Mimiran

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.

We’ve had other discussions about how for some luxury goods, the exorbitant price is part of the value (see $300,000 watches that only tell you whether it’s day or night).

Meanwhile, as some of you may have heard, Apple launched a new iPhone, along with the AppStore, which allows iPhone owners to install applications, much like you can buy music through iTunes. Prices for most apps range from free to $9.99 (see this post from Pinch Media with price distribution).

Bringing these two storylines together, someone wrote an iPhone application called I Am Rich, which simply displayed a ruby-like gem. The software cost $999.99, the highest price point that Apple currently permits in the AppStore. According the author, the I Am Rich application “always reminds you (and others when you show it to them) that you were rich enough to afford this.” Nothing like a little humor.

It turns out that Apple does not find this amusing, and removed the application from the AppStore. ZD Net writer Jason O’Grady thinks the cause may be angry customers who did not really mean to buy the application.

Tricking someone into buying something they did not mean to purchase is not good, on a number of levels. (Reminds me of the Dilbert cartoon where the team discusses charging a million dollars with a $999,999 rebate. “We only need one person to forget to send in their rebate form.”) At the same time, conspicuous consumption is a pretty big driver of the economy. Anyone know how many people actually bought “I Am Rich”?

Edit: Apparently, 8 people bought it. That means about $5,600 for the developer, after Apple takes a 30% take. My guess is that’s a lot more money than most of the $1.99 apps have made.

Here’s an interesting pricing model for t-shirts. 200nipples (yes, even the name is, umm, remarkable) sells limited edition runs of 100 tshirts. The first shirt costs $1, the second $2, all the way up to $100. This has the nice effect of rewarding your most loyal fans, who presumably will get some pretty cheap shirts, and spread the word. What you’re really counting on is people willing to pay $90-100 for a tshirt. (Count me out.) Has anyone bought one of these shirts? Know someone who has? How much did you pay?

In last week’s post How to Raise Prices, I referenced two interesting articles on techniques for raising prices, and also suggested using unbundling to differentiate between customers who want maximum value and customers who want minimum price. Today, let’s look at three interesting price increases– Oracle’s list price increases, Apple’s iPhone price “decrease”, and airline surcharges.

Oracle raises list prices by 15% or more
Oracle is making waves with double-digit price increases (see “Oracle increases prices 15 to 20 percent: The joys of pricing power” on CNet), but what does this really mean? Are they really getting customers to pay 15-20% more? Probably not.

Oracle is unusual in the software industry in that they publish a global list price. Most enterprise software companies (Mimiran included) vary pricing by region and don’t publish prices to avoid focusing on price early in the sales cycle. Oracle’s prices and earnings are dollar-denominated, meaning that overseas software sales have been getting cheaper for customers in Europe and Asia, while Oracle’s local expenses have gone up in dollar terms. In other words, a nominal price increase was necessary just to reverse the price decrease brought on the falling dollar.

Second, enterprise software deals rarely close at list price. The price increases provide more room for negotiation. One of the most important aspects of list price changes in B2B environments is how much of the price change flows through to the actual price the customer pays.

Third, the move serves as a nice signal to SAP and other vendors to stop driving prices into the ground.

The software industry is consolidating, especially around Oracle, which has been gobbling up competitors, but they won’t get a real 20% price increase. However, if they end up netting 1 or 2%, that’s still a few hundred million dollars in incremental profit.

Apple’s “Cheaper” iPhone 3G
Apple made a big splash by announcing that their new iPhone would not only support faster 3G internet access and GPS, but would also sell for the magic price point of $199. This represents a $200 price drop, along with more functionality. Isn’t the rapid march of technology amazing? Not so fast. At the same time Steve Jobs announced that he was making the iPhone more affordable, AT&T upped the price of data plans for the iPhone by $10/month. To get the discounting price, customers must commit for 2 years. So you might save $200 up front, but you spend an additional $240 over the next 2 years, and an additional incremental $10/month after that. Basically, Apple and AT&T are financing your iPhone purchase for you with a very high interest payment plan. The beauty of it is that the lower upfront cost only happens once, while the ongoing revenue stream stays as long they can keep the customer. And while everyone who does the math knows that this is actually a price increase, what sticks in consumers’ minds is “wow, an iPhone for $199.”

On the backend, AT&T’s payments to Apple make it a strong pricing move for Apple, as well, and analysts seem bullish on the revenue potential.

