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“When managers are desperate to close business, they lose the ability to pursue profitable business.”

Reed Holden & Mark Burton

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Newsletter: December 18, 2008

There Isn’t Any Price Low Enough

Mark Burton

Over the summer, we at Holden Advisors held up Dow Chemical as a shining example of how to manage pricing. The catalyst (pun intended) for our praise was the double-digit price increases that Dow announced. While skyrocketing oil prices provided a reasonable basis for increasing prices, many companies dithered. Dow acted decisively and profited handsomely for their efforts.

Now, scarcely six months later, Dow has announced that it is idling a third of its capacity and is laying off five thousand workers and terminating another six thousand contractors. What gives? Did Dow mismanage its business after all? Quite the contrary. They are still managing the business in a way that gives them the most pricing power, given current business conditions. The result of the current economic turmoil has been an evaporation of demand. Dow recognizes an important point that many managers miss–there isn't any price that is low enough to bring that demand back. Instead, they are working the other side of the supply-demand equation by cutting back supply until market conditions point to the ability to profitably restart idled plants.

We are experiencing perhaps the most volatile pricing environment that any of us will ever face. Just a few months ago, smart firms were pursuing price increases. Now many are faced with severe deflationary pressures (when the NFL reduces the prices of playoff tickets by 10%, we are in a deflationary environment.) These changes will whipsaw the unprepared and hamstring their ability to recover pricing power when markets eventually turn around. So what should we be doing with pricing right now?

Focus on maintaining the integrity of your price lists. Ad hoc discounts to help suffering customers and maintain at least some revenues might seem like a good idea–but they are a ticking time bomb. Customers learn that if they squawk, they will be rewarded with discounts. Here's a simple solution if you find yourself faced with a lot of these special cases–lower your list prices. You can always bring them up later in a systematic way as conditions improve.
Make sure that your price-setting processes are efficient and transparent. Given that the "future" is now defined in hours and not quarters or fiscal years, it is essential to have the capabilities to rapidly and systematically change prices. If it takes any longer than a few days to implement price changes, you are going to be forced to respond in an ad hoc manner (see point #1) and it will cost you dearly.
Never stop planning for the future. It's tempting to say that the focus on survival is paramount and that things like value-based pricing are quaint ideas of times gone by. Nothing could be further from the truth. Your offerings still have value, and you still need to fight for every milliwatt of pricing power. Tying prices to value and forcing customers to make trade-offs to earn discounts are the bedrock of profitable pricing. Price levels may go lower still, but how you manage that process now will have a dramatic impact of current and future profits.

Lessons Learned: Planning for a Recession

By Dr. Reed Holden

Business objectives and strategies evolve around internal business capabilities, competitive conditions, and market conditions. When one changes, especially market conditions, objectives and/or strategies should change, too. If they don’t change in a downturn, suppliers find themselves hiring people and building inventory when neither the products nor the people will be needed in, at least, the short term. When you build excess inventory, it uses up cash that is often needed to meet other obligations of the firm, like payroll and operating costs.

The same is true for pricing strategy. When demand slows, pricing strategies need to change from penetration strategy, where discounting is used to build volume and reduce costs, to neutral where price is used less as a tool to drive demand. In a downturn, demand is declining and is not as responsive to price discounts. If price is used to try to drive demand in a downturn, revenue will often still decline and profits will disappear.

The trick is to anticipate the changes in demand, especially declines, so that when they happen, market objectives and business and pricing strategies can change as well. If it takes too long to respond to market conditions, managers need to resolve excess production and personnel with lay-offs and use price as a tool to dump inventory. Unfortunately, it is only recently that government economists finally agree that we’re in a recession AND IT STARTED 12 MONTHS AGO! If you have been waiting for this report to adjust your production and hiring, it’s really too late. It should have happened last year.

The nuclear winter we now see in the automobile industry comes from failing to effectively respond to the current decline. Ford (in the best shape of the three), GM, and Chrysler have too much capacity and too much inventory. Chrysler has 124 days of inventory and usually shoots for 70-80. Among other management issues, the excess inventory has chewed up cash. Now the CEO’s of the Big 3 are coming to Congress and the American people with hat in hand.

The lesson of recent events is that if you wait for the government to say there is a recession, you’ll be a year late adjusting your objectives and strategies and especially adjusting your pricing strategies. You’ll use price to try to correct the problem, and it just won’t work. We all need to develop our own leading indicators of slow downs in our specific markets. You have to pay attention, and when it is appropriate, adjust objectives, strategies, including pricing strategies, before you end up leaving lots of money on the table.

Discounting’s Double-Edged Sword

Commentary by Steve Haggett

From:

“Discounts May Prove No Bargain to Retailers,” by Sandra Jones, Chicago Tribune, December 5, 2008
“Luxury Prices Are Falling; the Sky Too,” by Guy Trebay, The New York Times, December 4, 2008
“Retail Sales Are Weakest in 35 Years,” by Stephanie Rosenbloom, The New York Times, December 4, 2008

In retail right now, discounting is more contagious than the ball pit at Chuckie Cheese.

I confess that I don’t know what a Prada black pleated hobo bag is, but I see that Barney’s has marked the price down from $1450 to $869, a 40% discount. At Saks, one can find a ‘columnar Valentino evening dress’ at 70% off the list price of $2950 and $2000 Loro Piana jackets for $329. Bergdorf Goodman and Neiman Marcus are following suit, down top-end items 40% as well.

On the other hand, Abercrombie & Fitch has refused to discount, focusing instead on the power of its brand.

What can we learn from these alternative approaches?

Right now, Abercrombie is getting killed. November results showed same-store sales down 28% from a year ago, increasing the pace of the 20% decline in October and 14% drop in September.

Saks, with its more aggressive approach, is down only 5% in November. Neiman Marcus, with more moderate discounting, is off 12% in November, an improvement on the 28% drop in October and 16% drop in September.

The risk to this slash-and-burn discounting approach is that consumers re-set their reference points, and never again consent to pay premium prices for premium retail products. If you bought your last Marc Jacobs designer tote bad for $629, why pay the $1250 list for the next one?

Right now, customers have less to spend. Companies that discount dramatically are maintaining revenues, at the expense of profitability. Companies that hold the line on price are often facing significant revenue declines–which also drive losses. Neither option looks attractive.

Are there alternative approaches?

Automakers, forced into a cycle of discounting, have arrived at some creative options. Ford, among others, offers free satellite radio for new purchases–focusing discounting on the accessory. Chrysler took an even more creative route by offering a $2.99 gasoline price guarantee back in May, when gas prices were still $4.00 a gallon. That focuses the price reference onto total cost of ownership and away from the list price–a powerful pricing tool.

Restaurants are pursuing another approach, offering fixed-price value menu alternatives and limited-time offers, designed to fill seats during slow times. Using price to separate offerings into high-value/premium-price and lower-value/lower-price, alternatives can be the most effective weapon in the pricing arsenal. During periods of low demand, lower price can fill capacity. During periods of high demand, normal prices are not impacted.

Without the ability to create tiered offerings or a total cost approach, competing with increasing discounts is a double-edged sword.

The Price of Loyalty

By Nelson Hyde

I have been a loyal Hertz customer for years. But the other day I got a quote from them for a one-day midsize car that was outrageous. I told them I was interested in renting the car, not endowing it. Then I called Avis. Same location, 17% less–plus a grace period if I return the car late, which Hertz has eliminated.

Now over the years, Hertz has been good to me. But when I’ve used Avis, Avis has been good to me, too. They are basically the same cars and the same expedited, fairly reliable service. But different prices. What gives?

There are lots of good reasons to charge higher prices. Here are two: if you have some unique value that differentiates you from the competition, or if you are operating at or near full capacity. But Hertz over-reached. Hertz doesn’t create more value for me than Avis–certainly not 17% more. And even if Hertz was running low on cars that day, a 17% higher price says that Hertz forgot something important: it has competitors who do have cars that day. Yes, charge more where you can–but remember that customers expect similar prices on offerings of similar value.

And don’t soak your loyal customers. I started the transaction very much as a relationship buyer. I was used to Hertz and defaulted to them when using rental cars. But when Hertz over-reached, I lost my confidence in their value. Their poor pricing decision turned me from a loyal relationship buyer into one who wants to see more options, so I can get the best balance of price and value–in other words, a value buyer.

I called Hertz back to tell them the Avis price just to see what would happen. They put me through to customer service, where the recording told me that my call was very important to them–and that they would answer my call if I held on the line for 20 minutes. Sorry Hertz, but I’d rather pay less and give Avis a go.

Just the Ticket

By Steve Haggett

Many service providers operate without an ability to store inventory–an unbilled hour cannot be stored, no more than an unfilled flight can add customers after take-off.

The airlines have pursued a fine-toothed pricing strategy to address this problem, defining the value of a seat based on the time remaining until take-off, gradually increasing price as customer value increases and price-sensitivity drops.

Now performance and entertainment providers are adopting this strategy. A stadium or theatre offers a fixed capacity, but the value of the performance can change significantly from day to day. This is immediately recognizable in the scalper’s market. While the face value is the same, when the Red Sox play the Yankees, the street value of the tickets is orders of magnitude higher than the same seats the next week, when the Royals are in Boston.

Teams are now exploring variable pricing systems, designed to fill capacity when perceived value is lower, and maximize revenues when perceived value is higher. With the ability to reflect ‘street value’ on ticket prices, teams can both attract more fans and increase total revenues.

This strategy can work for any company facing changes in demand and perceived value for a static-priced offering. By matching the pricing metric to customer value, rather than offering cost, companies can improve satisfaction, demand, and profits. In the case of an airline, the value is based on advance purchase time. In the case of a theatre, it’s weekends vs. matinees–so a pricing approach offering different fees for Friday at 7 pm from Tuesday at 10 pm makes more sense than two simple prices. In the case of a sports team, it’s related to opponent. All the while, the cost of providing that service doesn’t vary.

Identifying the way your customers perceive value, as opposed to your basic cost, is a win for everyone.

Good Reading!

How Much Should I Charge: Pricing Basics for Making Money Doing What You Love by Ellen Rohr, 1999, Maxxrohr Press, Rogersville, MO. How many times have people told you that they hate pricing their products and services--especially small business people? Well, here is a simple, basic book on pricing you can recommend they read and get them to stop asking you questions. No business degree required!

Newsletter: November 14, 2008

Tough Times for Tough Pricers | Recession Busters | Stress-Based Pricing Strategies | The Pricing Pressure Cooker | Good Reading!

Tough Times for Tough Pricers

By Dr. Reed Holden

With the election over, we’re realizing that President-Elect Obama has a very difficult situation to manage, starting on January 20, and we’re all hoping that he hits the ground running. It reminded me of Michael Douglas in The American President when, after he’s been kicked around by his election opposition (Richard Dreyfuss), Douglas storms into the press briefing room and gives a terrific speech. Everyone smiles, his girlfriend (Annette Bening) comes back and all is right with the world. I don’t think it will be that easy this time but hope Mr. Obama can get the job done. These are tough times, and it will take a tough President to get the job done.

The same is true today for pricing vice presidents, directors, and managers. We are clearly in a recession. Demand is down, job losses are rising, and it looks like this will continue for six to eighteen months, depending on which pundit is speaking. The problem that pricers are going to see during these times is the following:

With demand down, competition is going to increase and be more fierce, and worse, the pressure will be more intense to increase price discounts to stem the falling tide.

The real problem is that using discounts in a down market will encourage a price war, and the reduced prices will cause revenue to drop and profits to disappear. Proper controls and processes will be needed to make sure the discounts given truly provide a benefit to the company–a.k.a. profits. Without that, price discounts will lead to more job losses, making the problem worse. It’s going to take a tough pricing manager to prevent the unwarranted discounting that senior leaders will favor.

There is going to be a natural tendency for senior leaders to want to reduce costs during the downturn. That’s OK in every area but pricing. Pricing is an area that needs resources, processes, and controls to protect whatever profits are available. Cut pricing people and systems now, and you’re going to see even less profits going forward. It’s going to take a tough pricing leader to fight for the pricing resources he/she needs to prevent that problem.

