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Newsletter: January 29, 2010

Getting to Value | Getting Back to Basics | An Important Ethic in Pricing—The Fairness Sniff Test | Good Reading!

Getting to Value

By Dr. Reed Holden

Lately, we've had several requests to do conjoint analysis. It's not something we usually see, and in most cases, the requests were to research products where conjoint just wasn't appropriate. In a recent case, we began the process of setting up to do the research with a partner, but as we drilled down on the product and competitive landscape, we found that it just wasn't the right method. As a result of these requests, we have some advice on when to use and when not to use conjoint analysis. My hope is to get a few comments from others so we can expand the discussion. For those of you who are strong believers in the technique, I promise to publish your comments along with the rest of them.

Conjoint analysis identifies relevant product/service attributes and compares their value to price with a weighted scale or by seeing how respondents select from pairs of choices. It is an "attitudinal" measure of value in that respondents weight their perception of a feature's value, relative to price. It is fast and easy to implement and is fairly inexpensive, relative to other methods. The resulting analysis gives the appearance of statistically significant precision. Also, it permits the building of complex models, which predict market share moves given changes in price and feature sets for the product.

This method works very well for complete consumer products where respondents understand and have a lot of experience with the product. By complete, I mean for things like cars, stereos, phones, PCs, etc. It works well when the results are going to be rolled out through retail sales organizations that don't have a lot of price negotiations or pricing flexibility.

It doesn't work well when one or more of the following conditions are present:

• It is a part of a more complex product or system—for example, a part for an automobile or machine, a process control valve in a chemical plant. The focus of the research needs to be on the performance of the part and how it impacts the broader machine or system.  The real value doesn't come relative to the price of the part but relative to the price of the machine. More than that, it impacts how it helps a firm earn more profits. Conjoint doesn't reveal that information. We know of a high tech firm that went bankrupt and had to be sold, because they dramatically underestimated the value of their solution and saw a massive decline in price and profits. They used attitudinal measures for components of a complex system, and it failed. 
• It is being sold through a field sales force. They will need to have a very specific understanding of the real mechanics of the value in use of the product or part—attitudinal results just don't do this, no matter what the researchers say.
• There is a likely competitive reaction which negates any pricing moves. This gets down to the basics of pricing strategy—tough to model in a simulation. It should be modeled in a series of scenario planning exercises.
• The results will be used to convince a discount-oriented sales force and senior executive to stop their behavior.

I tried to keep this list simple,but you can see that most BTB products and services fall into these categories. That is why we tend to use Business Case Analysis (BCA). Often called ROI analysis, BCA is the process of doing interviews with customers to see how the product has a direct impact on their business—in terms of increased profits and reduced costs. You need to look at both of these, as sometimes the increased profits from capacity improvements can make the cost reductions look quite small.

BCA requires depth interviews, which are often positioned as exploratory and qualitative, which at the start of the process, they are. But after an amazingly few interviews, the purpose evolves to confirmatory and quantitative. That is, they confirm what we have learned and use those confirmations to build a very quantitative model of how the firms use of the product or service improves their throughput, profits, and reduces costs.

The advantage of this method is that the resulting model (What we call CASE ROI—ask for the white paper) becomes a selling tool which a) forces the salesperson to "ask the right questions," b) subsequently shows what the specific value benefit is to each client, by plugging the answers into the sales tool, and c) is used to minimize the damage of price negotiations by providing a value frame rather than a "lower competitive price" frame the buyers often use.

My intent is to start a discussion on this sticky topic. Yes, there are firms out there that do a terrific job with conjoint, but we have found that "when you give a kid a hammer, everything becomes a nail." That is, they always want to use it, without giving consideration for the downstream results. I'd love to hear what you think, and as I said at the start, I welcome all comments.

Getting Back to Basics

Commentary by Mark Burton

From “Why the Highest Price Isn’t the Best Price” By James C. Anderson, Marc Wouters, and Wouter van Rossum
Sloan Management Review, January 1, 2010

The ultimate purpose for doing the hard work of tackling a pricing change is to increase revenues and profits. Having said that, we often see managers confuse the means with the ends. They get focused on implementing “value-based pricing” or “dynamic pricing” or “freemium pricing,” and lose sight of the part about revenues and profits. Stepping back, the idea of value-based pricing is extremely useful. It gets companies to focus on what is important; delivering measurable value to customers and getting fairly compensated for that value. The authors of this piece in Sloan Management Review do a nice job of getting practitioners oriented on the essential basics of value-based pricing.

Their advice is summed up in six simple questions.

• What is the market strategy for the segment? (What does the supplier want to accomplish? What would the supplier like to have happen?)
• What is the differential value that is transparent to target customers? (“Transparent” means that target customers easily understand how the supplier calculates the differential value between its offering and the next best alternative, and that the differential value can be verified with the customer’s own data.)
• What is the price of the next best alternative offering?
• What is the cost of the supplier’s market offering?
• What pricing tactics will be used initially or eventually? (“Pricing tactics” are changes from the price that a supplier has set for its market offering—such as discounts—that motivate customers to take actions that benefit the supplier.)
• What is the customer’s expectation of a “fair” price?

