Mimiran

Dell has launched a new back-to-school campaign highlighting the lower prices of of Dell laptops compared to Apple.  At a high level, this is a great idea.  Apple has regained a (the?) leadership position in the educational market, which is important beyond its immediate size because of its longer-term implications.  Dell has invested in design and now touts a nice-looking line that can reasonably compared with Macs.  Having the well-regarded Windows7 instead of Vista helps, too.  However, this effort suffers from several serious flaws:

• It’s really hard to tell what the advantages of the Dell are.  I think the point is that the machines are similar, at least in hardware specs, but the Dell is much cheaper.  Surely the web designers at Dell could have come with a way to highlight this point.
• The site ignores Apple’s student discounts ($200, plus a free iPod Touch– a small handout to both parents and students).  Even with this price difference, the Dell is still cheaper.  So why not be upfront about it?  Most students and their parents who are preparing to buy a new laptop for school probably know about the Apple offer already.  So now if anyone actually reads through the whole chart, they are going to doubt the veracity of the claims.  (Heck, Dell could always note that with their savings, you could buy your own iPod/iPhone/trip home/trip to spring break.)
• In addition to being hundreds of dollars cheaper, Dell is offering additional discounts in the range of $200-$300.  How many people are going to say: “I was going to spend hundreds of dollars more on a Mac, but now that Dell has reduced the price a bit more, I’ll buy a Dell. It must be just as good but costs half as much”?  Pitch the discounts when you’re targeting price sensitive segments, not when you’re trying to swipe people from Apple.  It’s worth noting that in it’s heydey, Dell was the Apple of the PC world, with the top-notch specs and higher unit selling prices than the competition, which had a very positive effect on profit.
• What family is this in the picture on the laptops page?  They don’t look like they’re trying to save money on a computer. 

What should Dell do?  Aside from addressing the issues above, they should talk about why the Dell experience is as good or better than the Apple experience.  Don’t just present a bunch of specs.  For example, one of the potentially powerful benefits of the Dell– the 25GB of free online storage– is buried at the bottom of the third tab.  Why not let them know that they don’t have to worry about losing that research paper, it’s all backed up online?  (Not that your Dell would ever crap out on you, of course, it’s just so snazzy that someone might walk off with it.)  And sure, more people may use Windows Live Messenger than iChat, but perhaps not in the student’s demographic.  Make sure they know that they can use the widest array of software, including the ability to do video chats and share files with Macs.

And if you really want to highlight the price, provide a comparison of what students and parents could do with that extra money.  All things being equal, maybe the kid would really want an Apple.  But what if he could do the same work on the Dell, and go to Europe for the summer?  (Don’t make it too much about the price– otherwise that $499 iPad might start to look appealing.)

Come on, Dell.  Here in Austin, we want you to succeed.  Now here’s a comparison.  Less specs, more about the benefits, the value.  Check out Apple’s education page.

If you haven’t already, check out Gerhard Gschwandtner interviewing Ron Hubsher from the Sales Optimization Group on the sales negotiation process.  Ron looks at the sales process with the same philosophy I do– namely, selling value instead of price, and using that profit increase to build a much more valuable company.  However, he approaches the problem from a sales training perspective, a nice complement to the analytical approach we use.

Check it out:

In a previous post (Be Better, Not Cheaper) I talked about the importance of differentiated value.  I have conversations about value almost as often as I have conversations about pricing, because a lot of pricing confusion is really value confusion.  If you don’t know what your value is, it’s hard to put a price on it.

Part of the challenge is going from “inside-out” thinking that focuses on your company, to “outside-in” thinking that focuses on what customers care about.  From a customer’s perspective, the price of your offering may only be a small part of a much larger value equation.  It’s easy to get hung up on the price (and offer deep discounts) without addressing the real issues that can hold up a sale.

Now Sales Compass includes the ability to map out the value you provide.  If you don’t have a Value Framework for what you sell, go in and create one (or more).  Show it to your colleagues and discuss.  I bet it clarifies a lot of pricing issues.

Value Framework

Who doesn’t love a bargain?  We all do, and we know our customers do, too.  But that doesn’t mean price is the only thing that’s important.  It becomes the only thing that’s important if everything else is the same.

Many companies feel they don’t have good differentiation, so they have to compete on price.  When Fortune 500 companies do this, the only implication is losing a few points of margin and billions of dollars of market cap.  When small businesses do this, they go out of business.  They either cannot sustain themselves financially, or they can’t sustain themselves psychologically.

