Mimiran

If you’re reading this blog, you probably know the dramatic profit impact of small price improvements.  (For a company running at 10% net margin, a 1% price improvement increases profit by 10%.)  Yet even when companies want to improve pricing performance, they often feel like they are at the mercy of the market.

If you’re truly in a commodity market, you are in fact at the mercy of the market.  Either focus on your cost, or differentiate to decommoditize.

Few businesses are in true commodity markets.  And for a lot of these businesses, especially at the SMB level, the first barrier to improved pricing is the one the business owner can control most directly: themselves.  Many business owners look at their costs, tack on a “fair” profit, and call it a day.  Or they look at the competition and price a bit below them.  Even when costs go up, they often have trouble raising prices.

Your pricing is ultimately limited by the perceived differential value of your offering.  I’ll go into more detail on the value side in a later post, but for now let’s think about the amount of value you can capture.  You work really hard to create value for your customers.  You work proactively to make them successful.  Don’t sit back passively when it comes to capturing your share of that value.  Pricing is the monetization of value, and you should be just as proactive about that as value creation.

So don’t be the limiting factor on your pricing.  If you think you should be achieving higher prices but you haven’t asked because it makes you uncomfortable, you need to fix that.  If you are used to giving big discounts when you get nervous in sales cycles even though the value is there for the customer, you need to fix that.

Here are some exercises to help you think about this:

• The Series of Increasingly Outlandish Prices.  From Steve Blank, author of 4 Steps to the Epiphany.  When the customer asks for the price, keep getting more and more outlandish until the customers pushes back.  For example:  “It’s $1M dollars.  Per month.  Plus $2M for setup.  Plus 20% maintenance.”  The point is to help discover the price for a new offering, but it’s also useful to force you to think beyond “I think it should be about $99.”
• Double Your Price.  Someone bursts into your office and holds a gun to your head.  They tell you that you have to double your prices in a month.  (Maybe it’s your accountant.)  What would you have to change about the way you sell, your products, your services, your customers, to achieve this?  While you may not be able to actually double your prices, you can make dramatic improvements.  We used this method to double consulting prices, although it took us 2 years, not a month, to actually do it.
• Visit a Porsche Dealer.  Test drive the fastest convertible on the lot.  When it comes to negotiating the price, keep insisting that you are deciding between this car and a Hyundai Sonata that seats 5.  Keep asking the sales manager to come back with a better price.  After they get done laughing and throwing you out, compare the reaction of the car salesreps to your reaction when customers try to chisel you down on price.
• Say It to the Mirror.  It may sound silly, but if you have trouble asking for the price you think you should get, practice saying it to the mirror.  Not just the price, but why this is a great deal for the customer.  Make sure there is no hint of apology in your voice or your body language.

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

Chris Anderson of Wired said that Free is the price of the future. Some of us beg to differ. Among those with other opinions are Lincoln Murphy of 16 Ventures who published a paper called The Reality of Freemium in SaaS, and Dave McClure, who wrote Subscriptions are the new Black on his always entertaining and provocative blog Master of 500 Hats.

Lincoln notes that “free” is a marketing tactic, not a pricing strategy.  (As a pricing strategy, free can work well as a defensive move to discourage other entrants from building free or cheap products that could threaten your core business.  It’s a hard way to build a core business.)

McClure writes (rants?)

ASSERTION #2: The default startup business model for 2010 & beyond will be subscriptions and transactions (e-commerce, digital goods).

Newsflash folks: The Internet does NOT want to be FREE… It wants to GET PAID on F&*&ing Friday, just like everybody else on the damn planet.

What does this mean?  It means you have to think about the value your customers receive from using your offering, and how that value compares to their alternatives, including the option of doing what they are doing today.  Value includes both positive and negative elements.  For example, saving time might be a positive value, whose worth depends on how much time and whose time you’re saving.  Signup time or data migration time would be a negative value.  If you can’t generate a strong value proposition and get your prospects to believe it, you’re going to be in trouble.

This can be especially hard for tech companies that create cool technology and focus on the features.  Features don’t have value.  Features can create value by providing benefits, but it’s the benefits that create value.

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.

For most people, throughout most of human existence, scarcity was paramount.** Now we live in an age of not just abundance, but superabundance. The agricultural revolution created abundance– not by today’s standards– in food. The industrial revolution created abundance in manufactured goods. The information revolution not only created an abundance of communication and information, it also dramatically increased our ability to move production to cheaper locations and manage the complex supply chains that resulted.

Buyers–both individuals and businesses- benefited from a huge increase in supply, selection, and a huge decrease in price. We also ended up with a superabundance of credit, which helped fuel appetites for the endless array of cheap goods.

For sellers, however, the situation was often disastrous. Many local businesses succumbed to larger competitors with lower unit costs and lower prices. Even large, successful businesses found themselves on a treadmill, running faster and faster but never getting a sustainable competitive advantage. You might have just moved manufacturing to China, only to find a competitor had achieved lower costs in Vietnam. This is before we even get to the internet, where prices are literally going to zero in many cases.

So what can we do about this?

We need to rediscover scarcity. In many cases, we’ll have to create it. This is not as simple as producing “limited editions.” This won’t work for everybody. (If anyone has any information on how Nomenus Quarterly is doing, please let me know. The trendy magazine made the New York Times after cutting production from 50 to 10 and raising prices from $2500 to to $6500 per issue.) Rental car companies have had success raising prices after trimming their fleets. It may be easy to make a car cheaply, but having one available at the airport when you need it is a different story.