Airline Surcharges
And now let’s get to everyone’s favorite pricing punching bag– the airlines. American, United, and other carriers have introduced fees on checked luggage to go along with fees for fuel prices, talking to a person, using curb-side checkin, and buying inedible snacks on planes. Delta also announced fuel surcharges on redeeming frequent flier miles. Naturally, travelers are unhappy. Checking a bag on some carriers will now cost you an extra $15, while the second bag will cost $25. And it’s an extra $50 if you actually want to pick it up at your destination. (Just kidding about that last part.)

While this is irritating for fliers (I’ve heard some say “why are you nickel and diming me?”) the alternative would be to raise prices across the board. Airlines are hemorrhaging money (what else is new?) because of higher fuel prices and the slowing economy. They need to do something, and price increases are an inevitable part of the mix. Flying is going to be more expensive for a while, until jet makers can create much more efficient planes. The next generation will help, but not enough to offset the rise in fuel prices.

Of course, airlines are good at slapping on surcharges. They are not good providing a good customer experience. They haven’t done anything to address the ridiculous “security” procedures. (I’ll save the story of how I accidentally took a swiss army knife in a carry on bag that was hand searched by TSI for another time.) They have taken pillows off planes and charged for “snacks”. Why not work with the government to reduce the unnecessary elements of the security burden? Why not team up with airport restaurants, or even bring in Starbucks or someone similar to allow customers to order onboard food when they checkin? The system might take some work to implement, but it would allow the airlines to bill customers immediately instead of worrying about making change on the plane, allow customers to get some halfway decent food (depends on the airport), and the revenue sharing would probably bring in more incremental profit than the current program. The partners would drop food off before the flight, the airline could keep the hot food hot and the cold food cold and deliver it after take off. The passengers waiting inline for 15 minutes at Starbucks would save 15 minutes. Food revenue per customer would probably go way up, even if the airlines turned the bulk of the revenue over to the partner.

Although I’ve said before that with luxury items, the price is the value, I’m still occasionally astounded. Now along comes one of the most absurd items I’ve ever seen. Swiss watchmaker Romain Jerome created a watch they call “Night & Day.” Why do they call it that? I’m glad you asked. Because it doesn’t actually tell time. It just tells you whether it’s day time or night time. How much would you pay for this? If you offered less than $300,000, you wouldn’t have got one, because they sold out within 48 hours.

Other luxury goods typically make a pretense that they offer some kind of functionality to justify their price. Ferraris are fast. Fine, rare wines are supposed to taste good– even if you’re not really supposed to drink them. Fancy jewelry is supposed to look nice. Even luxury watches, which are no more accurate than $10 digital watches, have complex mechanisms to tell you the phase of the moon or some other piece of not really useful information. But a watch that doesn’t even pretend to tell you the time?!?

As a pricing person, this is brilliant. This is about the story that you tell when someone asks you about your $300,000 watch. I imagine it goes something like this:

Nice watch. How do you read it?

See here? This means it’s day. If it was over here, it would be night.

Oh, I see.

Yes, it’s extremely useful when I’m in the media room of my yacht and I just really want to know whether it’s day or night, and my VCR is still flashing 12:00, so I just look at my watch.

Why don’t you just ask your butler?

Usually I do, but sometimes I’ve just sent him to get a bottle of that Chateau Lafite that you’re really not supposed to drink, but I’ve never understood senseless luxury, you know?

That’s great. Chronographic technology has come so far since man looked at the sky. I can never keep up with the time zone changes when I’m in my yacht. I should get one of those.

Sorry, they’re all sold out.

So can anyone come up with a luxury item to top this?

For many people watching the Elliot Spitzer scandal unfold, the shocking part of the story was not that a powerful politician went to a prostitute. That seems almost retro these days. What seemed jaw-dropping was the amount of money Spitzer was paying out. Well, it turns out that the world’s oldest profession knows a thing or two about high end luxury pricing. (As Bill Mahr pointed out, there’s a big difference between the high end call girls in Elliot Spitzer’s circle and the vast majority of prostitutes who have few or no options and no pricing power.)

As we pointed out in the recent post “In Luxury Goods, Pricing Is Part of the Value“, high prices for certain goods create a perception of high value in some markets. Brownwyn Fryer over at the Harvard Business Review Editors’ Blog takes a much more practical, hands-on view of the experiment we discussed that doesn’t involve MRI machines, but does require purchasing one bottle of expensive wine. (See “Are Your Prices High Enough?“) Bronwyn herself left a comment on one of the other comments referencing a recent New York Times article called The Double Lives of High-Priced Call Girls.