What about price increases? Watch out for dumbbell pricing. This phenomenon creates a price distribution that looks like a dumbbell–some high and some low. Worry about how the price increase will be applied. Some customers, usually the most loyal, will pay the increase, while others will demand to get bigger discounts. The net result of the exercise is that eventually the high-price customers learn what’s going on and end up getting the discount over time. When this happens, the price increase backfires, and chances are that it will lead to even greater discounts in the future.

To pull off a price increase now, you have to start by convincing your customers, salespeople, and competitors that it is reasonable and fair. Competitors need to follow your lead to make it work. In our book, Pricing with Confidence, we talk about “The Pricer’s Dilemma” – an exercise used to show people the fallacy of price competition in a mature/declining market. The exercise shows why it’s necessary to get your “constituents” to follow. If you don’t have the controls and the right communications program to let everyone know what you’re doing, it simply won’t work.

We know of one company that started this process over a year ago. The managers knew there was a problem on the horizon and wanted to get more discipline around a new system before the downturn hit. However, they were worried about the senior executives. So we put the senior execs through the Pricer’s Dilemma exercise, and after an hour, they began brainstorming how a price increase would play out in their market. Soon they were asking the PR people to begin making announcements about price increases to the marketplace. It took six months of deal analysis and “selective competitive response,” but the competitor finally increased prices, too. It took a tough pricing manager to get the job done, but she did it and got the senior execs to buy into the program.

I believe that it might be too late to execute a price increase now. Why? Because everyone knows that costs are starting to come down. The time to get price increases is when everyone believes the increases are reasonable things. With gas half the price of four months ago, steel coming down–as are other primary commodities–customers know that your costs are starting to come down, too. The time for the increase was six months ago. Dow Chemical, for example, got their increases communicated to the market in second quarter and have settled in to weather the storm. They have tough pricing managers. How about you?

Recession Busters

By Nelson Hyde

Economists have predicted five out of the last two recessions, but this one is starting to look like the real deal. Unemployment is on the rise, lending is tight, retailers are bracing for slow holiday sales, and CEOs are making dire forecasts.

Yet in the middle of it all, some companies are reporting double digit profit growth this quarter, even in some very tough industries. They did not achieve this just by cutting costs. Rather, they successfully tapped into two key drivers of profit growth.

The first is innovation. If you want to be growing the business in bad times, you have to expand your product footprint. If you want that growth to be profitable, choose high-margin segments like Apple has. Its third quarter profit was up 26% on the strength of its iPhone, first sold 16 months ago.

The second source of strength in bad times? Raising prices. That’s right, raising them. Higher prices at Sara Lee converted what would have been a loss this quarter into a 20% profit increase. Japan’s largest wireless carrier, DoCoMo, lowered its cell phone subsidies–a move that predictably slowed unit sales growth, but increased profits by 37%. On-line movie renter Netflix is taking a cue, too. Anticipating slower subscriber growth, it is raising prices $1 for some DVDs.

In raising your prices, demonstrate that the new prices are reasonable and justified–cite your cost increases and other benchmarks. Give your customers advance warning so they can pre-buy some at the old prices to ease in. Communicate your intent to the entire market, in public forums where competitors will hear it, too. If competitors try to undercut your new prices, take clear, targeted actions that hit them where it hurts to keep them in line.

Not everyone can duplicate this, but many who could, don’t even try. The problem with following conventional wisdom–“demand is weakening! lower prices!”–is that when the boat goes down, you go down with it. Some companies have created a few lifeboats of their own and set their own course instead.

Stress-Based Pricing Strategies

Commentary by Steve Haggett

From “Niche Companies Make The Most of The Crisis,” Robert Weisman, Boston Globe, October 21, 2008

In a recession, offerings that save customers money or reduce risk can yield a growth opportunity. For many companies, a lower-value flanking offering can maintain revenues and help build new customer relationships, relationships that could be a source of growth during the rebound.

Another trend during a recession, and the resulting reduction in incomes, is an increase in stress and, sadly, divorce proceedings.

New England Divorce Solutions has rolled out a new flat-rate option for divorce services. Their fixed-price offering ($5,000 to $10,000) is targeted at customers who seek to “do away with billable hours,” says co-owner Tim McNamara. The service reduces the risk of major unpredictable costs during an economic period when customers see their own income as unpredictable. Since offering the new option, New England Divorce Solutions is fielding a high volume of calls for services.

The key to an effective flanking offering is ensuring that there is an identifiable distinction in features and services (but not quality) between the premium offering and the lower-value offering. Smart customers will pay for the lower-value option, and hope to receive the services from the higher-value alternative. If you are going to cap your prices to serve this market, you need an easy way to cap your services–and your costs.

There’s a decent chance that, if you are not considering an alternative like this, your competitors are.

The Pricing Pressure Cooker

By Alison Yama

While at the recent Pricing Society Conference in Miami, I heard a scenario played over and over again as people came by our booth or asked questions during the sessions. See if this sounds familiar. Sales people call you, the pricing director, on a daily basis saying that competitors are lowering prices to win business, and they need authority to discount their deals. Your costs, once high, are dropping, further fueling customers’ demand for lower prices. Your executive team is calling for revenue improvement as demand drops. You are caught in the middle. That whistling sound you hear is the steam coming out of your ears as the pressure mounts to help meet financial goals.

Over the decade that I have been in pricing, I have had the pleasure of working with some exceptional pricing people who had the ability to be successful in the face of this enormous pressure. I want to share a few best practices from one pricing director to help other managers, directors, and vice presidents who are facing the pressure and looking for some relief.

Don’t be “Super Pricer” and try to accomplish everything at once: A pricing director from the chemical industry focused on not doing everything right, but rather, helped individual sales teams prepare for value-based negotiations. Those “small wins” added up to impressive incremental contribution that helped him gain credibility with sales and executives and helped the company meet financial goals.
Communicate the value of the wins: After each win, that same pricing director communicated to executives and other sales people the additional volume and price the successful sales team negotiated. The effect was two-fold: a) executives began to get their noses out of pricing as the trust in the pricing director increased, and b) sales people began to be more confident in their pricing.
Give sales the tools they need to be successful: As the pricing director worked with more and more sales teams, he was able to share tools, tips, and strategies across sales teams.
- Value stories: “Our service is able to speed up your time to market by X Months…”
- Negotiation tips: “If the customer wants a lower price, strip out our new product development service.”
- Negotiation power: “If the customer demands a discount of 50%, we don’t want them as a customer. Walk away…”

You may have picked out an underlying theme of these three best practices–they all involved a relationship with sales–a good, working relationship, not an adversarial one. This relationship is the release valve needed to reduce some of the pressure on your pricing department. Pricing is not the “sales prevention department” of old. Get out of the office, roll up your sleeves, and get to know your sales people.

Good Reading!

Double-Digit Growth: How Great Companies Achieve it–No Matter What by Michael Treacy, 2003, Penguin Books, New York, NY. This book is well written, contains no fancy graphics, and has a lot of very good stories. His model is simple and high level. The problem with any book which focuses on a few companies for stories, as authors Peters and Waterman discovered, is that some stumble subsequent to publishing (Dell and WaMu). Also, he tends to make extreme statements which aren't always true and some stories contradict. But a worthwhile read.

Harvard Business Review on Pricing, 2008, Harvard Business School Publishing, Boston, MA. This book contains a collection of prior articles from the Harvard Business Review on pricing, including pricing new products, fighting a price war, Six Sigma Pricing–generally a good collection from some of the top authors in the field.

September 19, 2008

A Get Out of Jail Free Card | There Must Be Something in that Cool Canadian Water | Pricing 101 | The Classic Battle between Pricing Managers and Sales Managers

A Get Out of Jail Free Card

Commentary by Dr. Reed Holden

From “Text-Messaging Rates Come Under Scrutiny,” by Fawn Johnson, The Wall Street Journal, September 10, 2008

The Wall Street Journal had an article about how the four major text messaging companies are being investigated by the Senate Antitrust Committee. Apparently, prices for text messages have gone up by 100% over the past year, and remarkably, the four major vendors in the US made the changes together and with the same prices.

This is worth several comments. Now, I'm not sure that text messaging is covered by current anti-trust legislation and that may be why the Senate Antitrust Committee is looking into it and not the Justice Department. If it isn't covered, but the four companies had discussions and agreed to across-the-board price increases before they took place, it wasn't smart. Initially, it would be classified as uncompetitive behavior, and it might cause the government to closely examine the laws to cover services.

Let's say for a moment that they didn't actually collude to make the changes. The fact that they made the same changes at the same time is called conscious parallelism. It is often part of a process of what used to be called “signaling,” and is now better referred to as "constituent communications" (thanks to Board and Cabinet Member, Gene Zelek of Freeborn & Peters in Chicago for keeping me up on the laws here).

Conscious parallelism should be a careful, quasi-objective of firms with products or services moving into mature phases of a market. In this case, pricing strategies should move to skim or neutral but often can't because of price wars that erupt. When a good pricing communications program (see our Pricing with Confidence podcast series when we discuss Rule 8) sends the right signals (don't compete on price) and other competitors hear it, prices begin to move together in an industry. Examples of this are the steel and airlines industries and might be happening now in the chemicals industry–that is, if others are listening to Dow Chemical. The result should be conscious parallelism.

Here's the problem. While conscious parallelism isn't illegal, it can be an indicator to the Justice Department of potential illegal activity (direct pricing discussions between competitors). And it can be used as the basis for an investigation from Justice Department attorneys. If and when that happens, you need to be sure of two things. First, you are clean as a company. That is, you don't have any discussions with competitors. Second, you have policies which prevent such discussions, and those policies are clearly communicated to all employees. If you don't have them, and an illegal activity occurs, the company becomes liable for treble damages. This is a bigger issue than most pricing managers realize. Something as casual as a comment between two salespeople in competing companies can constitute a violation.

We often work with managers to develop effective pricing communications programs. The first question we ask is what policies are in place to prevent illegal activities. Electrical device and box industry managers learned this the hard way (going to prison, in fact) and now have airtight programs. Other companies tend to be loose in policy. If this is the case, you do so at your own and your company's peril.

Note: I am not an attorney. This is my understanding of the law and if you need further information contact your own legal department or Gene.

There Must Be Something in that Cool Canadian Water

Commentary by Mark Burton

From “Price Wars Fail to Erupt as Bundles Proliferate,” Theglobeandmail.com, September 15, 2008

In our May newsletter, I wrote about how Canadian airlines were effectively managing pricing and avoiding unnecessary price competition during very trying economic times. This month, it’s the Canadian phone companies that deserve public praise. About a year ago, the Canadian federal government deregulated the telecommunications market. At that time you could literally hear the sound of hands rubbing together from the Maritime Provinces to Alberta as everyone waited for prices to crumble, due to the inevitable and bloody price war that was sure to break out.

Guess what? It didn’t happen. Instead, Canadian telecommunications provider actually raised prices on basic services. Prices for basic home telephone service have risen as much as 15% in the past year. How could this happen in a newly competitive market? I mean, where is the inevitable price-driven grab for share? The major players are competing hammer and tong, but they are doing it with bundles. Prices for services purchased a la carte have risen, but great deals can be found if you bundle up. Here is how Bell Canada views the situation.

"Every single customer had a chance to save money with these pricing changes. Like the whole industry, we're trying to encourage customers to bundle," said Kevin Crull, president of residential service at Bell. "The à la carte items will continue to go up."

This strategy is a win-win. Customers get lower total prices. Service providers increase revenues and profits without cutting each others’ throats. It really is that simple. If there were ever two industries in the US that have histories of messing up their pricing, it’s been telecommunications and airlines. While the US telecos have learned their lessons–it took them a while–the airlines continue to stumble around. Worried about your executive team over-using price as a competitive weapon? Perhaps you should suggest a vacation in the Canadian Rockies.

Pricing 101

By Steve Haggett

As the parent of a high school senior, I’ve been on the college tour over the past several months, preparing to part with my eldest child and about a quarter of a million dollars. Although each school she has looked at presents itself quite uniquely, describing a distinctive experience and approach, one thing is exactly the same.

In the world of price strategy, a neutral price is designed to take price right out of the selection criteria. If all products are priced the same, customers must use other criteria–related to the value proposition–to make a selection. Here’s the yearly price tag for the range of schools my daughter has targeted:

graph

Now that is a better example of a neutral price strategy than any cartel or centrally-planned economy could hatch. The standard deviation of prices is $335, or well under 1%.