And that is the key to rediscovering scarcity. You have to understand what the customer needs that’s hard to deliver. At one point, just making something was enough. Now, whatever you can make, chances are someone else can make and offer more cheaply. In pricing, after all, you’re only as smart as your dumbest competitor, and chances are some new MBA is looking to make a name for himself by getting 25% of your market, even though it’s a dumb move for everyone. (We’ll talk about the latest round of Google v Microsoft in another post.)

In an age when a device as mind-boggling complex as a supercomputer’s worth of processing power is a commodity, the silicon itself has little value. But the ability to turn it into a data center takes some skill. The ability to do it tomorrow, in a certain location, with training, monitoring, and reliability guarantees is actually really valuable.

Whatever it is you’re selling, think about how your customers use it, and how there are situations when the overall experience creates scarcity bottlenecks. This could be the fact that while Southwest flies 10 cheaper flights a day, if you actually want a seat at the last minute, you’ll be forking over $1000 to Delta. Or if your customers require extremely high reliability or precision. Or if your customers order commodities from you, but require logistical and service support to deliver them to the right people, at the right time, and perhaps even set them up. Note that this does not mean you can charge all potential customers high prices all the time. It means that certain segments place a value on your offering, at least some of the time. Understand this, deliver what they need, and price appropriately.

A lot of this comes back to the one thing that is getting less and less abundant as everything else becomes superabundant: time. If you can save your customers time, you can make money. If you can save them more time than alternative solutions, you can make a lot of money. If you’re stuck on how to create scarcity, start with the customer’s time, which is already scarce.

** This goes all the way to our genes. Before Quik-E-Marts, our craving for sugar and fat helped keep us alive. Now it gives us heart disease. For more on this somewhat-related topic, check out the New Yorker article XXXL: Why are we so fat?

In addition to the genetic arguments, the article notes that the price of food, especially calorie-rich, nutrient poor sodas and other processed food, has fallen sharply. (This is partly due to increased efficiencies in farming and industrial food processing, and also partly due to subsidies that encourage production of food that we probably shouldn’t be eating. The cheapest, simplest, least-likely-to-happen step we could take to improve our healthcare situation would be to end subsidies for corn.)

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.

Measuring risk is a critical, yet impossible task. How can we act effectively without understanding the risk? How can we see the future? Or, what is the right balance between educated estimates of risk and potential benefit? These questions are important in many aspects of life, not least pricing. A lot of companies make pricing decisions without a good understanding, or even an attempt to measure risks. And, as we’ve seen recently, even businesses who are supposed to be really good at measuring risk– banks– can screw up terribly. Now your business needs to weather a bad economy, while subsidizing those who are supposed to be experts at measuring risk.

I wrote a post a few of weeks ago about the risks in measuring risk. Here is another article on the pitfalls of simplistic risk measurement, focusing on recency bias. Recency bias– the natural tendency to weight recent events more heavily than earlier events that are just as statistically relevant– is a common trap in risk assessment. The article notes that if you took a simple view of the risk of recession in any economic quarter, your time horizon has a huge effect on your results. If you only look over the past 20 years, the threat of a crash appears very slim– once every 624 years! But if you go back to WWII, the same measurement leads you to expect a crash about every 8 years. What’s really interesting is if you graph the odds of a crash over any 20 year period, the results change dramatically depending on which 20 years you pick.

Here is the graph from the article (clicking will take you to the article):

Note how the relative stability of the last 20 years has caused a lot of people to “forget” about the possibility of a severe crash, even though everyone “knew” that a lot of adjustable rate mortgages were about to reset and their was a lot of risk in the system. (Here’s a great take on the problem.)

In my previous post, I noted that using multiple assessments of risk, and modeling risk at the lowest level of granularity and aggregating up would give much better results than simply looking at aggregate data and having one expert pronounce their opinion. There are three other things you can do to mitigate risk that are especially important when the economy is weak.

First, don’t force customers into all-or-nothing choices. This type of bundling might be useful when customer don’t have a lot of alternatives, but when times are bad, it can lead to cancelation of entire orders or contracts, rather than a “graceful degradation.” Removing value-added services or reducing order volumes might be painful, but it’s easier to manage, financially and operationally, than suddenly losing big chunks of business.

This leads to another important process when modeling risk. Don’t just consider the financial impact of what-if scenarios– consider the operational implications. In other words, what might you have to do under certain scenarios? How might you adjust discount negotiation parameters if your company’s economic climate changes? How might you have to adjust production schedules? Thinking about this in advance avoids panicky decisions that can make the problem worse. For example, companies that develop strict discount negotiation policies during flush times find that their sales are slowing, and instead of adjusting their discount parameters, they throw them out, which keeps deals flowing in, but starves the company of vital profit. Companies that are not actively tracking sales, orders and their profit implications can suddenly find themselves in a bad position and they lay off the staff they might need to dig themselves out. Having a contingency plan and a dashboard would have allowed less drastic, more effective action, earlier.

Third, go back further. A lot of pricing decisions get made “because that’s how we always done it.” Go back to the folks who set up the pricing policies in the first place. What were they trying to accomplish? Does the policy still accomplish that goal? What risks were they concerned about? Have any sales reps who sold through the last big downturn? What did they do to survive that one (or not?)? Reaching back and asking the right questions will help avoid or mitigate recency bias and devise better scenarios and better contingency plans.