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Newsletter Q1 2009: March | February | January
Tales of Endurance, Pricing or Otherwise | Emerging Market Innovations Protect Profits at Home | Pricing for CEO's | Pricing Services to Cushion the Shock of the Recession | Good Reading!
Tales of Endurance, Pricing or Otherwise
By Dr. Reed Holden
Most managers are beginning to recognize that they're in the toughest economic times of their lives. Sure, a few industries, such as software houses and the medical community, continue to do well. but when the dust settles from all of this, the only questions are whether the recession will a) become a depression and b) if it will be worse than 1929.
For a pricing blogger, this is certainly a "target rich environment." There are numerous examples of managers who are panicking and pulling the price discount lever. In doing so, they are dooming their firms to failure. As we said last week, "you can't price your way out of a recession."
But rather than focus on the failures, for the past week, I've been accumulating articles and notes on managers and companies that are little beacons of successful decisions in these trying times. What's been lacking is the bigger message that puts all of these together. After spending time on the phone with pricing managers over the past few weeks, it seems to me that the watchword for successful management today is "Endurance."
The thought comes from a book I read last year, Endurance: Shackleton's Incredible Voyage about Earnest Shackleton's voyage to Antarctica on his ship Endurance in 1914-15. Early in the 17-month trip, the ship was frozen in an ice pack, and the crew of 28 men had to live on the frozen ship for almost 10 months. When the ship was finally crushed and sank, they had to live on the ice for another 6 months (some had to live longer than that). They finally performed their own rescue by sailing to an island. It is an "astonishing" story of survival.
Another incredible story of survival comes from the book We Were Soldiers Once and Young by Hal Moore and Joe Galloway. It is about the month-long battle between the US 1st Battalion of the 7th Cavalry and a "superior force of North Vietnamese Regulars" in the Ia Drang Valley in South Vietnam in the fall of 1965, under the leadership of Lt. Col. Hal Moore.
The reason I selected these books is because in both cases, people faced incredible circumstances and survived (though too many were killed at Ia Drang). The other reason is that when the story finally was told, there were no dramatics. Yes, there were heroics, but that was expected from the trained and disciplined professionals who survived. And when they told their stories, it was about the basics of day-to-day survival of professionals who knew what they had to do and did it.
These are good stories to remember as we face our own harrowing economic times. Here, no one is facing death, and that's a good thing. If the crew of the Endurance and the members of the 7th Cavalry could maintain discipline and focus during their harrowing times, we should be able to as well. Hokey? Maybe, but there are good points here–leadership and discipline.
Last Thursday, Adobe Systems advised analysts that revenue was going to be down dramatically, and they were going to do what they could to control expenses in order to maintain earnings. This included the painful act of lay-offs of 8% of its work force. As we begin to see the nightly news images of the tent cities that are beginning to spring up, those visions of unemployment are sad for all of us. But the fact remains that those tough decisions need to be made or the whole company will be put at risk, as we are seeing in Detroit right now.
Speaking of Detroit, Alan Mulally, new CEO of Ford, seems to be making the decisions that GM and Chrysler have been avoiding. He got the unions to agree to dramatic wage and work concessions. He delayed the introduction of new models so that they could clear out the inventory of old models. And he ordered a 40% cut in production– this is on top of dramatic cuts he ordered over a year ago. It's no wonder that Ford continues to be the only one of the "once big three" that might not need any federal loan guarantees.
Finally, GE continues to rely on services to beef up the revenues of their extensive line of products. GE has continued their push to expand services on already-sold products, like locomotives and jet engines, to achieve growth and added profits.
How you survive in tough economic times and flourish in booming ones is through leadership and discipline, and by cutting revenue goals rather than cutting price, cutting costs rather than cutting price, relying on services revenue to beef up declining product sales, and by recognizing that profits are more important than revenue–much more.
No, the guys who head these companies might not be a Shackleton or Moore, but they are doing their best in tough times. They are facing the tough times, not with excuses and delayed decision but with clear purpose, focus on what needs to be done to survive, and the willingness to sacrifice the few for the greater good. Most of all, they know that they can’t change the circumstances, and that, in the end, they have to endure. Maybe when the story is written about the companies that survived and eventually flourished, they will be mentioned. Emerging Market Innovations Protect Profits at Home
Commentary By Mark Burton
From Innovation Trickles in a New Direction, BusinessWeek.com, March 11, 2009
One the most effective ways to preserve the pricing power of high-value offerings is to have low-value flanking products within the line. These flanking products are critical, because they enable sales teams to give customers a low-priced option when they try to negotiate price on the high-value product. This turns the tables on poker playing customers who are just fishing for a discount. They now have to make a decision: go for the low-price, low-value option or admit their preference for the high-value one. Whatever decision they make puts the sales team in control as they force the customer to decide between “price” and “value.”
