But it can be part of one. There were a couple of interesting article in the New York Times (free registration required) this weekend on B2C pricing for phone service and extended warranties. Almost everyone has seen the surcharges with names designed to sound like a tax (“property tax allotment” just means that you’re helping the phone company pay its property taxes).

As consumers, we’re used to taxes getting added to the end of the bill, at least in the US. In Europe tax must be built into the price, which is much more sensible from the consumer’s perpsective. (I think tax should be built into the price on the tag, but businesses should have option of listing other information as well, such as the price less taxes, the tax charge, and the tax rate. In some areas of the economy where taxes are built into the price, such as a gasoline, some vendors do display how much of the total price is going to taxes. But I digress.)

Price obfuscation reduces the customer’s ability to fully understand the price, and therefore to compare prices. It should therefore reduce price sensitivity. Phone service these days is a commodity (in most of the developed world, and increasingly in the developing world as well). So price obfuscation has been extremely important ever since the break up of Ma Bell. This worked well until Sprint came up with its “10 cents a minute” plan. All of sudden, customers had a plan that they could actually understand. Cell phone service is the same. Plans are complex, partly to obscure pricing. So some people buy prepaid cellular plans, which often work out to a much higher cost per minute, but at an easily understandable price.

This is similar to the “clarity premium” Saturn was able to charge. In effect, they made more money per car than competitors with no haggle pricing, because the customer was willing to pay a premium to not have to worry so much about pricing. A columnist recently noted that this is part of the appeal of the automakers’ “Employee Pricing” programs– people don’t have to worry so much about whether they’re getting a good deal. Unfortunately, I can’t remember where I read this, so I can’t properly attribute it. If anyone knows, please post a comment.

Extended warranties are similar beasts, but because they’re newer, consumers tend to understand them even less than phone charges. For electronics chains like Best Buy and Circuit City, these plans make up a huge percentage of profit. Often the sale of the product itself results in little or no profit. Hence the strong upsell at the register. However, different plans cover different things (like what happens if you break it because you did something stupid, like drop your cellphone off a balcony), and many include deductibles or other fees which greatly lessen their true value.

Indeed, you are not buying a warranty so much as insurance. Insurance makes sense to protect against catastrophic loss, not against minor inconveniences. The whole reason vendors are selling these warranties is because they think they will make more money than they spend actually servicing warranty claims. (So as a consumer, unless you feel you have better information about the chance of a product breaking than the company doing the insuring, you’re better off without it. Especially on electronic devices that come down in price quickly.) As a vendor– bravo. This is a great example of extending a product offering into a service offering.

There are a few problems with price obfuscation, however. One is that many policies blur the line between good pricing and bad ethics. Trying to trick your customers into thinking that one of your surcharges is a government tax is not right. (The FCC has made enforcement of complaints against these practices very difficult. For many companies, the money made easily outweighs the potential penalties.) Second, price obfuscation may also make it more difficult for you to understand what’s happening with your pricing. Third, you give competitors the chance to sneak in with pricing that customers can actually understand. These competitors may even be able to charge a clarity premium.

So if price obfuscation is important, make sure you stay on the right side of what’s right, and also make sure your story is coherent for the customers you target, whether that means blocks of calling time or rates or what’s included in warranty coverage or a project bid. If you target your customers well, competitors will likely have to target slightly different customers. They will have different blocks of time, different billing mechanisms, and so on. Natural obfuscation results in the market. You have a solid, targeted pricing strategy, aided by obfuscation.

If a competitor copies your policies and simply charges a lower price, you will likely loose some price-driven customers. These are the least profitable and least loyal customers anyway. You must be able to sell the others on your value. (Matching the price can be really bad for margins unless you can do it in a carefully targetted manner. The ability to do this may deter the competitor from entering your market in the first place.) A more interesting possiblity is that a competitor essentially copies your policies, adds some other premium offering(s), and charges a higher price. But that’s a subject for another day…

5 Comments

  1. Gervais Dubois

    Completely valid point, sir.

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  5. Alex Bentley

    Funny – this actually worked the other way for me yesterday. I broke the screen on my Treo 600 phone, and hadn’t paid for the insurance on it. A couple places on the web could replace the screen for 175, or I could get a new one for around 225 on eBay. I had resigned myself to punish myself by heading into the local T-mobile shop to get the cheapest phone I could.

    Aaron, however, after looking ay my account (and potentially my crutches from a knee injury) said “Well, I could send this in as poart of our exchange program for $70 – that would probably be cheaper than any of the other phones here (even the low end ones) and you’ll get it in a week.” That’s less than what I would’ve paid for insurance over the last two years I’ve had it. I’m guessing I found a loophole someplace for both PalmOne and T-Mobile. Some days, ya get lucky…

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