I maintain a relatively regular lunch rotation that features essentially the same main item at each eating establishment. Today, I was delivered a shock to my comfortable culinary routine: I was told that I could not substitute a brownie for the muffin that comes with the chicken salad sandwich box meal at, what I will call, “Establishment X.” (Note that the woman at the cash register was not the same woman I have seen for all these many months to-date. I can only assume that THIS time, I got the manager/owner!)
As I did my best to conceal my complete and utter shock and dismay, I casually observed that the brownie is the same price as the muffin ($1.99 vs $2.00). I was summarily informed that “the ingredients are different. They just use different ingredients. And the muffin is really good.” My overt protest shut down at that point, but my inner pricing analyst began gnashing away on the logic of this tragic situation.
Eating establishments typically use bundling to entice consumers to buy additional food that they otherwise would not have purchased separately, either because of price or (temporary) appetite constraints “at the moment or at the margin.” This technique is profitable when the complementary product has a high enough margin such that the effective discount applied to the extra food item still results in a positive overall margin.
In the case of the brownie vs. the muffin, I can only assume that the cost of the ingredients of the brownie are higher than those of the muffin (assuming no difference in labor and spoilage costs, etc..). If so, then all my earlier substitutions have caused Establishment X to lose some untold amount of profit (likely very small).
It was not in my interest to provide unsolicited pricing advice in this case since I am the consumer. However, if Establishment X hired Ahan Analytics, LLC for pricing consultations, I would likely recommend increasing the price of the brownie. Let’s assume a 25 cent increase still leaves the muffins with higher margins. This price increase would serve multiple purposes which should lead to higher overall profits:
- Drive consumers who are indifferent between muffins and brownies to buy the more profitable muffins.
- Extract more money out of consumers who strongly prefer the brownie and are willing to pay accordingly. I am biased on this point because I believe the brownie is at least ten times better than the muffin, and the slightly higher price would not discourage my purchase of the brownie by itself.
- Eliminate confusion about the relative value of the brownies vs. the muffins in the sandwich meal.
- Provide an opportunity to offer a brownie option for the sandwich meal at a slightly higher price.
Given I have plenty of other eating options in my lunch routine, I will not likely miss the chicken salad sandwich meal. I will just have to find solace in the “satisfaction” that on future visits, I will be purchasing the brownie at some discount to its, let’s say, “true price.”
This weekend, my alma mater, Stanford University, played football at Wake Forest. I was fortunate enough to make the trip although Stanford was not fortunate enough to win. I was also not fortunate enough to eat lunch before attending the game, paying $9.50 for the privilege of enjoying a small pepperoni pizza and an ice-loaded soda. I lamented with my friend the high cost of participating in a captive audience (the stadium does not allow outside food or beverage, but, of course, I cared more about attending the game).
Businesses love captive audiences because they provide a marketplace full of consumers who care more about an experience than its price. Moreover, a captive audience typically has no good alternative to the products and services offered for the duration of its “stay.” During a recession or economic slowdown, a captive audience can be an important and effective tool for protecting price points and maintaining profits. In the case of the college football stadium, the price of admission is relatively low ($17), while the price of staying is relatively high (in the form of concessions, seat rentals, and other products).
Investments in product quality can also help a business create a captive audience. Establishing a reputation for high quality products also translates into a strong brand name. A strong brand name consumes mind share in a marketplace – the captured audience – and constructs a higher barrier for competitors trying to win over customers. Most importantly, high product quality generates the goodwill in the marketplace that leads to the strong willingness to pay required to protect price points (and profits). These dynamics are particularly powerful during an economic slowdown where customers are extremely motivated to reduce expenditures.
There are a few required elements for high product quality to provide the kind of captured audience described here. Market and product analysis can verify how strongly a company scores on these elements.
- “Good enough” is not sufficient to accomplish the customer’s goals.
- Adequate substitute products do not exist and/or are extremely difficult to develop.
- Investments to sustain high product quality are not prohibitive in cost.