One problem many executives have with this concept is fear–fear of taking on additional development costs for a lower-margin offering and fear that the new offering will cannibalize sales of higher-margin offerings. Now one of the great forces of upheaval in our times, the growing power of “emerging markets” is being harnessed to make the process of introducing low-value flanking products easier.
General Electric and other firms are now introducing products designed for India and other price-sensitive markets into North American and European markets. GE, for one, is introducing an electrocardiograph (ECG) machine that was originally developed for the Chinese and Indian markets. While it has significantly fewer features than models typically sold in the US, it will sell for 80% less than machines with similar capabilities. The US development costs were 10% of what is typical. As for cannibalization of existing offerings, GE has been careful to manage this by targeting new customers that typically couldn’t afford an ECG and by eliminating features that are attractive to customers for big-ticket machines. Just the presence of the new machine in the line will enable GE to better control negotiations there as well. Pricing for CEO's
By Dr. Reed Holden
Pricing Services to Cushion the Shock of the Recession
You Can’t Price Your Way Out of a Recession | It’s About the Strategy, Stupid! | Winning the Game with Flanking Products | PWYW: A New Pricing Model | Good Reading! You Can’t Price Your Way Out of a Recession
By Dr. Reed Holden
Mark Burton and I were teaching a certification class using our book Pricing with Confidence at the Professional Pricing Society in Houston last week. We were talking about our famous "dirt" company (you have to read the book!) and repeated a quote from their CEO, "You Can't Price Your Way Out of a Recession." Someone asked what we meant by that.
Given the number of companies that we've spoken to in the past month that are still thinking about using price discounts to achieve: a) increased share, b) increased revenue c) increased profits or d) cover increased costs, it's worth it to give you the answer, too.
In mature markets or economic downturns, demand is down. That is, customers slow their purchasing. This is true for consumer sales, where year after year, demand is down 10% in retail and 50% in automobiles. And it's true in business-to-business sales, where declines seem to be in about the same range, except health care, which continues to show increases in demand. By definition, those markets are "inelastic." That is, demand does not respond (increase) that much due to changes in price.
When markets mature and demand becomes inelastic, price strategy for all products and services should stay skim, where you price high relative to competitors or evolve to neutral, where you stop using price as a competitive weapon. If you try to use price to increase sales, competitors respond, and price wars break out. When that happens, revenue drops (a characteristic of inelastic markets) and profits disappear. And during all of this, demand keeps going down, and it does not recover.
During the holiday season, we saw many retail companies try to use price discounts to increase demand. As a result, it is likely that many of those companies will go out of business. Some analysts predict that there will be "massive retail bankruptcies in 2009 and 2010." Reuters reported that "Restructuring experts see a wave of retail bankruptcies in the coming months, due to dismal sales and a credit crunch." What is interesting to note is that they failed to point to pricing strategy as the culprit, yet it is. The reason that many retailers are going out of business over the next two years is not because demand is down. It's because they are using price discounts to try to fix a problem that just can't be fixed with price. Business is going to be down for most of us for the foreseeable future. It's time to batten down the hatches and try to survive. Cut costs, put people on furlough, stop unnecessary expenses, but don't discount price. By using price discounts at the wrong time, retailers eliminated profits and sealed their fate with the bankruptcy courts.
We talked about Abercrombie in January, because they decided to stick with their skim pricing strategy in December. Lots of analysts thought this was wrong. Even some of our own people agreed with them. Yet most recent results for Abercrombie shows that while profits "plunged" 68%, their stock price is actually up 10%, because investors know that a) they'll survive and b) they have protected their high value-position in the marketplace, while many of their competitors (even Macy's!!!!) have pulled the panic lever and started dramatic discounting. Against the advice of many, Abercrombie used the correct price strategy and will survive the downturn.
What about the dirt company? Most recent results show that their revenue is up and profits are up more. They too will do just fine. Not without a little sweat but smart managers use recessions (maybe even a depression!) to tighten up controls and policies. They limit spending. They adjust their revenue goals down. They get people working smarter and better. The one thing they don't do is use discounting to try to solve the problem. It’s About the Strategy, Stupid!