That second problem may not seem intuitive, so let me explain.  Take a business that does 10% margins.  If the owner can raise prices 5%, she can increase profit 50%.  Or, she can make the same profit with a lot less work.  Less hours.  Less employees.  Less support calls.  Fewer customers.  Less stress.  If she feels she has to drop prices 5% to match a competitor, now she has to double sales just to get the same profit.  Even if this is possible, now she has double the orders to handle.  Double the chances of something going wrong.  She needs more people, more trucks, more inventory, more support staff.  More stress.  Even is she can keep the business afloat, at some point she’ll decide that it’s not worth trying to stay on a treadmill that keeps going faster and faster and doesn’t go anywhere.

What’s the alternative?  Be different.  Don’t let price be the only factor.  For many small businesses that sell the same commodities as larger businesses, the difference is service.  Note that a lot of the potential addressable market won’t care about your service.  They might even see it as a negative.  Don’t compete for those customers.  Go after the ones who value your differentiators(s).  The big companies have to appeal to broad markets.  That means there are niches where smaller companies can add value.  When a customer in your niche challenges your price compared to the big players, it’s a great opportunity to remind them of the value you deliver.

Remember, 10 years ago salesforce.com and Google were “niche” players in established markets.  Only hippies drank pomegranate juice or organic milk.  Blockbuster was the 800 pound gorilla of the movie rental market.

This summer, Steve Silberman over at Wired wrote a great article called “Placebos Are Getting More Effective. Drugmakers Are Desperate to Know Why.” While the implications for pricing in the pharmaceutical industry are obvious, there are also important analogies to pricing activities in a much broader range of companies.

The article discusses how big pharma saw controlling the central nervous system as a path to a whole new class of profitable drugs. What they found was that the mind had a huge impact over the body, but not necessarily because of the active ingredients in drugs. Patients who thought they were taking drugs often showed improvement even without taking actual drugs (placebo). This has been documented for some time. More interestingly, patients who received placebos from doctors who actively engaged with them and suggested the patient would get better had better results than patients whose doctors were strictly clinical and aloof. (They did as well as patients on the leading drugs– not that I want to veer into a discussion of health care reform.)

Placebo effects (or “responses”, as some experts prefer to call them) can also work the other way. Patients told of a drug’s potential negative side effects are more likely to report those side effects.

In short, our minds form expectations that end up shaping how we interact with the world and become self-fulfilling, or at least self-reinforcing prophecies.

So when you focus your conversations with customers on price, cost, discounts and other aspects of the pricing calculation, pricing takes the fore and you find out that customers “only care about price.” If you express your relationship with the customer in terms of the customer’s benefits, what other similar customers have achieved, and other aspects on the value side of the ledger, you generally find lower price sensitivity.

Don Hammalian, Senior Vice President at Alexander Proudfoot, a business process improvement consulting firm with a large sales process practice notes:

Salespeople tend to credit their competition with strengths and abilities that go far beyond reality, especially around competitive pricing. I’ve been with client salespeople who, on their way to close a sale, succeeded in convincing themselves in the car that they had to reduce pricing, even though the customer had not made it an issue. In some cases, they cut prices by 10-15% based on their own self induced fears. Rather than selling the value proposition, service and dependability of their organizations they focused on assumptive prices they could not match and missed their positions of strength. In nearly all cases, these concessions are made without a complete understanding of the impact on margin and market positioning. This is a formula for failure … they failed.

Selling on value is covered in Sales 101 and Pricing 101. The particulars of any given sales situation make it much more complex to implement, of course. Some organizations and individuals will try it, and most will see some kind of success. But it’s often anecdotal (despite the views of professor Jenny McCarthy, this does not make it valid). A couple of setbacks, and companies stop trying.

The goal is not remove price sensitivity, or win every deal at full price. This would be absurd. The idea is that overall, you can create a small but meaningful shift in pricing results, simply by positioning price appropriately. And if your margins are 10%, a 1% improvement just added 10% to your bottom line.

How can you use this effect to your advantage with your customers and sales team?

Part of it is a mindset shift.

We saw one company whose new executive team knew that it had to increase margins. They explicitly focused on value and improving price yield rather than just whether the deal is signed. They moved price exception approval from an administrative function to an executive function. They used our software to get details of open opportunities and how they compared to similar opportunities with the same customer or related customers. They even rejected a few deals that might previously have been considered acceptable. Within a month, the sales team had adjusted to the new regime and stopped asking for massive discounts. Sales and close rates did not change.

This effect is also why companies spend a lot of money on the customer experience outside the core “product.” Fancy restaurants have fancy decor and nice plates, setting your expectations for the food (and the bill). A Lexus showroom is very different from a used car lot. An Apple retail store looks different from Fry’s. Businesses communicate expectations about price and value, deliberately or not. Better to be deliberate, and aligned with your value proposition.