And when it comes to price, Ms. Xi’an shared a secret. When someone pays her $1,250 an hour, he gets exactly what he would for $200, her rate when she started out. The difference is psychological, she explained: “The more somebody pays for you, the more they’ll respect you.”

“Tell a guy you’re $100 and they’ll treat you one way — tell them you’re $1,500 and they’ll treat you better,” Ms. Xi’an said in a telephone interview from her home on Long Island. “I’ve heard a lot of girls saying, ‘Is this girl getting $5,500 an hour because she’s more beautiful? Is she doing something I don’t?’ The answer is no. But that girl is able to look a guy in the eye and say, ‘This is what I’m worth, and this is what you have to pay if you want me.’ And you have to be able to do that, and believe it.”

This can be true for a lot of purchases. People who buy expensive, top-of-the-line offerings, whether they are stereo systems, software applications, wines, or other indulgences think more highly of their purchases and invest more heavily in them that those who purchase cheaper offerings.

Luxury vendors have long known that high price is part of their appeal. Not the price per se, but the exclusivity that comes with it. Like a peacock’s tail, the conspicuous consumption of goods that lack any practical purpose is a display of status, which has a powerful draw on the human psyche. New research indicates that our brains react differently to the consumption of expensive goods. Researches used functional magnetic resonance image (fMRI) to measure blood flow to different areas of the brain while subjects drank wine. Researches used 3 different wines, costing $5, $35, and $90 per bottle. However, they had the subjects sample the $5 bottle twice, once under the impression that it cost $5, and once under the impression that it cost $45. They also double-sampled the $90 bottle, once at its actual price, and once under the impression that it cost $10. Participants experienced more activity in the brains’ pleasure centers when they thought they were drinking more expensive wine. They also reported that the wine they thought was more expensive tasted better. What I want to know is: why does no one invite me to be part of these studies?

On a related note, Forbes discusses the luxury pricing game, and gives some examples of very expensive goods.

As you may have noticed, the quantity and quality of posts has suffered since my writers have gone on strike. But like The A Daily Show, we’re back. Fittingly, when Jon Stewart returned to the studio last week, he had some things to say about pricing.

The writers’ strike is mainly around residual payments on internet revenues. The writers want them and the media companies don’t want to pay them. Regardless of who you think is right, the situation has led to some comically absurd situations, many of which revolve around Daily Show content on YouTube. Media giant Viacom claims on one hand that internet revenue isn’t worth anything, while on the other hand claiming that YouTube owes Viacom $1B for copyright infringement.

Stewart points out that the $1.99 fee for downloading episodes from iTunes is not actually revenue, but a “shipping and handling charge.” He also says that watching a show on an iPod is like a promotional sample of cheese, not a portion that anyone would actually pay for. The segment is tongue-in-cheek, of course, but is a humorous way to look at how changing technologies collide with psychological expectations. For example, we accept that movie matinees are cheaper than primetime movies, but we don’t accept that we should pay more for highly desirable movies, despite the obvious economic utility.

Stewart also points out that if Viacom was serious about the value of their content, they wouldn’t have sued for $1B, “clearly a figure they pulled out of their asses. If there were real money on the internet, don’t you think they would have gone with a believable number?” The patent absurdity of the number in this case almost seems like a ploy to give Stewart fodder for jokes. Much less funny, but perhaps more important, many companies publish prices that the market laughs at, and then says “OK, but let’s talk about the real price.” This wastes a lot of time both in preparing prices that don’t mean anything and negotiating deals. It also bleeds away a lot of margin. If your public prices don’t mean anything in your market, it’s time for new prices and/or a new market.

(One nice thing about the Viacom/YouTube dustup is that The Daily Show now has a complete, searchable archive, where you can watch the segment cited above.)

There’s an interesting article over at Fast Company on The Inevitability of $300 Socks, which talks about the formerly incredible notion of paying $300 for jeans. Remember when $50 jeans were “designer”? The authors, Dan and Chip Heath, argue that luxury is not simply about projecting social status or class, but about displaying appreciation for certain finer things, creating a sense of personal luxury that might involve wearing $300 jeans with a cheap t-shirt. I’m not sure if I agree with the premise– no one has been able to convince me that $300 jeans are in any way better than their cheaper brethren, unless you feel the need to advertise, to those who are in the know, that you are wearing $300 jeans. In some ways, the simple display of wealth is too common to be a meaningful conveyor of taste. So many people have Luis Vuitton handbags– so what’s the point? Status must now involve more than simple spending power, it must indicate appreciation or affinity for a certain type of fashion, “lifestyle”, or somewhat exclusive club.