Trina Solar understands these concepts. Trina Solar operates in an industry where projects cost a lot of money, project financing is tight, competing products are in high supply (quickly becoming commoditized), and pricing pressures abound. However, during its last earnings conference call, Trina Solar emphasized its advantage in this environment due to its reputation for high product quality, an extremely important characteristic in the solar marketplace. A substantial portion of Trina’s business has also been in small markets (Belgium and Italy) where it is considerably easier to construct the “captured audience.” Trina now looks to leverage its success into larger markets like China and the U.S. If the company continues to deliver on its promises of high quality (at lower costs even), it should continue to capture larger market share…and audiences.
The “tragedy of the commons” (Garrett Hardin, 1968) is a concept in economics that describes how a group of self-interested individuals can destroy a shared (and free) resource. Hardin’s classic is example is a group of herders who destroy a pasture as each herder maximizes his/her number of grazing cows to make the most use of the shared (common) pasture. The tragedy is that the destruction of the pasture is in no one’s interest even as maximizing use of the pasture may be in each individual’s interest. It seems Twitter may have brought the tragedy of the commons to the internet.
In “Can Twitter Be Saved?,” Mark Gimein writes that Twitter will collapse from the sheer volume of users and messages if users do not focus and reduce the number of their feeds, and if Twitter does not develop some automated tools for helping users filter out the garbage from the useful. Gimein’s description of the typical Twitter behavior strikes me as a classic tragedy of the commons scenario: users (herders) barrage their followers with messages in an effort to attract the limited and finite resource of attention (the pasture). Access to this attention is free and messages effortlessly accumulate for all to peruse, so it is no wonder that many users liberally sprinkle “Twitter-space” with chatter and, in parallel, follow as many users as possible in an effort to attract as large an audience as possible.
While charging for anything on the Internet is tantamount to heresy, Twitter may be forced to set up some kind of fee structure to have any hope of constructing a more useful (and efficient) experience as the number of users appears ready to engulf the entire planet. Here is one example of what Twitter can do (my own unsolicited advice):
1. Charge a small fee to join, say $10/year; perhaps even charge $50-100+/year for corporate accounts where identity is authenticated and validated by Twitter. This fee mainly captures some of the immense value that people get out of the service and provides some funds to develop the automated tools that Gimein recommends. It also gives users one extra sense of ownership and, perhaps, an incentive to act responsibly. Of course, venture funding could easily replace subscription funding but only in the short-term. Someday, Twitter will need to generate sustainable revenues from something (even if it is charity!).
2. Charge a very small fee for messaging. There are many ways to do this, but the fairest method would be to charge something like a penny for each tweet past some high daily or weekly threshold. This provides the financial incentive to focus messages.
One might reasonably ask why Facebook does not face a similar problem with a tragedy of the commons. I suggest that Facebook is not a commons where anyone can and will attempt to siphon off a user’s precious attention. On Facebook, users typically only accept links to friends and family and people one or two degrees separated from that closed network. Because users either know or know of everyone in their network, there is an automatic incentive to ration attention-grabbing activity. Users are their to share their lives and to participate in the lives of others. There exists a huge incentive to focus one’s network on the things that really matter in one’s life and not to drown those moments and memories with trivialities and incessant self-promotion. Facebook does not need pricing to encourage self-regulation: it has self-interest working in lockstep with group-interest.
Disney has increased prices at Walt Disney World despite experiencing a drop in revenues last quarter. In its earnings reported July 30, the company had this to say about operating income: “Lower operating income at the Walt Disney World Resort was primarily due to decreased guest spending and lower corporate alliance income recognition, partially offset by lower costs. Decreased guest spending was driven by lower average daily hotel room rates and lower average ticket prices, which included the impact of promotional programs such as our Buy 4, Get 3 Free program.”
So, how can Disney raise prices right after experiencing these kinds of declines in customer spending? Clearly, the company has a lot of confidence in its branding and large mind share when it comes to family entertainment at theme parks. In fact president and CEO Robert A. Iger said as much: “While a tough global economy impacted our performance in the quarter, we remain encouraged by the relative strength of our business…That strength is the result of Disney’s combination of strong brands, consistent business strategy and the steps we’ve taken to make our businesses more efficient without sacrificing quality.”