This uniformity of fees tells the customer not to focus on price, and given this consensus, the price must be appropriate. The schools are thus able to differentiate on other elements and not enter into a painful competition for customers using price as a weapon.

Another lesson from America’s finest universities. And this one’s for free.

The Classic Battle between Pricing Managers and Sales Managers

By Dr. Reed Holden

How many times have you heard the pricing department referred to as the “sales prevention department” with perhaps a bit of a sneer? “What a bunch of terrible people pricing managers must be.” They are the team who prevents the salespeople from doing their jobs–closing business, the team who prevents the necessary life blood of the business–a continuous stream of business to keep the engines of commerce running.

Let me ask you a question. Which is more important to a business, sales revenue or profits? You might argue that revenue is the key business need, but I would argue that it is really the profits that come from those sales that keep the engines of commerce running. This isn’t a chicken or egg thing. Yes, I know you need revenue to generate the profits. But if you really think about it, profit is the lifeblood of an organization. If you could generate fewer sales but more profits (quite possible if you think about it), is that good for a business? You bet it is.

Pricing managers focus on profitable revenue, but often, sales managers only focus on revenue. That’s a general statement, but for many companies, that is a very true statement. In their quest for revenue, profits become second in importance to sales, especially in downturns. When selling gets tough, profit declines even more quickly. The only control policies in place are “discount escalation” policies that say higher-level people have to approve it. Discounts increase over time, leaking out to more and more customers and salespeople stop drawing a line on where to discount.

What you’re talking about is order-taking, a practice that most sales managers accept from their salespeople. Just go out and close the business, and I’ll push the discount approval through for you. Those pricing guys have low power, so we will escalate to higher-level people to get the approvals done. To me, this means that salespeople don’t understand the product’s value or perhaps don’t care about it. Just get the business closed–at any price. That’s not selling, and I don’t care what you say about how tough it is out there. We have to demand more from our salespeople and sales managers. The essence of selling is to convince customers that your product is worth more.

This is why most companies, even big, well-known companies, fail to deliver the profits they should. The ones that do, know the importance of profits over revenue. They recognize the need for tension in the process rather than a wink, wink escalation clause that just makes the problem worse. The good companies are willing to sacrifice a percent of revenue for the sake of profits and do it with courage and wisdom. The good companies have very specific policies for what and how they can discount. And they follow those policies with iron determination, especially in a downturn. The good pricing managers work collaboratively with their sales counterparts to achieve the profit and revenue objectives of the firm.

I had a chance to visit recently with our favorite dirt company (mentioned in the book). We’ve been coaching this company for a few years. No big consulting contract, just an occasional visit to work with senior managers and now with the operating unit people. One of the managers came up and told me they were getting hit hard by the business downturn—revenue was down, BUT PROFITS WERE UP!! A couple of million dollars for that unit. It was a 5% revenue hit but a huge percent increase in profit.

Hey pricing guys, next time someone calls you the sales prevention department, call them the profit prevention department. Maybe we should get some buttons made up.

Newsletter: August 21, 2008

Pricing Critical for Cloud Computing

By Dr. Reed Holden

AT&T has recently announced that they will be entering the increasingly competitive cloud computing business. Cloud computing is a service that is currently provided by Google, IBM, and Amazon (See Wall Street Journal, Tuesday, August 5, 2008). The service is computing power and storage that is paid for on an as-needed basis. There are two primary needs that cloud computing fulfills. First, the service provides spare capacity for organizations that have seasonal swings in their computing and storage needs. An example of this is a retail organization during the holidays as pointed out by Andrew LaVallee of The Wall Street Journal. The second need fulfilled is a computing and storage system which might be used by a startup company.

This industry should develop quickly with its impressive lineup of committed vendors. The real question is which company will dominate? We believe the answer will be determined by how effectively the players use flanking offerings and subsequent pricing to entice companies to begin to rely on their services on a periodic or full-time basis.

In each case, the value proposition is different, as is the risk profile. Journalist LaVallee points out that Amazon has already had trouble with service outages–a devastating prospect for a retail operation. If reliability is a concern for customers, and it should be, that's an opportunity for suppliers to develop and offer highly reliable services. Those services should be priced higher than prices for smaller, higher risk suppliers that will certainly be entering the competitive landscape with similar offerings. It is inevitable that customers will use these lower priced offerings to try to bring down the prices of the majors in the business. The success of IBM, Google, and Amazon will be determined by developing a flanking "non-guaranteed" offering for significantly lower prices to match the new entrants. That way their salespeople will have value trade-offs to support customer negotiations rather than just price.

For the customer segment that wants cloud computing for swing capacity, the service will be even more valuable. This is because they won't have to purchase expensive full-time capacity. The pricing approach can leverage that value by offering discounts for customers that use the service on a full-time basis thus charging more and leveraging the value to part-time customers. By having dual prices, the portfolio of customers will add much greater revenue and profits to vendors and help block competitors that come in at the low end.

We talk about this extensively in Rules Five and Six of our new book Pricing with Confidence. We suspect that there will be some missteps along the way, but the victor will certainly Price with Confidence!

Playing with Fire Isn’t Dangerous – If You Know How

From “Microsoft: Virtualization Party Just Getting Started,” ChannelWeb (crn.com), August 18, 2008

Commentary by Mark Burton

By now, even non-techies have probably heard about something called “virtualization.” It’s a technology that allows a single piece of hardware to simultaneously run multiple operating systems and applications to produce dramatic increases in utilization and efficiency.

Up until this point, the firm most associated with virtualization has been VMware, but Microsoft is now jumping in with both feet. What are they doing with pricing? In general, they are using a penetration strategy that focuses on undercutting VMware. This might sound like a recipe for a price war in a high-value, developing market. While that might be true, if both firms play their cards right, it could actually be beneficial to both of them.

Why would Microsoft even risk a price war? Aren’t they playing with fire here? The answer lies in an interesting statistic cited by a Microsoft executive: less than 10% of servers are currently virtualized. They believe that the market for this technology is about to take off. If they are correct, a penetration pricing strategy is exactly the right thing to do as it will accelerate customer adoption and grow the market for all providers.

Now a word of caution. The growth phase of a technology lifecycle is the only time that it is appropriate to focus on a penetration pricing strategy. Too often, firms stay with the strategy even as their markets start to mature. The result? Every unit of sales becomes less and less profitable, managers start to adopt a commodity mindset toward their high-value offerings–and profits literally go up in smoke.

Beating the Recession

By Nelson Hyde

As oil prices remain high and the economy softens, like many industries, the recreational vehicle (RV) market has been hard hit. Sales are down 17% from last year and even more in some segments. The knee-jerk reaction of most vendors selling into industries like that is to lower prices. Yet some vendors in the RV industry have recently raised prices. How did they do that?

It all comes down to clear, consistent communications–and strong fortitude. One company anticipated and planned for the downturn. Managers knew costs were going up so they developed very clear, specific messages about the need to raise prices, well ahead of contract renewals. They presented a legitimate and understandable rationale–costs were rising–and highlighted ways it had already aggressively managed costs down. They talked up the story, both individually with large customers and in carefully chosen industry forums where everyone, including competitors could hear the story. They had a well-thought out plan for how to respond and communicate if market players tried to take advantage of their increases and carefully analyzed each competitive move.

It worked, they maintained their share, didn’t see a dramatic sales decline, and most importantly, profits stayed high, too. It didn’t require rocket science –but it did take advanced planning, exceptional execution, staying on message, and the guts to do something that everyone else said couldn’t be done.

Agassed at Hertz Pricing

By Dr. Reed Holden

Yes, I know ‘agassed’ is spelled wrong–that was to make a point. I spend more time in Hertz cars than my own. It's always been interesting to watch them look for "pockets of profitability" with their exorbitant prices for gas. While it's well accepted, it's something a loyal customer notices. When they go overboard by not filling the tanks up, that's a different story. When I noticed it the first time, I mentioned it to the manager. The second time and third time, I rented from Avis–that's the nice thing about being a consumer–we can vote with our feet.

I was recently in North Carolina, and my Hertz Honda was pasted with yellow sticky notes asking me to trust their new gas prices and not fill up at the station just outside the airport. Sure enough, the price for their gas was $3.77–two cents less than the service station. That's a great way to build another brick to the foundation of customer loyalty–proactively moving to a "fairer" pricing strategy. It will be interesting to see if they've done the same thing at SFO. I highly doubt it, but if they do, you'll sure hear about it.

I'll Bet United Airlines Won't Blame it on Pricing

By Dr. Reed Holden

So, it's Sunday and still a travel day. What better time to point to the growing pile of writers who believe that United Airlines just needs a yellow rose to compliment the grave. Roben Farzad of BusinessWeek wrote an article (United: O'Hare Today, Gone Tomorrow) where he believes that it's all over but the funeral for United Airlines.

Those of you who follow my blog know that I switched from United to American for a bulk of my travel several years ago. The switch was driven not by the lousy service–we get that from most airlines when we travel–but by the pricing. I had to make a last minute change due to a United cancellation and got charged an additional $1,200 for the change. Did I complain? Sure, but nobody listened. That was it. Game, point, match. Despite 20 years of loyalty, I left United. Despite better flight schedules to one of my popular haunts, San Francisco, I just left and will now do anything I can to avoid flying on United Airlines.

Sure, similar things have happened on American, but they have a) been responsive and b) their upcharges are nowhere near what United got away with. I should say got away with in the short term. Price sensitivity analysis might show that the airlines can screw us in the short term, but don't we have great memories, and when we get hosed enough, we're going to make the switch.

When United goes under, as they probably will, they'll blame fuel prices, they'll blame the pilots, and they’ll blame the mechanics. Heck, they'll probably even blame the customers who departed. They won't blame the two real culprits. The first is the pricing that drove loyal customers away from them. The second are the guys who should be hanging in the management hall of shame: the managers who let this happen.

Good Reading!

The Pixar Touch: The Making of a Company by David A. Price, 2008, Alfred A. Knopf, New York, New York. I'm not much of a historian, but I do love business history. As we look at successful businesses today, the truth is that the path to getting there was ugly and littered with good, bad, and daring decisions. If you are like that, then this will be a good and interesting read. It's about the evolution of a business and a technology. It’s also about the people who made the commitment and stuck to it despite advice and pressure from some very powerful people.

Newsletter: July 25, 2008

The Apple 3G: Finally A Better Sequential Skim Pricing Story! | But What About My Frequent Flier Miles? | SAP and Oracle Raise Prices…Because They Can | Great Pricing Sometimes Means You Can Gobble Up Competitors | Negotiations with a Footing Guy | Good Reading!

The Apple 3G: Finally, A Better Sequential Skim Pricing Story!

By Dr. Reed Holden

Apple recently announced the introduction of the 3G iPhone. The 8 GB model is being sold for $199, and the 16 GB model goes for $299. It's worth noting that inside sources say that 8 GB of flash memory only costs $2–so, the profit on the higher-end model is quite a bit higher, as well it should be. This is 1-1/2 years after the introduction of the iPhone for $700 and the $200 price cut several months later. What's my real reaction to all this? Finally, all of us pricing consultants will be able to dump the old Polaroid charts when we talk about sequential skim pricing.

Sequential skim pricing is used for both consumer products and business products when the initial product is high value and somewhat proprietary. The basic concept is to start with skim pricing (high relative to competitors and/or value) and sequentially drop the price and product value down. It's a way to start by pricing the product high to both reflect its value and appeal to the early adopters, who tend not to be price sensitive. Once the early adopters buy, the high prices prevent the broader market from purchasing. So, conventional wisdom is to drop the prices of the high-value phone to appeal to the broader market and begin introducing different versions to cover the high- and low-value price points. Apple's second step was to offer different levels of memory. With the 3G, they continue the process.

What's the result? People were lined up at Boston's Apple Store (biggest in the world yet) 24 hours before they opened this morning to get access to this new gem. The technical guys have their knickers all twisted, because the 3G basic has limited functions and users can/have to spend all sorts of money to get additional features. Hey guys: THAT’S THE POINT! It's a low value, flanking product strategy. If you want the features, spend the bucks.

