change significantly. Mix in weak demand that makes many executives anxious for business-on-almost-any-terms, and you have a recipe for a pricing death spiral. Companies need business, so they are willing to negotiate ever-steeper discounts. But negotiating prices on supposedly high-value offerings makes it obvious to customers that any initial prices they are given are not to be trusted. This in turn undermines loyalty and increases price-buying behavior.

This vicious cycle is why pricing integrity is so critical. The actual costs due to increased customer churn and spread of the price negotiation virus are likely orders of magnitude higher than measurable discount dollars.  Leading marketers like Proctor and Gamble, American Express, and Starbucks see this, which is why they are engaging in systematic changes to prices and focusing on trust in their marketing messages and interactions with customers. Does your organization understand the cost of eroding customer trust? Do you have a plan to build trust to grow profits?

The Fairness of Fees

By Dr. Reed Holden

I've been struck by fees over the past month of traveling and think it's worthwhile to make a few comments about the pesky things. Fees can be effective facilitators of increased profits. But they can also drive customers to switching to another vendor and higher-price sensitivity, if not used carefully. There is a balance between excessive fees and fair ones that pricing professionals and marketers need to be aware of.

Last year, we moved our business and personal banking accounts to a local bank, due to two things. I started the move when the big bank we were working with started charging me a fee for a monthly wire transfer. The fee was just $15, but I kept the right minimum balance in my accounts and was a good customer. It just didn't seem fair. I knew that it didn't cost them anywhere near that much to handle the transaction (it's all electronic anyway). I met with the branch assistant manager, and he said that he couldn't waive the charge. At the same time, we were also getting mediocre to low service on our business account, so we moved all accounts to a local bank where we are dealing with a VP Branch Manager, who had been in the position for quite a few years. We now get great service and fair fees.

What's the message? Fees can cause loyal customers to switch when they are perceived as not being reasonable. What is reasonable? Security fees on airline tickets are reasonable, because of all that security we see at the airport these days.  Plus, all the airlines charge the fee. Fuel surcharges when gas prices are high are reasonable, but they're not when the price of gas goes down. We rejected several moving quotes this year, because they were still charging the fees, even though the price of gas had dropped more than one dollar.

Baggage charges for the airlines appear to be reasonable, because of the handling of the baggage.  Plus, they often get charged to vacation travelers, who are not high value, loyal customers of the airlines. Me? I never check luggage. Even if I did, it would probably be on American, and they waive the fee for their loyal customers. That's effective use of fees.

Recently, I have been flying on Northwest (now part of Delta), because they are the only direct flight to a new client. Northwest has a fee of $20 for a better seat–a lot like Jet Blue. On last week’s flight, I noticed that they only had one regular seat for no extra fee. It was way in the back of the bus and a middle seat. So, I paid the fee for an aisle seat up front. It was worth it, because the aircraft was packed. If it hadn't been packed, meaning that the airline was not showing available cheaper but still better seats, I would have switched to American and taken the hop through Chicago.  Not the case here, and I felt the fee was fair. We had to change flights and had to pay a $50 change fee–again. Fair? Yes, but I'm feeling a little nickel and dimed by these guys. If the fees continue, I'll probably say the heck with it and start doing the indirect on American. Do you get the picture here? Even though we have a client paying the charges, I'll still switch, because I don't think it's fair!

Southwest has begun charging a $10 fee for those people who want to get to the front of the line. For business people, it means a front row seat, a guaranteed place for the luggage, and first off at landing–not a bad deal. That's a well chosen fee for a target market of people who will be willing to pay the fee and think it's fair. I do wonder what the impact will be on people who are the casual traveler. Will they get angry when people pay to cut to the front of the line? It should be interesting.

The bottom line is that fees are an important consideration for companies that are looking for ways to increase profits and charge for special services. Whether to a general population or to specific segments, when those fees are viewed as fair, they are effective ways to call out the special features and services that customers can receive, if they want to pay. When fees are viewed as unfair by an increasing percentage of the population, however, they can cause increased switching and a declining population of loyal customers–something that has to be monitored over time. Yes, it is tricky, but if properly managed, fair fees work and can be a significant boost for profits.

Good Reading!

By Reed Holden

• The Experience Economy: Work is Theatre & Every Business a Stage by B. Joseph Pine II and James H. Gilmore, 1999, Harvard Business School Press, Boston, MA.  This book has an interesting discussion about the difference and value of viewing a service business as a more theatrical "experience" business. It's a good read for all services businesses and has good insights for how BTB companies can better relate to its customers and intermediaries.