The Reader’s Digest version of all of this is keep it simple, don’t get greedy, and be sure that you think about how your pricing is going to play out in the field. Words to live by.

An Important Ethic in Pricing—The Fairness Sniff Test

By Dr. Reed Holden

It's been interesting watching Google's moves with the Chinese government over the past few days. It's nice to see an ethical high-tech firm doing things that are in the best interest of their consuming public, even if it hurts their business. Like Johnson and Johnson, Google is letting their corporate values drive their decision process—always a sign of a great company.

This led me to thinking about ethics in pricing. When we did the second edition of The Strategy and Tactics of Pricing, we included a discussion of ethics. I think we might have missed on perhaps the most important element of pricing ethics—the "fairness sniff test"—a highly technical term. This test follows on some of the work Mike Marn has done at McKinsey in the area of price transparency.

The test is a simple one. Are you able to show your prices, all your prices, to your sales people and customers? The goal is they agree that even the prices that are lower than prices they are getting are fair. I can just hear everyone out there cringing at the thought—well, you fail.

The test is an important test of whether or not you have a defensible price strategy and execution structure. It is a test of whether or not you are letting ad hoc discounting and deal price setting run away from you. This is the standard for big ticket items (even cars), which are often negotiated on a deal by deal basis. That doesn't mean it's right. Good pricing is a defensible structure of discount, bundles, and net prices that make sense to well-informed customers and salespeople. If you flunked the Fairness Sniff Test, it might be time to be working on that structure. The payback can be incredible.

Good Reading

1. What the Dog Saw and other Adventures by Malcolm Gladwell, 2009, Little, Brown and Company, New York, New York.  Malcolm Gladwell is a favorite author (The Tipping Point, Blink), but I had held off buying this book, since it is a collection of articles from his work at The New Yorker. Fortunately, a late night desperation buy at an airport bookstore solved that problem. It really is a terrific book, with lots of great insights into questions we normally might not ask but are pleased to get answered: Why is there one dominant brand of ketchup? Why are investments really a crapshoot even for the best? Why isn’t finding the blame always the best thing? That's just three out of many. It really was an enjoyable read.

2. Deep Survival: Who Lives, Who Dies, and Why by Laurence Gonzales, 2005, W. W. Norton and Company, New York, New York. I read this book in the general interest category but decided to write about it. The reason is simple—there is advice in this book which will keep businesses from failing—really. For example, the author talks about how survivors do a great job accepting and adjusting to their new reality, be it in the wilderness or a survival raft in the middle of the storm. They adjust so well that when the danger is over, they are actually quite comfortable there. As we've seen the number of spectacular business failures over the past several years, I was struck by how relevant this piece of advice was for their managers. Executives leading companies that survive don't deny their dire circumstances, they embrace them and figure out how to survive, then how to flourish. There are some other interesting insights here and certainly worth the read for personal reasons.

3. Behind the Cloud by Marc Benioff and Carlye Adler, 2009, Josset-Bass, San Francisco, CA. This is the story behind the explosive growth of Salesforce.com told by it's CEO. It is written as 110 "plays" that helped them get to where they are. It is a bit antiseptic, but it has some good stories. Also, it has a good thread of how they evolved their offering to multiple levels to meet the needs of different segments, and how they had to evolve their pricing model to accommodate the offering, too. Thanks to good friend John Kador for this recommendation.

Good Reading!

1. What the Dog Saw and other Adventures by Malcolm Gladwell, 2009, Little, Brown and Company, New York, New York.  Malcolm Gladwell is a favorite author (The Tipping Point, Blink), but I had held off buying this book, since it is a collection of articles from his work at The New Yorker. Fortunately, a late night desperation buy at an airport bookstore solved that problem. It really is a terrific book, with lots of great insights into questions we normally might not ask but are pleased to get answered: Why is there one dominant brand of ketchup? Why are investments really a crapshoot even for the best? Why isn’t finding the blame always the best thing? That's just three out of many. It really was an enjoyable read.
2. Deep Survival: Who Lives, Who Dies, and Why by Laurence Gonzales, 2005, W. W. Norton and Company, New York, New York. I read this book in the general interest category but decided to write about it. The reason is simple—there is advice in this book which will keep businesses from failing—really. For example, the author talks about how survivors do a great job accepting and adjusting to their new reality, be it in the wilderness or a survival raft in the middle of the storm. They adjust so well that when the danger is over, they are actually quite comfortable there. As we've seen the number of spectacular business failures over the past several years, I was struck by how relevant this piece of advice was for their managers. Executives leading companies that survive don't deny their dire circumstances, they embrace them and figure out how to survive, then how to flourish. There are some other interesting insights here and certainly worth the read for personal reasons.
3. Behind the Cloud by Marc Benioff and Carlye Adler, 2009, Josset-Bass, San Francisco, CA. This is the story behind the explosive growth of Salesforce.com told by it's CEO. It is written as 110 "plays" that helped them get to where they are. It is a bit antiseptic, but it has some good stories. Also, it has a good thread of how they evolved their offering to multiple levels to meet the needs of different segments, and how they had to evolve their pricing model to accommodate the offering, too. Thanks to good friend John Kador for this recommendation.