This was Polaroid's strategy for years as they introduced new technology cameras. The first one sold for a lot, then they discounted it, then they introduced a camera that wasn't gold plated at a lower price, then they introduced one that was plastic at a rock bottom price. For decades, it was the best example of a sequential skim pricing strategy–one that most pricing consultants loved to talk about. Polaroid, having lost sight of the fact that they were in the film business, not the camera business, is a mere shadow of its former self. This is the next millennium, and now we have a new story. Thanks, Steve Jobs!

But What About My Frequent Flier Miles?

From “We’re All There, And Here,” Carolyn Johnson, Boston Globe, July 14, 2008

Commentary by Steve Haggett

Videoconferencing technology was introduced in the 1980’s but failed to catch on. Companies touted George Jetsonian technology features, such as compression rates and bits-per-second call speed. The industry technology leader, PictureTel, lost over $100 million and was absorbed by a smaller rival, Polycom.

Now, rising travel costs are providing a huge boost to the industry. “Oddly enough, the economic recession is helping our sales, which seems counterintuitive,” notes Polycom vice president of marketing Joan Vandermate.“ This is one of those technologies that [benefits] when organizations look to cut operational expense.”

EMC, according to the Boston Globe, has saved $300,000 in travel costs and 3,000 employee work hours–the equivalent of 1.5 employees
WR Grace said it cut travel and outsourcing costs by $8 million in one year
Cisco has saved a staggering $150 million in travel costs (apparently they stay in different hotels than I do)

This article reads like a how-to guide in value-based pricing in an economic downturn. Advanced telepresence systems cost $200,000 or more each. However, when first-year savings represent anywhere from two to 750 times that, the price is almost irrelevant.

In tough economic cycles like this, spending the time to interview existing customers and quantify the value of your offering is the single most powerful tool available to fuel sales growth. Discounting is easily matched–or increased–by competitors facing the same pressures, but value quantification offers a unique selling proposition.

Of course, the downside of this technology is the loss of the joys of exotic business travel.

SAP and Oracle Raise Prices…Because They Can

From “SAP, Oracle Boost Software Prices,” The Wall Street Journal, July 17, 2008; Page B9

Commentary by Mark Burton

In the past several weeks, software industry titans Oracle and SAP have both announced significant price increases. Oracle raised list prices on its software 15% - 20%. This also has a knock-on effect for maintenance and support as those prices are tied to license prices. Similarly SAP raised its prices on maintenance and support by 30% and introduced added services.

The market for enterprise software has been marked by bloody price competition for several years. The recent consolidation, driven in large part by Oracle, has enabled the survivors to regain pricing power–and they are exercising it. Good for them! As we say in Pricing with Confidence and in our seminars, there is only one purpose for price–to increase profits. After paying their dues, Oracle and SAP are doing just that.

I know what you’re thinking. “It must be nice to be in an industry with just two major players. If we were, we could raise prices, too.” First, even with a limited number of competitors, it doesn’t always work that way (see Boeing versus Airbus). Second, every firm has some offerings and parts of the market where they are differentiated and can increase prices.

We see too many managers adopt the mindset that their offerings are commodities and give up hope of exercising pricing power. They become price victims. As the old saying goes, if you think you can’t–you’re right. The companies that succeed in making pricing a strategic asset have a different mindset. They are constantly looking for opportunities to improve prices through understanding their value, creating new offerings, or even fighting the change in the structure of their industries. What’s your pricing mindset? Are you a victim or a leader?

Great Pricing Sometimes Means You Can Gobble Up Competitors

By Dr. Reed Holden

We've long known that companies with smart pricing learn to increase both sales and revenue. Yes, it does get tougher in a downturn, but the sharp ones know how to protect profit at the expense of sales. One of our poster companies for great pricing has been Dow Chemical.

We talked about the wisdom of Dow's Xiameter product line as a low-value flanking offering in Pricing with Confidence. They introduced the line specifically for price-oriented customers. It is available at a 20% discount, as long as customers are willing to accept bulk purchases, longer lead times, no technical service, and a limited number of products. With Xiameter, Dow has been able to continue to grow without lowering prices in the downturn.

It is also because they have been one of the leaders in using cost increases to justify increases in prices in the current downturn. They've been talking about rising raw material prices and eventually raised their own prices a whopping 20%. A smart thing to do in the current environment–all customers understand that costs are going up, so why not? It's a lot smarter than taking it on the chin with lower profits when you don't have to.

Well, I guess there is some justice in the world–Dow Chemical has announced that they will be purchasing somewhat competitor Rohm and Haas (R & H). The acquisition gives them an opportunity to continue their move out of commodity products into higher-value areas. They have paid a high price to do that, but our bet is that they will make this acquisition count for their business and their shareholders. And, if they can get the pricing capabilities of R & H improved, it should really pay off for all concerned. This will be fun to watch.

Negotiations with a Footing Guy

By Alison Yama

Recently, I’ve been searching for the perfect footing for my back yard horse ring, something that is easy on my horse’s joints, yet stable enough to prevent slipping. It’s been a difficult search–there are many suppliers out there touting their footing as the best. Finally, I narrowed it down to two suppliers: one local, one based on the West Coast.

The local supplier was my favorite. Shipping would be less, of course, but I also have experiences riding (and falling!) on it as well. But the West Coast supplier was highly reputable, and the list of installations for their footing was impressive–and their material was on sale. I called the local supplier to let them know that I had gotten a better price from the West Coast supplier, expecting them to rise to the occasion and drop their price. I told him their footing was the same as the other guy’s, and the lower price would have my business. Instead, the local supplier told me that he would have to research the competitor’s footing and get back to me.

Well, he called back the next business day and told me, “I checked out the West Coast footing, and I would like you to go speak to people who have had it installed for a long time. You see, that footing is made with crushed sporting goods rubber, and ours is made with tires. Ours is going to last a lot longer.” He continued, “So we aren’t decreasing our price.” There it was. The value sell. To top it off, he added, “And we can deliver on Wednesday.” That’s a full week before the other company could even hope to get the footing out to me. Sold.

I wasn’t happy that I didn’t get my discount, but I will be thrilled with the product. I will also take away a few lessons from this experience: 1) My local supplier had pricing confidence that came from doing his homework about the competitor’s footing, and 2) He also was willing to walk away from business that was potentially not profitable and let the competitor have it, in order to protect his pricing. Don’t you wish you all could do this?

Good Reading!

Exceeding Customer Expectations by Kirk Kazanjian, 2007 Doubleday Broadway Publishing Group, New York, NY. This is not as much a book about pricing as it is about how to build and grow a world class company. This is a no BS, inside look at how Enterprise quietly and competently became the #1 car rental company in the U.S. We get to learn about how they price used cars ("no-haggle"), how they respond to customers (fast and well), and how they absolutely trounced their competitors by focusing on getting the job done. Finally, we learn about how they used simple market research to evaluate performance and how they used the results to become the best in the business. A good, quick read too!
The Big Talk: How to Win Clients, Deliver Great Presentations and Solve Conflicts at Work by Debra Fine, 2008, Hyperion, New York, NY. There are some good points in this book, but it suffers from one big problem–the author jumps around too much. One minute she’s talking about dealing with the boss, the next, it's a problem employee. My sense is that she would have been better served with better organization. A bit of a disappointment.

Newsletter: June 24, 2008

Dumbbell Pricing Returns to the Airlines or Goodbye Sweet American

By Dr. Reed Holden

We've all heard about the rising price of fuel and how that has impacted the costs and profits of most businesses in the world today. It is especially a problem in the airlines business where more efficient, lower cost carriers continue to eat the lunch of the major airlines.

In past columns, I've been quite critical of most of the majors (except Alaska Air, American Airlines, and possibly Delta) for charging loyal customers extremely high prices to change a ticket. It’s called dumbbell pricing, because there two price distributions that result from the practice. This results in high prices at one end and low prices at the other end, and it looks just like a dumbbell.

I got hit by a $1500 change fee from United several years ago, and that was the straw that broke the back of loyalty to United. So as a weekly business traveler, I moved my travel business over to American. Until today, I've been quite satisfied with both their service and their pricing. They have very reasonable rates (they allegedly moved to every day low pricing several years ago) and reasonable change fees–no more than $300 to $400.

Well, I just got off the phone after changing a reservation for travel next week. Moving the reservation cost me $911. Yes, I understand their logic. Travel closer to the time of departure is less price sensitive, and the $421 ticket is now probably worth $1,300 in the open market.

Here's the problem–with all of my knowledge of what is going on in the cost of fuel and competition in the aviation business, added to my alleged experience in and knowledge of proper pricing strategies and models of yield management–I STILL FEEL LIKE I GOT HOSED. Now, if I feel like that, imagine how the uninformed buyer feels. I had high hopes for the logic of American's pricing model, but they have let desperation outweigh their concern for loyal customers–always a danger sign. Any time companies begin taking advantage of their loyal customers, the decline is usually in sight. When it happens, American will blame competition and costs, but that won't be the real reason. It rarely is. Loyal customers understand a firm's need to recoup costs–but only reasonable costs. Hosed customers turn into switchers and/or price buyers, thus dramatically undermining the profit structure of any business.

There is one ray of light in this cave of pricing darkness. The ticket agent, Alfred Lloyd, was quite understanding and maybe glad that I didn't blow up with him. I agreed to book the ticket and explained that this would probably impact my future loyalty to American and why. He apologized and put me on the first class upgrade list for no charge. Smart employees can sometimes compensate for lousy management. I'm not sure it will work in this case. Safe and disgruntled flying!

This Month’s Pricing with Confidence Award – Goes to NVIDIA

Commentary by Mark Burton

From “NVIDIA Plays Hardball with 3-D Card Pricing,” CNET news.com, June 19, 2008

Let’s face it. A lot of the rhetoric about pricing to value often goes right out the window when you sell your products through powerful distribution channels. Poorly designed and executed channel strategies cause all kinds of problems for managers who want to use price strategically to increase profits. Since most distributors have razor-thin margins, they make money by driving inventory turns. And often, the tool they rely on to do this is price-discounting. The problem is that this approach leads to adversarial behind-the-scenes price negotiations with the OEM and open conflict in the market as distributors look to undercut each others prices to gain volume. None of this is good for the profits of the OEM. The result is that many OEM’s view their channels as necessary evils, not true partners.

Graphics chip maker NVIDIA is working to change the game. Supported by recent legal rulings in the US, they are actively seeking to enforce Manufactured Advertised Pricing (MAP) policies that enable them to exert stronger influence over the retail prices of their products. While this is viewed as breaking ranks within the business, their apparent rationale is sound. Reducing price competition arising from channel conflict improves profits for licensed distributors and thus makes them better partners. Increased influence over actual selling prices can also serve as a lever to better control gray market activities. Both should enable NVIDIA to focus on the one and only purpose for pricing moves–increasing profits.

Taking on your channels can be scary. After all, they seem to hold so much power through the volumes they deliver. It’s actually not that complicated. It takes some insight into how to make everyone more profitable and the confidence to stand up to entrenched practices to protect for your value.

What’s In a Name?

By Steve Haggett

Anyone who attends events–concerts, sports, shows–deals with Ticketmaster.

Ticketmaster has built an enviable business model based on monopoly. You want to see Police, or the Celtics, or Lion King? You have to buy tickets through Ticketmaster. As a monopolist, they have the right to mark up the tickets as they wish.

In a related story in recent newsletters, we have commented on Canadian airlines charging a fuel surcharge, while American Airlines charges for checked bags. One fee is accepted as sensible; one is harder to understand and is objectionable. Why charge me for luggage if it’s fuel prices that are driving your costs?

The fee that raises my blood pressure every time I face it is the Convenience Fee.

To purchase a ticket, I have to wait online, navigate their system, type in the squiggly CAPTCHA (Completely Automated Turing Test To Tell Computers and Humans Apart) word, and pay for the ticket, delivery fee, and maybe a venue-renovation surcharge. And then there is the Ticketmaster Convenience Fee. Where is my convenience?

Most customers don’t mind paying for the offering they are requesting–and receiving. A Ticketmaster Processing Fee would be understandable. That Convenience Fee always gets me.