By Mark Burton
As Reed so simply put it, you can’t price your way out of a recession. Too many firms have gotten caught flat-footed and are using price discounts in a panic to try to keep demand that is going away no matter what they do. The firms that do this are creating two very significant long-term problems. First, they are destroying the integrity of their pricing and the value of their brands. Second, they are training their customers to negotiate for every last penny, thus undermining their most valuable asset–trusting customer relationships. Both of these forces will make it extraordinarily difficult to bring prices back up when the economy finally does turn. In addition, it will take much longer to bring prices back up to a level that reflects the true value of the goods and services being sold.
The way around this is to look objectively at pricing as a strategic tool that must be managed systematically, based on value, market demand, cost structure, product lifecycle, and firm capabilities. This view leads one to make decisions on the basis of preserving and gaining pricing power, be it through reducing capacity to match demand, introducing low price–low value offerings, or making systematic adjustments to price lists, so that list and street prices are more in line.
Two weeks ago, Reed and I spoke with one of the most capable pricers that we know about getting through these times–“Fred.” He is thinking strategically. What has he done? First, he recognized that much of the incremental revenues that had come from pricing last year were going to disappear this year. Next, he engaged with his CEO, and they came up with a plan to reduce capacity to well below current demand levels. This creates pricing power and protects them against further downside risk from collapsing demand. It also paved the way for passing through a 20% price increase for their least profitable accounts. Some accounts will walk away–that’s OK, because there is not enough capacity to serve them all any more. The others will take the increase, because they value the service they get. Fred’s firm has now set the stage for a stronger recovery by enforcing a pricing strategy.
Clever pricing tactics and working the price waterfall are necessary but woefully insufficient for these times. The firms that understand that pricing is all about strategy will come through stronger and more formidable competitors. Those that don’t will be lucky to survive. Winning the Game with Flanking Products
Commentary by Mark Burton
From “Used Games Score Big for GameStop,” The Wall Street Journal, January 21, 2009
Amid one of the worst fourth quarters in history for retailers, video game seller GameStop didn’t just survive, they blew the doors off the place. In January, they reported a 22% jump in overall sales and a 10% increase in sales at stores open more than 12 months. By comparison, heavyweight champ Best Buy reported that sales of video game hardware fell by “mid single digits” and overall video game sales climbed 9% in December.
GameStop outperformed the market and the competition by using something that we remind value managers of every day–lower-price flanking products. In the case of GameStop, they are the only major retailer that deals in used games. That is something the competition didn’t want to touch for fear of cannibalizing sales of new games, and now it accounts for 23% of GameStop’s revenue. They also became a driving force for sales as the recession hit. In the nine weeks that ended January 3, sales of used games and consoles rose 32%.
Not only do used games keep cash-strapped customers coming into the stores, they serve two other valuable purposes. First, since customers can trade in games and use that money toward new games, it means GameStop is able to preserve price integrity by avoiding the massive discounts on merchandise that other retailers rely on. Second, as is the case with everything from used cars to used college textbooks to refurbished truck engines, the margins on used games are higher (48% versus 7% - 20% for new consoles and games). There is, after all, only one good purpose for price–to increase profits. GameStop has that game figured out.
By Steve Haggett
A recent pricing study conducted at the University of Frankfurt (Main), Germany, summarized in the current American Marketing Association journal, describes the impact of Pay What You Want pricing.
The Frankfurt team tested PWYM on three offerings: a lunch buffet at a restaurant, a cinema, and hot beverages at a deli. Prices were eliminated from the menu, and customers were asked to pay what they wanted.
Pay What You Want is an extension of the Name Your Price model employed by companies like priceline.com, taking it a step further. Where Priceline finds a match with an unnamed provider offering a flight to a specific city or a hotel somewhere in that city, Pay What You Want allows the customer purchasing a specific product or service to pay anything, including zero.
Risky?
The results of their study identify situations where a PWYW approach is much better than discounting.
Last year we wrote about the band Radiohead experimenting with a PWYW approach with their new album, In Rainbows. In the end, Radiohead made more money from digital downloads of the In Rainbows album than downloads of all other albums combined.
In the German study, the restaurant saw higher volumes during the PWYW test drive revenues up by over 32%, and surprisingly, the average price of hot beverages at the deli increased by over 11%.
What factors make the PWYW approach work?
At the end of the research, the restaurant decided to continue the PWYW pricing approach and opened another restaurant featuring the same price. If you have an opportunity that fits these very specific criteria, this can be a creative, effective pricing approach.
Head-Off Price Wars with the Right Communication | Clorox Finds Green in “Green” | Tune Tiers | Finding the Bottom | Not Your Father’s Rolls Royce | ABD: Anything But Discounts | Good Reading! Head-Off Price Wars with the Right Communication
By Dr. Reed Holden
Over the past decade, companies like Monsanto, DuPont, and Novartis have invested heavily to improve the performance of seeds. They’ve made seeds for a variety of crops more disease resistant and higher producing. The current recession has had a dramatic impact on farmers, but seed companies still want to leverage the increased value of their seeds.