More importantly, I suspect that Disney discovered that their promotions did not significantly increase foot traffic into the theme park. In other words, demand for Disney World remains relatively inelastic, even in this recession. It appears that Disney will be better served getting more revenue out of the core group of consumers who attend its theme park for many more reasons beyond price.
Disney’s stock dropped 4% on the day in response to the poor earnings and revenue report. I will be checking in again next quarter to review the impact of these price increases.
First Solar (FSLR) talked about its pricing challenges in last Wednesday’s conference call with analysts. The company is having trouble sorting through the various factors slowing demand for their thin film solar panels: for example, lack of credit and financing or competitor pricing. I suspect that First Solar’s sales teams need to do more aggressive market intelligence: talking to customers, monitoring the conference calls of competitors, and cataloguing the reasons motivating buying customers. Since the company is sure that prices must come down (demand continues to weaken), it makes sense to start as soon as possible with at least modest price concessions and schedule frequent reviews of pricing policies. Hopefully, the company also has a formal pricing team in place.
Here is the blurb from the Reuter’s story from June 24, 2009 (“First Solar sees costs down by a third in 5 yrs“:
“First Solar has said it would cut its prices to remain competitive with silicon-based panels, but Chief Executive Mike Ahearn said it was still unclear whether it was a lack of access to financing, competitors’ prices or other factors that were slowing down demand.
“Broadly speaking we need to look at price as a way to drive throughput against the production plan we’ve put in place. The question becomes, is price the constraint?” Ahearn said. “Is that the issue or is volume throughput constrained by other factors like project finance or permitting approvals and so on? It’s pretty easy to get caught up in market hype … Sometimes it’s hard to see what the real data points are.””
Bloomberg reports “Loyal ‘Simpsons’ Fans Fetch Higher Ad Rates on Web.” Premiun programming on the Web has gained pricing power due to the scarcity of popular, targeted advertising inventory. In the future, I would look for the industry to find ways of increasing ad inventory and creating more tools for mass audiences to create and manage their viewing experiences. This is mass customization at its finest: the point of differentiation happens exactly at the point of consumption. Advertisers will pay higher prices for being able to insert themselves into these differentiated moments of value.
This free webinar from the Stanford Graduate School of Business, Executive Education, looks interesting. I hope to post a review soon after attending:
Title: Mind Tricks: How the Brain Reacts to Price-Based Offerings
Host: Professor Baba Shiv
Date: Tuesday, June 23, 2009
Time: 8:00 AM – 9:00 AM (Pacific Daylight Time)
In light of the current recession, the media is filled with stories of consumers favoring products that deliver a price-based value proposition. Recent scientific investigation concerning how the brain processes information throughout the consumer decision making process has uncovered many surprising findings. In fact, these findings counter the conventional wisdom surrounding the development of a successful customer value proposition.
Professor Baba Shiv, Professor of Marketing at the Stanford Graduate School of Business, will examine the customer value proposition from the perspective of the buyer decision making process.
||Based on insights gained through cutting-edge neuroscience research, the key takeaways will include:
- The interplay of pricing and benefits in creating value
- The hidden downsides of a price-based value proposition
- An examination of the brain’s emotional circuitry and its impact on purchase
- Findings from recent fMRI examinations of brain activity
- Practical solutions for brand managers and marketers
||Baba Shiv is Professor of Marketing at the Stanford Graduate School of Business. His research is in the area of consumer decision making and decision neuroscience, with specific emphasis on the role of emotion in decision making, the neurological bases of emotion, and nonconscious mental processes in decision making. His rece nt work examines the potential for nonconscious placebo effects related to pricing, showing for instance that the higher the price of a product (e.g., wine) that one consumes, the greater the pleasure one experiences as manifested by a higher level of activation in brain centers that code for pleasure. Your attendance will also give you a glimpse of the Strategic Marketing Management experience and will further demonstrate the value that our ten-day advanced management program can provide to you and your organization.