Just a Thought–The Price of Loyalty

By Dr. Reed Holden

We spent the week in San Francisco recently in two different hotels. The differences were interesting. The Westin in downtown was expensive and luxurious. The La Quinta at the airport was cheap and spartan. The Westin charged $54 for parking; the La Quinta parking is free. The Westin charged $15 for 24 hours of Internet access; the La Quinta gave it for free. The Westin charged a lot for breakfast; the La Quinta had a free buffet.

If La Quinta gives all this stuff free as an incentive to stay there (it did), does the Westin charge for it all because it can (yes) and as a disincentive to stay (yes)? What does that do to the loyalty for Westin users (decreases it)? Here's the rule–never get greedy with your loyal customers. As an alternative to charging for everything, think about offering a "full menu" price to customers. If you have to drop price to meet competition with non-loyal customers, take the "free" things away and charge these to price-oriented customers only.

Does That Come With Fries?

Commentary by Steve Haggett

From “Burger King Launches World’s Most Expensive Hamburger,” Fox News, June 19, 2008

When Burger King launched the Whopper in 1957, the 29¢ price was almost double the 15¢ McDonald’s hamburger. It was bigger; it had more stuff; it was the super-premium.

The folks at Burger King are back at it. This time with a burger boasting Wagyu beef, Italian white truffles, Pata Nega ham slices, pink Himalayan rock salt, Iranian saffron, and other delicacies. It’s price? Two hundred bucks.

Don’t line up at the local drive-through yet. This is currently featured only in London– and selling surprisingly well. Before anyone complains about decadence and obese profits–Burger King is donating all the proceeds to a London youth charity.

However, Burger King will gain plenty of attention, no matter how many are sold. By offering a small number of super-premium burgers, Burger King claims a position as the premium fast-food competitor. The coverage of the high-priced launch, which is reportedly one tasty burger, should offer a value trickle-down affect while it raises awareness. Similarly, Sam Adams consistently sells out its production of Utopia, a high-quality, high-alcohol beer priced at $130 a bottle.

The Whopper is a bargain by comparison.

In Favor of High Gas Prices

By Dr. Reed Holden

We were out for dinner last week and someone sitting next to us started complaining about the high price of gas. Me? I went right down that road with him. The price of fuel seems to have doubled in the past six months. Gas prices go up on a daily basis, and it's been affecting prices for everything else–food, heat, electricity, basic materials.

We're lucky–we can afford it. But think about those who have to make the choice between eating or heating a home or driving to work. How about having to keep your kids in clothing or in food? Times are tough in America, and they're tough for just about everybody. And it seems that the root cause of it is fuel prices.

Well, then I started thinking about what's been going on around our house. Suddenly those funny looking energy efficient light bulbs I purchased in a weak moment, the ones that had been gathering dust, are being brought out and put to good use. We're keeping the AC turned up and the heat turned down. Recognizing that we have four too many cylinders in the garage, we have a plan in place to reduce driving, rely on the most efficient vehicle, and swap them out for more fuel-efficient cars when the time comes. We've even selected the best hybrid car when that time comes.

For home, we bought a soda machine with a plan in place to stop using plastic bottles. We are learning to use canvas bags for shopping instead of taking plastic bags. We're even using biodegradable poop bags for the dogs. Though I must admit that I'm holding out on the poop bags until Carolyn tests the extent of their biodegradability.

The fact is that we've all gotten lazy. We're turning into a nation that wastes too much and uses too much. There was an article in The New York Times recently that looked at the consumption of electricity in the United States. It contained some interesting numbers. PLEASE PAY ATTENTION!

We consume 13.8 quadrillion btu's of electricity every year. I'm going to call them q's. The article didn't mention if this was in the US or the globe, but I'm going to assume the US. 3% is lost when it is transmitted through wires (seems like electronic friction to me). That means we really need 14.2 q's to get through the night. Now here's the rub. Coal powered plants produce 20.7 q's. Huh? Did you have to go back and look at the number? So did I. The reason is that coal, nuclear, and to a less extent, natural gas are inefficient at getting the power to the wires. They waste over 60% of their g's just making the power. Leaky pipes, inefficient turbines, etc. What is efficient? Windmills. In fact, though windmills currently create only 11% of our electricity, they create 33% of the energy we need. That's because they plug right into a pretty efficient electrical network. Here in Massachusetts, residents on Cape Cod have been fighting a wind farm for years. The guys in California bit the bullet long ago, and they're doing their part to end this madness.

What's the point in connection with oil prices? Easy. We use oil to heat our homes, but maybe we should be using electricity. To do that, we have to dump coal electricity production and open up lots more windmill production. What's getting in the way? The environmentalists and politicians. Time to get efficient folks. Time to start demanding that our politicians start doing the same thing. Time for the environmentalists to start recognizing that a wind farm is good for our ecology and, by the way, it's good for fishing.

One thing I know is that we as a country can always rise to the occasion when we need to. In World War II, we started in 1939 as a second-rate military power (number 17, if I recall). When it was over, we had risen as a nation to vanquish the bad guys. We did the same thing after September 11. But now we've gotten lazy. Response to Hurricane Katrina should put us all to shame. Maybe the high oil prices will give us the kick in the butt we need. Me, as an individual, I'm going to try to do better. I AM going to do better. But it has to move to more of us to do the same thing. And it has to cause us to demand more from our energy companies and our politicians.

High gas prices? Bring it on. We're going to beat this one, too. But we all have to stop being victims and start being part of the solutionS! And, yes, the S is intentional.

Good Reading!

Optimal Bundling: Marketing Strategies for Improving Economic Performance, Edited by Ralph Fuerderer, Andreas Herrmann and Georg Wuebker, 1999, Springer-Verlag, Berlin, Germany. This book is a collection of working papers on the theory behind and the state of bundling and pricing of products and services. As such, it is a very technical work. But it does contain good and complete examples of work done by some of the leading scholars and practitioners in the field.
The Speed of Trust: The One Thing That Changes Everything by Stephen M. R. Covey with Rebecca R. Merrill, 2006, Simon & Schuster, New York, NY. OK, maybe I'm biased by a few years of research on trust, but I did like this book. Trust is something that is often dismissed as not being relevant in business. The son of Stephen Covey, the Seven Habits guy, does a great job of not only showing why it is important, but he gives great advice on how to get there. Too many managers make little slips in this area and wonder why they don't have a culture of trust. If you're worried about that, read this and find out where the problems are.
Our Iceberg is Melting by John Kotter and Holger Rathgeber, 2005 St. Marten's Press, New York, NY. John Kotter is one of the leading specialists in organizational change, and he has finally become "Blanchardized." You might be familiar with how Ken Blanchard and his cohorts develop memorable stories to go along with their models and books. This one is an entertaining and quick read about the eight steps that organizations need to think about in addressing change. Pretty good for the troops if you're going through a change process.

Newsletter: May 30, 2008

Profits are More Important Than Revenue in a Downturn

By Dr. Reed Holden

Yikes, another discussion of pricing in a downturn. Sorry, but I just finished an interview with Fast Company magazine,and the discussion point was how to get more for less. The writer’s initial thought was to figure out how to get more lean in a downturn by cutting costs and driving more efficiency at the same time. The problem is that cost cutting and efficiency can only go so far–you run out of fat to cut and you can only get so efficient.

We ended up talking about how most managers use price to solve revenue problems in a downturn. That's the real problem–when business slows, managers offer more discounts to hit revenue targets when they should be lowering the revenue targets first, since that move saves profits. It's unfortunate that we couldn't have spent more on that subject–how to get more profits using fewer discounts.

One of the keys to success in a downturn is to stop chasing unrealistic revenue goals with price discounts. The revenue you thought you were going to get just isn't there any more. As we've discussed probably too many times before, chasing declining revenue with price discounts just makes the problem worse--you end up with less revenue and no profit. Smart pricers look for ways to eliminate discounts, especially on high value products and services–even in a downturn!

Let's look at two examples from our local paper, The Boston Globe. On April 25, they reported that Ford "Surprises with 1st-quarter profit of $100M." Remember, we talked about Ford in December? About how they had cut sales expectations and shut down capacity. Now we see that they're one of the few auto makers that made a profit. Also, the Globe reported that "Demand (is) down at Thermo Fisher." The real news of that header is that first quarter profits "rose sharply." That should have been the headline! Unfortunately, the press hasn't figured this out yet.

In Tough Times – Price Transparency is Key

Commentary by Mark Burton

From “Fuel costs will lessen demand, Air Canada says,” The Globe and Mail, May 22, 2008

While American Airlines was making headlines through its “creative” means for dealing with higher fuel costs, Air Canada and its local competitors WestJet and Porter Airlines were trying something truly revolutionary: telling their customers the truth. All three Canadian airlines are dealing with the same escalating fuel prices that American is, but they have chosen a very different path. Rather than taking away basic services that have always been offered for free, they are adding a separate fuel surcharge onto their tickets.

The smart money is that Air Canada and the gang will have a much easier time of it than American for a couple of reasons. First is the issue of fairness. The skyrocketing cost of oil is in the news every day. Consumers are aware of it and are more likely to be accepting of a price increase that is driven by the costs of a key input that they understand. In addition, by calling out the fuel surcharge separately, the Canadian airlines are making the oil industry the bad guys in their approach–a perception that is already widely held. In contrast, American is giving customers the impression that service will suffer (now I’ve always had to carry my bag on–and those already crowded overhead bins just became more valuable than beachfront real estate on Maui) and thus damaging their own brand, rather than fobbing the problem off onto already unpopular suppliers.

The second reason is that the competitors in Canada are more disciplined. When Air Canada first rolled out their surcharge, they hid it in the fine print–and subsequently got whacked by full-page newspaper ads from WestJet, pointing how they don’t hide anything from their customers. This public shaming of Air Canada reminded all players of their common cause and has led to a consistent pricing approach. If only American Airlines were as smart as our friends north of the border.

Giving Credit Where It's Due

Commentary by Dr. Reed Holden

From "Dell Cuts Gap with PC Leader Hewlett-Packard,” The Wall Street Journal, Thursday, April 17, 2008

We've been pretty hard on Dell for the past two years. They used price discounts well into the downturn and paid for them with dramatically lower revenue. To make matters worse, Hewlett-Packard, under CEO Mark Hurd, made a change in strategy to better support their dealer firms. As a result, they took over the number one position in global PC sales by leveraging their strength in retail. They did this by better leverage, a distinctive competence, rather than going after Dell aggressively in the direct business.

Now we're beginning to see the results of Dell's response–expanding into retail. Dell has a big enough brand that they will do well in retail, as long as they don't blow their "hybrid" pricing strategy. When businesses sell direct, they have control of price discounting. When they sell through distribution and direct, they have to be careful of "bounding" their selling so that dealers don't compete much with their direct business and prices are rationalized in each channel to accomplish that goal.

It made sense for HP to focus on retail distribution because the dealers still control a bulk of the global PC business. It made sense for Dell to expand into retail, because, while they dominate the direct PC business, if they want to continue to grow, it's going to take a move into distribution. The current result is that both firms are growing share and shipments.

The big question lingering in my mind is: how are their profits doing? Dell just cut 10% of its workforce, reflecting the pressures of the downturn. As business leaders using pricing correctly, they should be able to drop revenue and grow profits in a downturn. My guess is that Dell is still going to be struggling with profits. At any rate, we'll continue to follow this–it's fun to watch.

Flank Steak

Commentary by Steve Haggett

From “Cutback Cuisine: With food costs soaring, restaurants are making changes” by Juliet Chung, The Wall Street Journal, March 8, 2008

Restaurants are currently caught between two opposing forces:

An inflationary impact on supply, driven by rising oil prices increasing transportation costs, and all corn-based food costs and also by the weak dollar, increasing the cost of all imported foods.
A recessionary impact on demand, reducing the number of families eating out at restaurants.

The inflationary force pushes prices up. The recessionary force pulls prices down. Simultaneously, restaurants face the demand to raise prices across the board and to lower prices across the board.

Sound familiar?

Anytime a business faces this problem, we look to a flanking strategy, replacing some high-value options with low-value options, yielding a tiered menu. Smart restaurants are adopting the same strategy right now. For example, Gramercy Tavern in New York is replacing caviar-topped hamachi with tuna and beet tartare and tenderloin trimmings at Murray’s Steakhouse in Minneapolis that used to be ground into hamburger are now re-named steak tartare at $12.95.