Let’s look at an announcement from Monsanto’s CEO Hugh Grant, who stated in The WSJ today that “he saw signs of a brewing price war…. (and that they) will hold the line on pricing, even if competitors turn to aggressive promotional strategies to win market share.” Kudos to Mr. Grant, because he is using communications to voice his concerns about a price war and his desire not to engage in one. Showing competitive leadership in tough times is what most markets need. Though Monsanto is not the dominant player in the industry, sending the message that competitors should avoid price wars is a good move in mature and declining markets, because price discounts don’t create more business. They just encourage switching. For more information on derived demand, see our book Pricing with Confidence.
Where Mr. Grant fell short in his announcement, however, was that he unwittingly told competitors that if they want to use price to gain share, Monsanto will let them. Competitors might interpret the announcement as now might actually be the time to use price discounts to gain share. BAD MOVE. Rather than state, “Monsanto would hold on price, even if competitors turn to aggressive promotional strategies,” the announcement would have been more effective if Mr. Grant had said, “We will respond to competitors’ moves to gain share but hope we don’t have to.” That would have told the competitors that if they tried to use price discounts, they would be matched to the detriment of all competitors.
Price communication is not easy and the practice is loaded with landmines. Too many companies don’t do it or don’t do it effectively. Too many corporate attorneys take the position that the firm shouldn’t announce because it is illegal. In both cases, they’re wrong. A top advisor in price communication in the country is Gene Zelek of Freeborn and Peters in Chicago. Effective communications can prevent price wars, even in a recession, and end up preserving profits and revenue.
Commentary by Mark Burton
From “Clorox a Green Market Breakthrough,” bnet.com
Lately we’ve been telling anyone who will listen that pricing strategy is a forgotten art. Over the past few years, the emphasis in the pricing world has been more consistent management of pricing processes. Fueled by powerful software and the promise of easy returns, managers have focused on bringing visibility and accountability to street-level pricing. We applaud these efforts but worry that their very success will mean that pricing will continue to be viewed only a tactical tool.
The best companies are moving well beyond this emphasis on tactical pricing and blending competitive strategy with pricing strategy. Clorox provides a great example via the introduction of their Green Works line of natural household cleaners. How does a company known for selling harsh chemicals like bleach break into the emerging market for low-impact “green” products? Very carefully–and with a smart pricing strategy.
In setting their pricing strategy, Clorox made two critical observations. First, they were truthful with themselves in deciding that their brand would be seen as a liability (and thus diminish perceived value) amongst hardcore greenies. Second, they realized that the market for green products is starting to move out of the introduction phase and into the growth phase of its lifecycle. Both of these factors point to the use of a penetration pricing strategy. Penetration strategies are successful under these conditions as lower prices serve to increase the size of the market by bringing in new customers. And that is exactly what happened. In November, Clorox Green Works toilet bowl cleaner was selling for $2.89 versus $4.29 for a comparable product from green leader Method. Yet an interesting thing happened, while Clorox generated new revenues from Green Works, the sales of Method and another green leader Seventh Generation have not declined. Clorox has simultaneously brought new customers into the market, grown revenues, and avoided a price war with entrenched competitors . Isn’t it great when a plan comes together?
Commentary By Steve Haggett
From “Apple Changes Tune on Music Pricing,” The Wall Street Journal, January 7, 2009
Last month, we wrote about sports teams and entertainment providers beginning to replace fixed ticket prices with variable value-based pricing, matching customer value with price (see Just the Ticket, December 2008). This month, Apple’s iTunes has announced a new value-based, three-tier pricing system, replacing their standard 99¢ song pricing system. Under their new plan, iTunes has created three tiers:
iTunes is sure to promote the message that most songs are now one-third cheaper, and both iTunes and the labels hope this will spur additional volume. At the same time, the high-demand hits, reaching a less price-sensitive customer base, will generate 30% more revenues–for the same costs.
A tiered pricing plan like this makes a lot of sense, even for offerings that appear standard, like a song download. One standard price for everything fails to recognize differences in customers’ perceived value. Pop music enthusiasts may find the 99¢ Billboard hit a great bargain compared to the $15 CD, while another consumer is unmoved to transition the old LP collection to MP3’s due to the high cost.
Tiered song pricing fits naturally with the tiered offering approach the iPod features, with $49 flanking products (the Shuffle) supporting the $399 premium product (the Touch).