So if you feel you have a premium offering, act like it. This will help set customers’ expectations for price. If you want to communicate that you’re a low-price offering, don’t try to be as fancy as the more expensive competitor. Just don’t fall into the trap of saying you’re the premium offering and acting like you’re the discounter– you’ll incur the expenses of developing the premium product, but fail to achieve premium margins.

I wrote a couple weeks ago about Value, Scarcity and Pricing in the Age of Superabundance. Now there’s a timely report about the concentration of profits among cell phone makers from Bernstein Research analyst Toni Sacconaghi. Sacconaghi estimated that while Apple only accounts for 8% of the revenue among handset makers, it gobbles up an astounding 32% of the profit in the industry. (If you exclude losses at Sony Ericsson and Motorola, the number drops to only 25%.)

This is a great example of how diffential value has a huge impact on profit. By creating and sharing a value surplus between buyers and your company, you can dramatically increase profit. The flip side of this is that if you can’t differentiate, you end up in the commodity trap and you have a good chance of having negative profit. (Motorola made a ton of money in the cell phone business when a phone that made calls and was really slim was differentiated.) If you’re in the commodity business, you have to find a nice in your market where you’re actually differentiated.

Unless you’ve been assiduously avoiding the news lately, you probably heard that Apple announced a new iPhone model yesterday at their World Wide Developer Conference (WWDC), along with updated laptops and various software updates. Most of the news coverage focused on these items, but the real story was buried.

For the first time in years, Apple shifted their laptop price points. Unlike most PC makers who manage configurations, and adjust prices over time to track the inevitable decline in the value of silicon, Apple manages price points, and updates the components over time to maintain perceived value. Apple’s entry-level Macbook Pro notebook has started at $1999 since it was introduced in 2006. Apple dropped $300 to $1699 yesterday (along with some component changes). The mid-level and high-end 15″ MBP’s dropped $500 to $1999 and $2299, respectively. The 17″ MBP dropped $300 to occupy the $2499 slot. 13″ Macbooks were rebranded with the “Pro” moniker (and received some component upgrades), while dropping $100 in price.

This indicates that while Apple is weathering the recession well, they are adjusting to changing value equations in the market. Apple hates dropping price points. (One could also argue that there aren’t enough compelling upgrades to justify keeping the prior price points.) However, these adjustments will boost sales significantly and dropping component costs mean that Apple won’t take a margin hit.

We mentioned in a previous post that Microsoft is in the grips of a pricing dilemma. Changing paradigms have weakened Microsoft’s dominant position in operating systems and office productivity programs. Businesses and affluent consumers no longer upgrade regularly. What they have now is good enough. Developing markets that don’t need to maintain backwards compatibility with Microsoft Office file formats are turning to free (!!!) software alternatives.

So what can Microsoft do? They can’t simply drop prices or give away software without further depressing their share price. Their efforts to gain online revenue through advertising have been disappointing. Vista, even more disappointing.

Microsoft’s efforts to offer a stripped down version of Windows for developing markets and netbooks is a step in the right direction. They are cannibalizing their own profits, but that’s better than having someone else cannibalize them.

But this is an incremental step. Microsoft “won” as much through clever pricing as through clever technology. They licensed their operating system cheaply (at the time) but made sure that computer makers paid them royalties regardless of whether they actually installed the system. They realized early on that they could create a whole new market for software if they could make it more affordable. Rather than charge $500 for a word processor, $500 for a spreadsheet, and $1000 for a database, they gave buyers the whole bundle for $500. How could you say no?

This helped them kill the competition and for a while, they added enough features to subsequent releases to get consumers and businesses to upgrade regularly.

The problem is that they were so good at killing the competition that they forgot how to innovate. The incremental value of each release got smaller, while even contemplating a switch let users think about using alternative applications like Google Docs, that suffice for many users. Using Windows and using Office hasn’t changed much in the past decade.

In addition to making desktop computing prettier, they need to make it faster. In theory, it should be. In reality, I stopped using Outlook when I realized that it faster to use the Google browser application directly, even with Xobni installed in Outlook. When is it faster to search the web than to search my own computer? Desktop computing should be instantaneous. It should provide a noticeably snappier experience than the web. (If this required a major rewrite that would break backwards compatibility, they could always run a virtual Windows XP or Vista instance. This works amazingly well on my Mac.)