A flanking strategy enables companies to protect their premium-priced offerings (prime rib, the wine menu) for value-oriented customers, while offering an affordable option for price-oriented customers. The strategy protects volume, covering capacity costs; protects premium prices, lessening pressure to reduce prices on the high-value offerings; and flanks competitors offering cheaper substitutes.

It's the Services, Unenlightened One (Didn't want to say Dummy!)

Commentary by Dr. Reed Holden

From "IBM Lifts Estimate as Profit Jumps 26%" by William M. Bulkeley, The Wall Street Journal, Thursday, April 27, 2008

There are really two ways to make money in a downturn. The first is to walk away from price negotiations which will turn into price wars. That is, turn down unprofitable business–let your competitors take it. We know of several companies that are doing that now with dramatic results. The other way is to better leverage services. IBM, which started it's "services transformation" under then CEO, Lou Gerstner in the early 1990's, is seeing extraordinary pay-off, even in the midst of what is turning into a global recession.

Sure, currency devaluation helped. With a bulk of its business coming outside the US, IBM is able to weather the devaluation of the dollar better than most. Revenue is up a bit but profits are exploding higher. They're declining in the semiconductor business but are growing in the "way beyond mature" mainframe business. Remember when the strategy pundits told them to get out of that business? Good thing they didn't.

By focusing their development on the services that wrap around their technology, they were able to weather the decline in hardware demand. Even in downturns, customers want their IT systems to improve in how they handle internal applications and external relationships with customers. Providing more and better services to customers expands the customer and global footprint and protects firms from the decline in demand during a recession. Finally, it gives salespeople more price leverage with customers.

Some Simple Advice About HP/EDS

By Dr. Reed Holden

I have a pile of articles about the proposed acquisition of EDS by Hewlett Packard. The one that struck me most was from Business Week. They expect the acquisition to be a bit of a disaster and use the 10% decline in HP's stock price as an indication of the doom to come. The problem is that they might be right.

In recent years, EDS has struggled to move from their "your mess for less" strategy to one of value-added IT services. Yes, they have had a lot of change at the CEO level, but current CEO Ronald Rittenmeyer seems to have the business back on track with some level of profitability. The problem was that he couldn't change their strategy that fast, especially with the blistering price-oriented competition from increasingly higher-quality Indian competitors like Wipro.

HP is getting their product portfolio back on a strong track, and their services business continues to do well, though still a number seven player on the global scene. Rather than continue the growth approach, CEO Mark Hurd decided that an acquisition would help them play with the big boys, especially number one IT services provided by IBM.

There are a lot of things to think about. EDS has a lot of high quality and capable people. Yet, we know that most acquisitions fail to deliver their promises in growth and profits. This one looks problematic, given the very different, yet strong cultures of the two firms.

The reason that Business Week was negative was because of the competitive nature of the IT services business. They feel that with the continued growth of Indian-based competitors like Wipro, HP will spend a lot of money to get into a business that is rapidly becoming commoditized. BusinessWeek is right to be cautious, because HP must be able to distinguish and leverage their competitive competence. Clearly, a cost reduction approach is going to put them right into Wipro's sweet spot. Fortunately, there is still the fact that most customers continue to be very dissatisfied with the price-oriented approach of even the best IT services firms. Hurd will need to understand how the new HP can do better than the others and charge for that difference with customers that are willing to pay for it. If he can do that, HP will do just fine. We wish them luck.

Good Reading!

Value Creation: The Power of Brand Equity by William Neal and Ron Strauss, 2008, Cengage Learning, Mason, Ohio. I'm going to warn you right up front that the punch line of this book is using the author's predictive model for improving the effectiveness of branding efforts. Generally, you know I frown on consultants writing books where you have to use their services to get anything out of it. Fortunately, this isn't the case here. It is a well-written, well-researched effort which ties the brand identity to not only the CEO but other constituencies in the firm–workers, customers, and dealers. I like the way it connects brand results and satisfied customers with happy employees and draws well from the work of people like Fred Reiccheld along the way. This is both an introductory and a technical book, but for those who use branding research, there is an excellent discussion of different methods. I did find the few chapters that had a long story in them a bit distracting.

Getting to Yes: Negotiating Agreement Without Giving In by Roger Fisher and William Ury. Second Edition, 1991, Penguin Books, New York, New York. I have to admit that I was pleasantly surprised by this oldie but goodie. Generally, books on negotiating lack the depth needed to deal with price-oriented customers in today's world. This book does not suffer from that malady. It is a well-written book that covers a wide range of negotiating topics in a manner that provides the reader with great insights on improving their skills. It doesn't really get to specifics on aggressive price negotiations, but with a little bit of thought, it's not hard to connect the dots there, too.

Newsletter: April 18, 2008

The Value of Kicking the Discounting Habit

By Reed Holden

In the 1980's McKinsey did a study that showed if a firm was going to focus on improving something, the area with the highest return was pricing. By improving pricing by 1%, they said, firms could see an 11% improvement in the net profits of the firm. This was a lot more than anything else the company could do. This was a terrific piece of research at the time. There are three problems today with the work. First, that was 20 years ago and a lot has changed. Certainly McKinsey has moved way beyond this conclusion. Second, every pricing consultant quotes this work as a justification for getting hired.

Finally, companies that pay attention to the conclusion are led to believe that all they have to do is raise prices to improve their performance. Here's what happens when they do that–some customers don't pay the increase. In fact, they often negotiate for lower prices. If the company tried to increase prices by 10%, they are happy when they get an average increase of 5%. Then they do it again the following year and again the following year. What they ignore is that some customers accept the increase and others don't. The ones that do end up paying prices that are sometimes over 100% higher than those that figured out how to negotiate for lower prices. Over time, more and more loyal customers figure this out and start asking for the same discounts.

That's why the first rule in Pricing with Confidence is to Kick the Discounting Habit. Rather than trying to raise prices to customers who won't pay for the increase, begin to look at the customers who are getting discounts that shouldn't. Put a line in the sand and stop giving them discounts. If you focus on this, we've found that returns to the bottom line exceed 20%. When I say exceed, I mean exceed–we've seen returns of 100%.

So if you want to fix your pricing, fix your discounting first. Yes, software can help to identify which customers get discounts but simple plots can do the same thing. By flexing your capabilities of saying "NO" to discounts, you begin to build your discipline around price execution. If you can't do this, all the software and strategy in the world isn't going to help. If you can, the payback is INCREDIBLE.

Skybus, Ya Think?

Commentary by Steve Haggett

From “Skybus Ends Service, Third Airline to Fold This Week,” By Nancy Kercheval, Bloomberg, April 5, 2008

Skybus Airlines shut down its engines this week, the third US air carrier to bail out in a week.

Skybus, a discount airline, was famous for offering $10 fares on flights to California, New York, Florida, and other destinations. “Nobody has a long-term viable business plan that can be sustained at these jet-fuel prices,” said Darryl Jenkins, an airline consultant. “What do you do in a situation like that?”

Charge more than $10 for a trip from New England to Florida?

The Skybus reservation page now states:
Skybus struggled to overcome the combination of rising jet fuel costs and a slowing economic environment. These two issues proved to be insurmountable for a new carrier.

But what is being mourned as a cost problem is wrapped up in a pricing problem. Who decided to set prices in competition with highway tolls, or the cost of a single movie ticket, or even the cost of sending an envelope to the same destination? When we read that US Airways has found problems on Boeing 757’s because “a wing part on one of its planes fell off during a flight” recently, those $10 fares start to sound like discount seafood. There is a discount price level below which a customer is forced to question basic safety. Would you respond to a new clinic at the strip mall offering $10 laser eye surgery or $10 brake replacements? There’s no way you’re getting me on the land bus from Boston to New York at $10, let alone the sky bus.

Customers understand rising fuel costs and have no expectation that an airline ticket across the country should cost significantly less than filling a gas tank. Fuel prices may have quickened its demise, but by choosing unrealistic reference prices, Skybus drove itself to the breakdown lane.

The Smart Way to Meet Competition

Commentary by Mark Burton

From “Verizon Attempts To Be More Competitive With Smartphone Plan Pricing,” InformationWeek.com, Eric Zeman, April 14, 2008

Let’s face it, sometimes the pressure to meet a competitor’s lower price can at times be unbearable. In the world of wireless service, all major providers have been playing “can you top this?” with recent roll-outs of flat-rate, all-you-can-eat voice and data plans. You can understand the dynamic. Once one competitor makes this switch, old-style (and more expensive pricing models) on your core services can drive customers to the competition.

It’s been interesting watching industry leader Verizon Wireless play this game. Having more to lose than some of their competitors, they were not the first to jump into the new pricing plans. And once they did, they set their prices higher–$45/month for data plans for smartphone users, compared to AT&T’s $30/month. This past week they gave into apparent competitive pressure and matched AT&T’s price.

What’s more interesting is what Verizon did to recover some of that lost revenue and to protect their high-value business. First, the new plan does not include integration with Microsoft Exchange. For this they rolled out two additional services–one at $8/month and one with more storage at $15/month. Second, this plan does not include owners of BlackBerries, who tend to be corporate users that run up larger monthly bills. By unbundling the offering but creating fences between high and low-value offerings and customers, Verizon has shown that they know effectively use price segmentation to maintain market position–and not panic when a competitor offers what appears to be a good deal.

Pricing is Important, But Not How You Think: How to Price Smart in a Recession

By Reed Holden

Yes, the economy is hurting and most companies are reacting with big price cuts to keep your people and machines busy. Yet despite those price cuts, customers don't buy more. In fact, they are buying less, because they're going through the same recession you are. Don't feel bad. Most managers react with the wrong pricing decision in a recession. And they find that price discounts are quickly matched by competitors causing declines in revenue and profits to disappear.

A far better approach when there is a downturn is in the following rules:

Reduce sales objectives before you discount price. Sales growth is no longer a reasonable objective. Using price discounts to achieve sales objectives is just going to destroy profits. Both GM and YRC International cut sales objectives going into the recession and have protected price and profits.

Develop low-value flanking offerings. If you have to drop price, do it with your low-value offering. Develop them by taking out high-value features and services. The alternative is to drop price on high-value offerings which undermines your value proposition and makes it harder to profit when the upturn starts. Nokia developed both high- and low-value phones to meet the needs of different geographic segments and has seen profits, revenue and share go up despite the recession.

Increase prices if your costs are going up–even in a recession, it is possible to get price increases if you use cost increases as a justification. Lots of commodities producers are doing this and increasing profits, despite decreasing revenue.

But only increase prices if it doesn't result in "dumbbell pricing." If only some of your customers pay the increase, be cautious of big differences in prices to similar size customers or of small customers paying lower prices than big customers. If that is the case, work on eliminating some of your discounts to those small customers. Many firms could improve profits by 20-40% or more just by eliminating unnecessary discounting.

Play better poker with customers. Customers want high-value products and services for a low price and play great poker to get them. Learn to bluff by taking valued features away if you reduce price. Even small companies can protect their profits and value propositions with smart negotiating.

Surviving in a recession is hard. Avoiding knee jerk reactions of price discounts is even harder. By following these simple rules, companies can not only survive but flourish in a downturn.

Star Wars

Commentary by Nelson Hyde

“Economy Fare ($100,000) Lifts Space-Tourism Race,” by Andy Pasztor, The Wall Street Journal, March 26, 2008.

What if you had a dramatic new technology under development that will create an entirely new industry? How would you price it? The first customer won’t be until 2010. Do you price it to reflect the value or is it already time to lower the price?

That’s XCOR Aerospace’s strategy in the emerging market for commercial space travel. XCOR will be flying civilians into space in a couple of years. Because XCOR’s development costs are one-fifth those of its chief rival (Richard Branson’s Virgin Galactic), XCOR is charging half of what Virgin is. Does that make sense?

Nope, not if it offers just as good an experience. The very first customers into space are not the kind of people who are going to worry about whether it costs a mere $100,000 versus a mere $200,000. The very earliest adopters don’t buy because the price is right, they buy because they want to be the first. They certainly won’t choose a carrier because its spaceship was cheaper to make. They will choose the carrier that gets them to space first, provides the best total experience, and has a spaceship with the best shot at getting them home again. In fact, you might argue that a low price might actually scare some people from buying. Would you rather be safe or cheap?