Tiered pricing may seem challenging for many products, but the marketing team can break down the offering into constituent elements of products and services, matching different elements to different customer pockets. This is a particularly effective exercise right now, when the resulting revenues from a price-tiering approach can counteract the demand damages from the recession. While the tiered approach may be easier when you have a broad value portfolio of products (think of Nokia’s suite of cell phones, for example), the iTunes case suggests how much more powerful the approach can be when creatively applied to a category that typically does not include that product breadth.
It can work for you.
Commentary By Nelson Hyde
From “High-Tech Companies Take Up Netbooks,” by Don Clark and Justin Scheck, The Wall Street Journal, January 6, 2009
For companies whose products and sales have been savaged by the recession, try heading down market. The low end of the market is still strong in areas like computers, where a new breed of $300-500 laptops called Netbooks is taking off. 2008 Netbook sales leapt to 10 million units from a few hundred thousand the year before.
Netbooks are cheaper for a reason. They are slower to start, have shorter battery life and do not display videos or graphics very well. Some traditional PC makers whine that Netbooks are not real PCs. That’s right–and that’s why they’re doing great right now.
Some PC companies who turned up their noses at the thought of Netbooks in better times are now behind the eight ball. They are missing the market, and their delay made it easier for new competitors to get a foothold they can later use to attack up market. Having a low-end offering is a good hedge against bad times.
But covering the lower end of the market is also a good strategy during boom times. One of the best ways to protect the price on your high-value offering is to also have lower-value offerings. When customers complain about price, you can offer them a cheaper alternative without compromising the price or value of your higher value offering.
The lesson from Netbooks is to make sure you cover a range of value in your offerings. Go down market before you are forced to. And be careful not to make your lowest end flanking offering too attractive–it’s there for the price buyers, not the general market. Netbooks got it right: strip out the costs and boil down the features to only what’s needed to function. That’s all price buyers want. Overloading it just gives away value that price buyers won’t pay for anyway–in bad times or good.
By Dr. Reed Holden
OK, my father never owned a Rolls-Royce. A Chevy Impala was his ride, but there is a terrific story in this week’s The Economist about how Rolls-Royce has rebuilt itself, not as a car maker but as the dominant global supplier of jet engines. It’s an interesting counterpoint to the problems we continue to see in the automobile industry in the United States.
The most important thing Rolls-Royce did was to take a huge risk and invest in new technologies for jet engines. While some of the investment didn’t pay off, they successfully developed a new series of engines which were cheaper to operate, more reliable than existing engines, and could be easily scaled to meet the needs of different types of aircraft. Their primary competitors, GE and Pratt and Whitney, also make engines that are efficient and reliable, but they need to invest extensively in the design for each engine that goes into a new aircraft. Rolls Royce is able go from design to production faster than their competitors. Consequently, Rolls-Royce now produces engines for 45 of the “50 leading airlines.”
Rolls-Royce also moved aggressively into providing analytical services that gave the airlines the ability to monitor engine performance, predict likely breakdown, and assess the extent of technical problems if the aircraft is struck by lightning, for example. All of this extends the engine’s performance, dramatically reduces the operating costs, and increases the in-service time of the engine.
The capstone of their success was to change their offering and pricing model. They moved to what is known as “power by the hour.” They don’t sell engines to the airlines, they sell the power those engines produce. The benefit to the airlines is predictability and lower capital costs. The benefit to Rolls-Royce is that they are able to accrue the benefit of improved operating costs themselves.
The importance of this story is that Rolls-Royce went in the opposite direction than many traditional manufacturers. While the traditional manufacturers have focused on more efficient and effective production, Rolls-Royce has focused on evolving their offering model to include valued services and leveraging those services with a better pricing model. This has provided them with a competitive advantage that should sustain them for the next decade, if not further.
By Steve Haggett
Studies consistently demonstrate the persistence of prices. Past prices create a powerful internal reference point for customers. (For those interested, see recent studies below.)
There is risk, then, that current demands for discounts will stick. That 30%-off, or even 50%-off response to the market could well set the future price ceiling.
A better response is to bundle another offering, or a valued service, and communicate the total value of the offering to your customer.
For example, a software provider facing clamoring customer pressure to discount 50% below historic market prices would be better off holding close to those recent reference points and bundling free on-site service or adding an additional module. An instrument maker could add training or a measurement tool to the offering. Communicate the total cost of ownership, and you have taken a further step in encouraging your customer to quantify your value.
Faced with excess inventory, University Dodge an auto dealer in Davie, Florida, takes this to the extreme, offering a free second Dodge Ram, Caliber, or PT Cruiser with the purchase of a 2008 Ram. But this is still a better approach than slashing the price by 50%.
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