Next, desktop computing and productivity work should look good. The templates in Office 2007 are actually a lot nicer than the ones in previous versions of Office, but they still look pretty lousy. (You can pick a template in Apple’s iWork, which has only been around for a few years, and get much better looking results.) Microsoft should spend the money to get or create some really nice looking templates. And everything on the desktop should be “HD”. PowerPoint should look nice, not grainy with clunky animations. Speaking of HD, desktop video editing is the killer app for operating systems– one of the few things it’s currently really hard to do in the Cloud. Windows Movie Maker is a joke. Build or buy a really good, easy video editing program. At this point, the DoJ won’t care if you bundle it with Windows. Make PowerPoint output to this HD format, but make it interactive, so you can give a really high quality presentation. And because the average business user won’t know how to create professional animations, have a huge gallery available for instant download. This is stuff that Linux can’t do well, and even Apple users need a fair bit of expertise (and possibly expensive extra software) to create.

Next, think about how users want to work with documents. For a software company that tries to reuse code, Microsoft makes it pretty inefficient to work with documents. Many business documents have various sections– headers, footers, standard terms and conditions, snippets copied and pasted from other documents, and some original content. But it’s hard to keep the snippets up to date. If the company changes a logo or a business address, you have to update all the documents individually. If standard legal terms change, you have to update them all individually. If a 10 page section of a proposal template changes, you have to copy and paste that into individual proposals. Office should allow users to “link” to other documents or snippets and update automatically when those links change. This would dramatically enhance productivity in many cases. (Office has made strides in this direction, but they’re clunky and they may require you to set up server software on your network, rather than allowing you to login to a virtual network.)

Finally, the internet has moved beyond the ability to insert hyperlinks and save as HTML. (Even that doesn’t always work well, as my recent attempts to view a PowerPoint presentation saved as web document demonstrated.) “Track Changes” is an awesome feature, but you still have to email around documents or set up a server. Apple beat Microsoft to the punch with its iWork.com concept, which allows users to collaborate online. Microsoft should provide a similar service, which would also include an easy way to manage the snippets I mentioned above. People with the appropriate permissions could update the snippets and apply the changes to sets of documents. This virtual space could support the automated backup of important files of any type, but with additional capabilities for Microsoft file formats or other file formats if their vendors created the right plugins. Make it easy for businesses and consumers to upload files to YouTube, Picassa, and other sites.

Now you have an operating system and a set of productivity applications that actually make people more productive. You can be better than Apple not just at the individual applications, but in the way they work together to help users perform tasks.

When it comes to pricing, you now have a lot more room, because you have created more value. For the people who don’t care about all the bells and whistles, offer the simple version of Windows with an online version of Office with basic capabilities. (Having a 3 application limit in the basic version isn’t as much of a restriction now that so many apps run in browsers– make sure users are at least running your apps.) The “standard” version should include HD authoring tools and should cost about what Windows Home costs now. The “advanced” version should encrypt users’ data, and come with a login to your company’s Windows Live intranet.

There’s a lot of talk that Microsoft should pursue subscription pricing. However, past efforts to do this raised customers’ ire when expected upgrades did not arrive during the subscription period. Until Microsoft demonstrates that it can release meaningful, compelling upgrades regularly, they should stick to licenses. (They can always offer financing to defray the upfront cost.)

What about all these extra goodies? What are they worth? They are worth spurring an upgrade cycle. They should be bundled into Windows and Office. Down the line, Microsoft can charge for them (think about moving SharePoint into the Cloud). More than falling behind the times in the pricing game, Microsoft has stood still while the value game has changed. Fixing the pricing problem and the sagging stock price start with fixing the value problem.

When commodity prices surged and governments around the world pumped hundreds of billions of dollars into markets, crippling inflation was a major risk. However, demand is so soft that the Consumer Price Index (CPI) fell a record 1.0% in October. With the critical holiday buying season coming up, a lot of retailers aren’t even pretending that they will be limiting discounts. The New York Times notes that Online Sites Are Waging PreHoliday Price Wars, and a lot of them won’t survive– they simply can’t make it up in volume.

In both B2C and B2B, this is going to be a tough quarter. While there are no magic bullets, you can get better results with a lot less stress by developing an analytical framework to help you make decisions quantitatively, rather than by “gut.” Using your gut to guide pricing decisions while your gut is panicking is probably the worst way to set price, markdowns and discounts. Determine what you need to achieve, and your current plan for getting there. Determine the boundaries for walking away– whether it’s negotiated discounts or markdowns. And have a “3D” plan that lets you move more creatively than just tweaking the price lever. At a simple level, this means unbundling to allow you to serve more of the demand curve without hurting margins or destroying your value proposition. It also means using discounts effectively to exchange value, rather than just giving value away.