For the rest of us, price is clearly going to be an additional factor. So as the early adopter market becomes tapped out, it will be important for carriers to drop prices some to help fuel growth. That’s when XCOR’s strategy makes sense. But dropping price now only makes it harder for XCOR to recover its costs–and may even send the wrong signal: first-adopters will wonder exactly what XCOR compromised in order to keep price low.

When the Going Gets Tough, Focus on the Fundamentals

By Alison Yama

Wholesale prices are soaring, customers are beginning for discounts, layoffs abound, and we are squeezing out profit wherever we can. Now is not the time to panic. Now is the time to focus on the pricing fundamentals to survive this tough business cycle.

Business is not a sport – In sports, you never want to lose. In business, you have to be willing to walk away rather than actually win unprofitable business.
Never give up price without taking something away – If the customer wants a lower price, the answer is always “Yes, we can do that. But you want this offer here, without the services A, B, and C.” Lower price? Lower value.
Sell the people what they want – Don’t stop creating higher-value features and services just because times are tough. Customers are looking for ways to save money or make money now more than ever. Meet the need and win the business.
Put the money where your mouth is – Make sure that you can back up your value case with hard facts. Quantify how your high-value features and services help your customer save money or make money. This makes for a very persuasive case when customers are focusing on every dime.

Don’t worry about having all the perfect numbers available or installing the right systems in place – just focus on the fundamentals and you will see significant financial improvements immediately.

Innovating Down

Commentary by Steve Haggett

From “ANA Planning Budget Airline,” By Bruce Stanley, The Wall Street Journal, March 27, 2008

Companies depend on innovation to fuel revenue growth. A constant stream of new-generation services, break-through technologies, and advanced capabilities enable firms to differentiate, support value-based pricing, and grow profits. However, for successful companies, attacks seldom come from above but from below–from commodity firms offering discount products, nipping at your heels.

Japan’s All Nippon Airways is joining a number of firms who choose to innovate down–to launch a new low-cost offering targeting price buyers in their customer base. ANA is planning to launch a separate low-cost carrier as a competitive strategy, anticipating the opening of a fourth runway at Tokyo’s Haneda airport and the entry of additional competitors. “We’re just being realistic looking at the possible competitors,” says ANA spokesman Rob Henderson. ANA is planning to run the division outside Japan, away from the high costs of Tokyo.

Innovating down is often more challenging than innovating up. There are good reasons market leaders fear innovating down. The hard work building a premium brand can be threatened. Cannibalism as existing customers are tempted by the low-cost offering is a strong concern. Service leakage as adept, powerful customers attempt to demand the premium offering at the low-cost offering price is a third worry.

However, ANA’s strategy of separating the divisions helps build a powerful fence between the offerings. Further, the separate offerings enable ANA to maintain more customers within its corporate family, serving both price buyers and value buyers. This enables a company to focus more of it’s high-value services on the premium brand, rather than attempting an uneasy compromise.

For ANA, this move protects them from above and below–a reassuring strategy for an airline.

Good Reading!

The Price is Wrong: Understanding What Makes a Price Seem Fair and the True Cost of Unfair Pricing by Sarah Maxwell, PhD., 2008, John Wiley, Hoboken, NJ. This is a book about the psychology of pricing in a consumer environment. There are lots of good stories, insights and information for true students of pricing. Also, a lot of good insights about what to watch for in unfair pricing. There is a good discussion of pricing power and trust which is relevant in a BTB world. I liked this book–well written and interesting.

Newsletter: March 20, 2008

A Recession–So Now What?
By Reed Holden

We try to think ahead of an issue so that we can prepare for it. For the past six months, we've been talking about the recession and how to get prepared for it. Now it is here – that is -–according to The Wall Street Journal article on page A14, March 13, 2008 “Most Economists in Survey Say Recession is Here,” by Phil Izzo and Sudeep Reddy.

What should a manager do? First, you should do all the things you should have been doing for the past six months:

Keep a tight rein on expenses
Reconsider all capital projects
Lower expectations for demand and revenue for the near future
Make sure salespeople are focused on selling value to the customers who are willing to pay for it
Sell your low-value offering to all customers who don't want to pay for value.

OK, the real list is a lot longer than that, but notice that we intentionally left "lower prices" off this list. That's because lowering prices in a recession won't get you much. Why? Because competitors will match or beat them and customers aren't going to buy more volume no matter what you do–they're going through the same recession you are.

Second, you should be looking for signs of a turnaround. The signal we watch is a buildup in the early stages of our sales funnels. Maybe your clues are the number of customer inquiries or longer lead times. Right now, a lot of businesses are in survival mode. At some point, you're going to have to switch back to growth mode. Unless you're looking for the signs that the time is right, you're going to miss an opportunity to start growing again. OK, you may get the message eventually, but if you are looking ahead in the business cycle for the next change, you'll be ahead of the revenue and profit curve when it's done. Remember–always look ahead of the cycle. Manage for today, but be ready for tomorrow, whatever comes.

A Note to Supply Chain Managers – Welcome to the 21st Century
By Mark Burton

From “Beyond Buying” By Larry C. Giunipero, Robert B. Handfield, and Douglas L. Johansen, The Wall Street Journal, March 10, 2008

There was a fascinating piece in The Wall Street Journal about how there is a skills gap in many supply chain departments. With the increasing complexity of supply chains and globalization of all business, supply chain managers are recognizing that they need to be able to do much more than just beat up suppliers on price.

In short, many companies are recognizing the very real costs attached with being price buyers. Consider this quote from the story:

“(Supply chain managers) must resist the temptation to make decisions that satisfy short-term needs at the expense of long-term organizational goals. In particular, they must learn that price savings are not the holy grail. Usually, supply-chain managers have focused on getting the lowest price when picking suppliers. But increasingly, the managers in our focus groups said it's more important to examine the total cost of the deal. Purchasing from suppliers with a lower price may not be the smartest move.”

Here’s what we need to do. If your customers are not aware of the costs of price buying, you need to do your homework on the total cost of ownership of your solution versus low-price alternatives. You should also be able to prove how you help customers generate revenues. Finally, you should not try to sell full-value solutions to price-buying customers. One supplier to the auto industry that we know of always sold their best new technology to Ford a year before they offered it to GM.

As for the supply chain managers, we only have one thing to say. “Hey, nice to see you. Where have ‘ya been for the last 20 years?”

Using Price Protection to Break the Discounting Spiral
By Steve Haggett

From “Builders Court Buyers with ‘Price Protection’Dawn Wotapaka” The Wall Street Journal, February 6, 2008

Whatever you term it – “recession” according to the economists but only a “slowdown” according to the government – the economic situation has rocked the housing market. Dramatic price reductions and discounts have not been enough to calm frantic home buyers who have seen values spiral faster than a house built on an Indian burial ground.

The problem is the fear of further value losses between contract and delivery. New home buyers agree to a floor plan, appliances, and a specific price before construction is complete, and then await completion of the unit. During a period of rapid value erosion, buyers are holding off purchase, or canceling contracts during the interim period, leaving builders with dwindling cash and growing inventories. Banks expect home values to drop another 20% this year.

The immediate recourse is discounting to entice buyers, but the market uncertainty leaves both sides edgy. Builders’ attempts to offer anticipatory price reductions only creates a self-fulfilling prophesy, driving prices down and fears up.

In a spiraling market like this, an effective strategy is price indexing. Builders like Los Angeles-based KB Home and Ryland Group are offering “price protection” – linking the final price of a home to comparable home prices at the time of delivery. Although this move tends to increase commoditization, it solves the more immediate problem – reducing the cancellation rates and increasing close rates. Further, it communicates to the market that the seller does not fear further price erosion.

In a market characterized by fear and irrationality, an objective risk-sharing pricing strategy is more calming and more profitable than the spiral of anticipatory discounting, and can help you walk away from the light.

When Flanks Attack
By Steve Haggett

From “Drug Prices Surge Despite Criticisms On Campaign Trail” By Heather Won Tesoriero, The Wall Street Journal, February 21, 2008

Flanking strategies can be an effective means of protecting a premium price. Companies often use a low-value “price fighter” product to offer an option for price-oriented buyers in competitive, commodity-oriented markets, counteracting discount pressure on the premium product. You want a low price, we have the commodity offering. You want the performance and service benefits of the state-of-the-art offering, there is a premium price.

Often, it is the prior generation product that acts as the flanker. Seen as a commodity, the older generation offering has its price reduced to compete with other commodity offerings, both fighting back against competitors and offering a potential migration path for your customers up to your premium product.

However, discounting a prior generation product is risky business. A medical devices example shows the danger of flankers gone bad. When launching a new-generation heart device, an international devices firm recently cut the price of the existing product from $18,000 to $16,000, setting it up as the price fighter. However, that policy acted as an anchor, and quickly dragged the price of the new product down as well – which led to further discounts in the flanker, and so forth.

The pharmaceutical industry often follows a different path. As The Wall Street Journal article states, drug makers raise prices on the older generation product expressly to shift customers to the next-generation drug, where they enjoy patent protection. For example, Sanofi raised the price of sleep drug Ambien 70% ahead of the launch of Ambien CR, its new formulation.

When you are preparing to launch a new generation product that enjoys strong performance benefits or patent protection relative to competitors, this out-flanking strategy can be effective.

Mark Who?
By Reed Holden

We were having a discussion earlier this week about the CEOs who had made a real difference in their companies. Mark Hurd of Hewlett Packard came up. Here is a guy who took over a company that was on the ropes. Its share was down, sales were stagnant and profits were in decline. He took over from a CEO who had rock star status and was a big name in the press. No one really talks much about Mr. Hurd, and you don't see many articles about him. But take a look at the company.

Since he took over, HP has obtained the position as the number one global supplier of PCs. They did that by reversing the strategy of attacking Dell head-on and instead, relying on one of their strengths, their dealer network. To that end, HP has beefed up in-store promotions and local advertising for dealers and at the same time has shut down the national branding program that had questionable value anyway. Dealers are beginning to trust HP and certainly appreciate the resources being sent their direction. The result isn’t hard to figure out–dealer sales are up and HP is now the number one PC supplier in the world. Why? Satisfied dealers push your products. Wow, what a revelation.

I have to stop for a moment and give Mark Hurd his due. He is a good manager. He asks for and gets results from his team of leaders. No flash, all substance. In his own quiet manner, he has helped the tarnished star of Hewlett Packard regain its luster.

A Blue Star
By Reed Holden

We got a package in the mail yesterday from Dave Phillips of Vulcan Materials. Dave is a kitchen cabinet member (advisor on our new book), a long-standing professional pricer, and a good friend. The package contained a small flag with a blue star on it. The flag was a tradition from the proud war–World War II. When a family had a son (now its child) serving in the military, they hung the star on the front porch. Dave has one and now we have one.

As I think about Dave's grand gesture, I don't want to talk about the pride a parent feels when one of the kids is serving in the military, that's too personal. I do want to talk about the pride I feel in the military in general and the job they do at home and abroad for all of us. They are there for a reason–they understand it, and they are willing to sacrifice for it.

Too many times, we forget that. We spend more time talking about whether a war or a deployment is good or bad. The shadow of Vietnam loomed over the military for decades. The shadow was cast by a public that was more concerned about the "goodness" of the war than the terrible sacrifices those who fought it paid. That to me is the real tragedy of a war, when men and women sacrifice and those of us whom they're protecting don't appreciate it.

When Mike Lawson came back from Iraq, we asked him if it was a good war. He said it was. He talked about the progress. He talked about the motivation and good intentions of the Iraqis whom he was training. To me, his impression counted most of all. He had been in the arena.

We're going to hang the blue star–not in a gesture for a child serving, that's too private. We're going to hang the blue star in appreciation for all who serve in the military, past and present, for what they are trying to do and how, in the end, it helps all of us.

The day after finishing this article, I received an e-mail from Traci Inness who is a Medical Corpsman serving in the Middle East Theatre. We had sent Traci a care package the prior week. Her response, in part was: "I received the package on Wednesday just as I was returning from a 24-hour duty and was ecstatic when I saw it. Everything that was in the box is much appreciated by my fellow Corpsman and myself. Most of the guys here don’t have friends and family like I do that send them packages often. I love to share everything I receive just to put a smile on their faces when they are having a rough day or have been on a mission for more than 10 hours."