Which brings us to the socks. The authors write: “Yes, we all know that no one in their right mind would ever pay $300 for socks. But having a right mind is so yesterday.” So, starting from the price point, how would we create and market such expensive socks? The article notes: “V.K. Nagrani, a designer of high-end men’s socks that retail for about $35, believes socks are a signal of intimacy. Think about it: In a formal situation, you’ll rarely see someone’s socks.” So you need people to be able to take off their shoes, or at least put them on their desks, to display their trophies. This could be in a country club locker room, in many homes, particularly in Asia, or after a date. Assuming you give people the chance to show off their fancy footwear, what would they show off? Catchy designs, with high-end materials, most likely. A distinctive pattern on the side and/or the bottom of the foot to let people know “yes, these really are those $300 socks.” Of course, you should make them really, really comfortable. Make them socks for business people, but design them like athletic socks with cushy bottoms, heels, and other places that might rub, but thinner material on the sides so your feet can breathe better. Perhaps make them easy to wash and dry in a hotel. Pitch them to executives, sales people, business people who spend a lot of time in nice shoes and on their feet. How much is it worth to them to have their feet feel less tired at the end of the day? Next, guarantee the socks for life. If you buy these socks, and 5 years from now they’re worn out, come in for a brand new pair. That not only directly increases the value, it also provides an interesting story, and a chance to re-engage with customers. The interest earnings should easily pay for the new socks, anyway.

Anyone have any better ideas? If anyone can sell these successfully at retail, I’ll buy a pair, just to wear them to pricing conferences. Then I can start my talk with “how many of you think you sell a commodity with no pricing power? How much do you pay for socks? What if you could charge 30 times the going rate?”

An alert reader sent in an article from the Wall Street Journal (free for one week) called The Psychology of the $14,000 Handbag, which delves into why stores offer, well, $14,000 handbags, and what this means for the rest of us, even if we might prefer to buy a car instead of a bag. The article raises the concept of price “anchors” or “reference points.”

Some people cut and run when confronted with prices that seem crazy. But many of us experience a sudden emotional-mathematical transformation. We set a new ceiling for a “reasonable” price. Disinclined to go all the way to buy the trophy, we instead settle for a consolation prize. Mr. Schwarz, a jeans-wearing type, walked out of Boyds with a suit that cost merely $800 — the most he’d ever spent on an item of clothing.

“If you’re in that world long enough, $800 stops even feeling like a lot of money,” Mr. Schwarz says.

This concept is one of the reasons for the proliferation of $300 designer sunglasses these days. The fact that Ralph Lauren is charging $14,000 or so for an alligator “Ricky” handbag makes it easier for a consumer to justify in her mind paying $300 for a rather simple sweater. Many Chanel sunglass owners are actually would-be owners of Chanel suits. Something similar has happened to many owners of Tiffany keychains, Prada legwarmers, Coach wallets, and Frette tea towels.

Of course, this thinking is not limited to fashion. Mercedes makes $150,000 cars in part to indicate that a $50,000 vehicle is not that expensive. By framing the comparison as “less than our $150,000 model” rather than “twice as much as a Honda”, many buyers will be more likely to accept the price. The customer ultimately controls which prices serve as reference points. However, most buyers are not consciously aware of how they think about relative prices. Even those who understand how reference prices work, like Mr Schwarz, a psychology professor, who earlier in the article marveled at $3,000 suit before selecting his $800 purchase. So sellers have the ability to influence reference points. One way a lot of retailers reduce their pricing power is by establishing their own low reference prices– by featuring clearance merchandise right at the front of the store. It may get people in the door, but everything else in the store looks expensive in comparison. As I’ve noted before, Apple does a good job of retail pricing, in part by putting clearance merchandise in a low prominence position at the back of the store. Some retailers may complain they don’t have iPhones to sell, but hey, in fashion– you’re supposed to have something new to sell all the time.

Studies have documented that having 2 price points (high, low) results in lower sales, particularly of the high-priced item than 3 price points (highest, high, which is the new “medium”, and low).

Another way to think about this is to ask yourself how you’ve made decisions based on price in certain situations where you have little other information available. Ordering wine at a restaurant, buying some technical gadget that you don’t really understand, or a piece of clothing from a seemingly similar array? Some people gravitate to the lowest price point possible, some to the highest, many to some comfortable middle ground. This often works even in business-to-business settings, where many buyers don’t want to go for the “cheapest” option, in case something goes wrong, nor for the most expensive option, for fear of getting past the purchasing committee.

As Homer Simpson once said: “Garçon! Another bottle of your second-least expensive champagne.”