Don’t do what one online service provider did. They recently sent emails to some of their former customers, with the message “just in case price was the reason you stopped using us, we’re going to offer you over 50% off.” Not only is this unlikely to get a lot of former customers back in the fold, it’s going to ensure that the ones they get back are the price buyers. And it conditions all of their customers and prospects to push back on price. (Incidentally, we didn’t stop using them because of price. We actually decided to pay more for a similar service that offered better value.)

Wired editor-in-chief Chris Anderson recently wrote a provocatively-titled article called Free! Why $0.00 Is the Future of Business. Anderson argues that the economics of computing on the net, where storage and bandwidth costs fall even faster than the cost of processing power, will drive the price of many services to the marginal cost– in other words, $0.00.

Anderson starts by recounting the story of King Gillette, whose disposal razors laid the foundation for a multi-billion dollar industry. Now some companies have “razor blade” strategies. Think Hewlett Packard printers and cartridges, commoditized industrial products and high-margin services, Xbox video game consoles and games. The loss leader products in these examples have substantial marginal cost, which, along with antidumping laws, prevents companies from giving them away for free.

On the web, however, marginal costs are often close enough to zero to be zero for practical purposes. Anderson notes:

Not too cheap to meter, as Atomic Energy Commission chief Lewis Strauss said in a different context, but too cheap to matter…

From the consumer’s perspective, though, there is a huge difference between cheap and free. Give a product away and it can go viral. Charge a single cent for it and you’re in an entirely different business, one of clawing and scratching for every customer. The psychology of “free” is powerful indeed, as any marketer will tell you.

This difference between cheap and free is what venture capitalist Josh Kopelman calls the “penny gap.” People think demand is elastic and that volume falls in a straight line as price rises, but the truth is that zero is one market and any other price is another. In many cases, that’s the difference between a great market and none at all.

This concept is powerful and disruptive for problems that are amenable to web-based solutions. It’s not so powerful if you need a giant locomotive to move goods across the country. However, if information can replace the physical goods, prepare for disruption.

Microsoft, whose Windows and Office software programs generate billions of dollars in profit every quarter, thought it was immune to the web-based threat. Microsoft thought that the web could never provide rich enough functionality for users, and users would never accept a solution that required a live internet connection. Funny thing. Google just introduced technology that allows people to use its Office-like applications without an internet connection. Meanwhile, when connected to the internet, users can share documents and work collaboratively more easily than with the more fully-featured Microsoft version. Cost for Microsoft Office? About $300 for an upgrade. Cost for Google’s version? $0.00.

So where does the money come from? After all, a business is a business, and if it is to remain so, a fundamental inequality must hold true:

Value Provided to Customers > Price Paid by Customers > Cost to Provide Value

Leaving aside questions of value, the only way for a price to really be zero is if the cost is less than zero. While this may seem absurd, it’s the magic behind Google. It’s just that instead of serving customers for free, Google serves an audience to advertises for high margins. Anderson would like us to think that this is a fundamental change in the nature of business, but it’s really as old as newspapers.

Free is not a pricing strategy. It’s an advertising strategy (gather as large and valuable an audience as possible). It’s a promotional strategy (offer free services to cross-sell or up-sell other offerings). It’s a testing strategy (allow users to test your software for free, so that the premium version is more reliable).

Companies that take part in the “free” economy need to have a good strategy for monetizing what they giveaway at some point. And as Anderson points out, while we have more and more abundance in many aspects of our lives, our time and attention are scarcer than ever. The ability to offer something for nothing, even if the offering is valuable, is worthless if no one notices. Along with the abundance of the web, comes a strong network effect that Robert Frank and Philip Cook explored in The Winner Take All Society. In this global age, benefits accrue disproportionately to the “winners.” Google makes billions from “free” search. A small group of other search companies combined makes less money than Google. But offering a free search service is unlikely to generate significant profits, unless you can find a valuable and underserved niche. Similarly, a handful of popular bloggers make good money by giving away their ideas for free, and charging for ads. I am not holding my breath for this strategy to work for pricing blogs.

So we still have to provide value to customers, whether they are users or advertisers. We better be able to charge more for this value than it costs us to provide it. Otherwise we will go out of business. Anderson is right that the cost side of inequality is changing rapidly and that this can have a disruptive effect on markets. But while $0.00 may make for a catchy headline, it is not the future of business.

(Anderson, who previously wrote The Long Tail, is developing a book based on this concept, titled FREE, which will arrive in 2009.)