Here's a question for all of you: Do you want to have a good day? Of course you do. Then send a package to the troops. Forget who you are voting for. Forget whether you support the war. I got that e-mail early in the morning of what was going to be a long day. Boy, was it a good day because of that e-mail. If you're interested, here is a web site to give you some ideas: http://www.anysoldier.com.

Thanks for the blue star, Dave.

Good Reading!

In Search of Stupidity: Over 20 Years of High-Tech Marketing Disaster, Second Edition by Merrill R. Chapman. I've always like to learn from other's mistakes rather than my own, it's cheaper and more fun. This is a good book that pokes brutal fun at all of the high-tech blunders that occurred over the past twenty years. Yes, it does get a bit too technical for me at times, but if you want to know why your favorite technology company imploded, you'll probably find it here. Pricing? Oh yeah, enough discussion of pricing blunders to make it worthwhile too. Thanks to Jim Geisman of MarketShare (www.softwarepricing.com) for sending this book along.

The Future of Management by Gary Hamel, 2007, Harvard Business School Press, Boston, MA. This is a fairly good book about how several organizations have moved from top down, command and control management to individually empowered organic organizations. Originally led by Meg Wheatley over twenty years ago, one of the leading strategic thinkers picks up the pace with a number of in-depth examples of how companies have moved into this better space. The problem is that in most cases, it took a CEO willing to change and drive change to accomplish it. What are the rest of us supposed to do?

Newsletter: February 15, 2008

Announcing the Release of Pricing with Confidence
By Reed Holden and Mark Burton

Achieving Pricing Confidence
an excerpt

When customers ask for discounts, salespeople should turn the discussion to value. Customers expect this and typically attempt an end run on the salesperson. The customer telephones a senior manager at the salesperson’s organization to rattle his or her cage in an attempt to get the manager to buy into the White Horse Syndrome. Sometimes the senior manager saves the customer the trouble by initiating the call. In either case, salespeople learn that when they try to hold the line on price, someone else in the organization will criticize them for messing up the sales opportunity. Salespeople quickly learn that they would be foolish to try to get additional profit for the company with higher prices. After all, aren’t they paid to close deals, regardless of the costs for the company?

The real challenge is getting salespeople and managers to have more confidence in their pricing. This requires salespeople and managers alike to resist undermining prices with short-term, panic-oriented tactics. The bad news is that most companies do exactly that. The good news is that it takes just a few simple rules to reverse the process, build discipline into the pricing process, and stop leaving money on the table. In fact the following 10 rules will lead to your pricing with confidence.

Replace the discounting habit with a little arrogance. Price discounting is entrenched in most organizations. The best way to dislodge any deep-rooted attitude is to replace it with another. Arrogance—feeling good about your products and services—provides the confidence needed to kick the discounting habit.
Understand the value you offer to your customer. You can’t have confidence in your pricing until you have confidence in the financial value that your offerings create for customers. Most of your customers are eager to tell you. All it takes is asking the right questions and being willing to listen.
Apply one of three simple pricing strategies. Know when to price high, when to price low, and a strategy for everything in between. To create confidence in your prices, strategies can and should be simple and agreed to by everyone in the firm.
Play better poker with customers. Understand the four types of buyers, and develop a pricing strategy for each one. The trickiest is the fourth type—poker players, who love to play the pricing game and have learned that if they focus on price, they can get vendors to leave money on the table but continue to provide high-value features and services. Knowing the strength of your own hand—the value you offer—gives salespeople confidence to resist the temptation to close at any price.
Price to increase profits. It’s a myth that if you discount price to increase sales, you will see increased profits. Profits result when an organization does many things right, including simplifying costing approaches so they permit more effective use of your company’s resources, be they people or machines. Efficiency, controlling costs, better profit metrics—all are required for pricing success.
Add new products and services that give you negotiating flexibility and growth. When your products are regarded as commodities, add services to differentiate products and prop up prices. An effective strategy for market dominance is to develop a dual offering that covers both the high- and low-end customer needs. If customers want a lower price, subtract features and services.
Force your competitor to react to your pricing. Smart players know they don’t have to participate in a competitive pricing death spiral. Every player enjoys one or more value advantages. Map your markets. Define where you do and do not have a value advantage over your competitors. Know where and how to compete on price—and where and how not to.
Build your selling backbone. To have confidence in negotiation, salespeople and managers need confidence in pricing. Confidence in pricing comes from knowing the value of your products or services. It also comes from knowing your customer. Backbone comes from knowing the tricks your customers use to get you to drop price and how to deal with them.
Take simple steps to move from cost-plus to value-based pricing. There is nothing wrong with cost-plus pricing as long as it does a good job of leveraging the financial value you create for customers. Value-based pricing is an ideal. It requires sophisticated internal skills and systems. The trick to value-based pricing is to evolve pricing as the discipline and skills of your people improve. Start gradually. Once you learn those skills, moving forward to real value-based pricing is a snap.
Price with confidence: Remember who you are. Shift the negotiation to how you provide concrete results for your customers. Customers buy results, not rhetoric. Moving beyond the rhetoric of value will enable you to prove those results to customers.

Newsletter: January 25, 2008

Listen to Sal | Niche Strategies | The Chopper Look | Flanking Strategies | Good Reading!

The Recession Issue

Listen to Sal

By Reed Holden

Sal is my barber. He's been a barber for forty years and has seen it all. Sal doesn't think a recession is coming; he knows it's here. How does he know? He sees customers taking longer to get their hair cut. Someone who used to get it cut once a month is stretching it to once every six weeks. And that's happening with lots of his customers. He hears them worry about meeting the mortgage, paying for food, and paying for basic services, like heat. Sal is one of my early warnings of an economic downturn, and he's a good one.

Bill Zollars, CEO of YRC Worldwide, the newly expanded Yellow Freight, saw two disturbing trends happening around Christmas time. Customers were shipping fewer shipments and putting a fewer number of things in each shipment. What did he do? He met with his senior managers and "reacted swiftly" to the problem. They cut back on drivers by 10%, stopped renting trucks, and put 10% of their current trucks in the parking lot. He and his team got ahead of the problem. They didn't kid themselves and didn't drive the price down to meet suddenly unreasonable projections. Instead, they did what senior leaders are supposed to do—address and solve the problem head on.

Look at Ford Motor Company. During a downturn, they would have traditionally kept building cars and pushing them out to dealers, who would rely on massive price discounts and incentive rebates to chase a shrinking base of consumers who wanted new cars. For the first time in a long time, they have decided to reduce production to match the shrinking demand. The result? They are "the only one of the six biggest carmakers that did not raise (price) incentives in December." This is when they are losing ground and ranking to Toyota and sales are declining.

Tough choices in tough times. But Kudos to Ford and YRC for being willing to face the music and make the decisions that need to be made. How about your company? Are you still chasing unrealistic objectives? Are you using price to fill the hopper when there is less business out there? No wonder your profits are down. Listen to Sal—he knows what's going on.

To talk with Reed about Sal, please click in to his new blog site: www.reedholden.wordpress.com.

Niche Strategies

Commentary by Steve Haggett

From "Textile Firm Toray Takes High-End Foray"
By Hiroyuki Kachi, The Wall Street Journal, January 2, 2008

Low-cost Chinese products have crushed much of the Japanese textile industry. As many Japanese manufacturers have found out, fighting a cost battle with China is a losing proposition. But Japanese firm Toray Industries is succeeding, not by competing with the Chinese. but by targeting specialized niche segments.

"We have no way to fight in the world of textiles except by promoting such high-end products," said Nobuyuki Tanaba, general manager of the fabrics department. Even facing a recession, Toray continues to invest in R&D, continuing to build differentiation from cheaper Chinese synthetics. "Japan has managed to reawaken its textile industry," says Paolo Zegna, president of the Italian fashion and textile industry association. "They have succeeded by moving the playing field from traditional fabrics to ultra-technological fibers and products." While Chinese imports into Europe now command the largest share, their imports into France grew only 2% a year since 2000, while imports into Italy, Spain, and the US fell. Japanese textile imports into France grew at over 15% in 2007.

Toray has launched a new fiber 40 times thinner than human hair, giving fabrics capabilities that natural fibers cannot. Toray has built a strong position in Prada, Yves Saint Laurent, and Louis Vuitton.

Launching new products into specific niches, such as high-end, high-performance segments, can be a very successful strategy in mature and declining markets where price competition can be brutal. There are always segments that value unique differentiation, whether in times of growth or recession. By maintaining investment in innovation, Toray is able to command premium prices during a downturn in their industry and create an island of profitability that other competitors can only dream of.

The Chopper Look

Niche Strategies, Part 2

Commentary by Steve Haggett
From "Motorcycle Makes Tap Chopper Niche"
By Jonathan Welsh, The Wall Street Journal, January 3, 2008

The growth of custom motorcycle shows on cable television has increased interest in the chopper look, originally made famous by the bad boys in the movie Easy Rider. Riding around with your hands up in the air and your front tire a yard away from the steering wheel may not be comfortable, but it sure looks cool.

A Harley Davidson Sportster, their basic model, starts at $6500. Harley now offers a chopper-style ride, the Rocker C, for $19,495, almost triple the price of their base bike, and the same cost as a new four-door Honda sedan.

Comparing the value of their offering to the product coming out of the custom garages, they can point to greater reliability and maneuverability of a researched-yet-unique motorcycle. By targeting the niche interested in custom choppers, Harley is able to command premium prices. That's also cool. Maybe I'd better get my order in.

Flanking Strategies

Commentary by Steve Haggett

From "U.S. Game Sales Rose 28 Percent in December"
By REUTERS, January 18, 2008 (reported in The New York Times)

Sony has publicly struggled with the launch of its premium PS3 game console, the industry's highest-priced game platform. In 2007, the PS3 was outsold by its aging predecessor, the PS2. Meanwhile, long lines persist for rival Nintendo's Wii platform, which has nearly double the sales of Sony's flagship PS3. In the face of impending recession, Sony should be worried if they lose the high-end market to Nintendo. One easy move for Sony to make would be to slash the price of the PS3 to build greater share.

Instead, Sony recently announced the launch of a flanking product. Sony is offering a new PS3 platform with significantly lower performance. A new, lower-priced PS3 will be available in 2008 that offers 40GB of memory and a single USB port for $399, compared to the 80GB of memory and two ports in their $499 product. However, an even more powerful fence between the two products would be the inability to use PS2-based games on this lower-performing option, which are fully compatible on the premium platform.

A flanking move is often a smart alternative to discounting a higher-value product, particularly in the face of a market downturn. The strong, clear fences protect the premium price—and perceived value—of the flagship product, while the lower-performance flanking product can compete with other lower-priced or commodity offerings. When demand picks up for higher-performing consoles, based on the requirements of future game software, Sony has the high-end product available at a more profitable price. The only question is whether the game compatibility might be "too high" of a fence and reduce the demand.

Good Reading!

Reviews from Dr. Reed Holden

Value Merchants: Demonstrating and Documenting Superior Value in Business Markets by James C. Anderson, Nirmalya Kumar and James A. Narus, 2007, Harvard Business School Press, Boston, MA. For those of you who want an in-depth indoctrination to understanding and selling value in business markets, this is a terrific book. Though academics, the authors have presented a very pragmatic and usable model with lots of good stories to support it's application.
Strictly Speaking: Reid Buckley's Indispensable Handbook on Public Speaking by Reid Buckley, 1999, McGraw Hill, New York, NY. I would have like this book if it was an article, but it does what it says—provides a terrific handbook on public speaking. What's the problem? It covers all of the situations—it seems like every last one of them. Fortunately, it is written quite well and has a lot of supporting anecdotes. He teaches the best speakers, and if you want to improve your public speaking skills, it's a worthwhile read. By the way, if you are a public speaker, you should want to improve your speaking skills.
Pricing with Confidence: Ten Ways to Stop Leaving Money on the Table by Reed Holden and Mark Burton, 2008, Wiley & Sons, Hoboken, NJ will be shipping at Amazon in February!