The following excerpt from the November 20, 2013 Wall Street Journal article titled “Price War Looms For Electronics” screamed out at me that there is a lesson here to be learned about trying to avoid a price war. First, read the excerpt.
Best Buy Co. shares plunged 11% Tuesday, after the electronics chain warned investors that it was prepared to sharply cut prices—even at the risk of its profit margins—to keep up with competitors that are aggressively discounting to win market share. Chief among those rivals is Wal-Mart Stores Inc., which last week stated bluntly that it will turn to even more price cuts to boost its stagnant sales.
I’m especially enamored with the comment that Best Buy warned “that it was prepared to sharply cut prices to keep up with competitors.” Think about what this statement says.
Maybe it’s completely truthful and it means exactly what it says. They are ready and willing to fight any price war that comes along.
However, think deeper. What it could mean is: “I’m warning you competitors to not start a price war because it won’t end in you gaining share, only in lower profits for all. We are committed to maintaining our share even at lower prices. Since lowering prices won’t gain you share, you might as well not try.” The statement could be an attempt to stop the price war from ever beginning.
Economists call this “cheap talk” and would take the logic even further. They point out that it is costless for Best Buy to make this statement. And, if Wal-Mart aggressively lowers prices, there is no gun to Best Buy’s head forcing them to fight a price war. Hence it may simply be an idle threat to keep competitors from lowering prices. The logical conclusion is that competitors should not believe this threat is credible.
Although economists are usually right in theory, this doesn’t feel like the best explanation. Since Best Buy made the statement to their investors, they are essentially committing to a course of action. Yet surely they are hopeful that announcing these intentions, their competitors will choose to not compete so aggressively. This holds industry profits up for all.
Regardless of the truth of Best Buy’s intentions, we can learn a lesson from this. Threats of aggressive retaliation often keeps competitors from using price to compete. That has the potential to keep profits, yours and the industries, higher. The lesson, be strong and threaten retaliation in a price war. After all, the threat doesn’t cost you anything and it just may work.
Think about supply and demand. Years ago I wrote a blog post on how supply and demand aren’t typically related to pricing because supply is usually abundant. Implicit collusion, not supply and demand holds prices above costs.
Today, let’s think about when supply is limited. We see this for consultants who have more business than available hours. We see this for airlines and hotels during the holidays and other busy times. Each year, some toy will become the hot, unattainable plaything that every kid clamors for.
In each of these cases, demand exceeds supply. This means ideal pricing is driven by supply and demand. Excess demand is an opportunity to increase price.
We see that airlines and hotels charge higher prices during their busy times, when demand exceeds supply. Savvy consultants do the same. Ticket scalpers for sold-out events are taking advantage of excess demand while new dynamic pricing methods are trying to capture more of that profit for the venue and promoter.
Constraints don’t mean you have to raise prices, but it is an opportunity.
Remember when Volkswagon re-launched their Beetle. It was a huge hit and there were long waiting lists to purchase one. However, VW did not raise their prices. Notice that because VW didn’t increase prices, some entrepreneurial people were able to buy a Beetle off the showroom floor and then sell it aftermarket for a profit.
The same is true for the new video game consoles when they are first released. Usually there is a temporary “used” market at prices higher than what the manufacturer charges. Of course this market goes away once the supply constraints go away.
Constraints can drive higher prices even if you are constrained and your competition isn’t. Since the constraint means you can’t completely serve all of your customers, you may choose to only serve those with the highest willingness to pay. This often means raising prices. Of course, be clear about what may happen when your constraints diminish and you try to win back lost customers.
Now apply this concept to your business. What constraints can you foresee? Are there super busy times, or a lack of supply of a critical component, or not enough hours in the day? Plan now what you will do when these constraints arise. It is much easier to make these decisions logically when customers aren’t screaming for more.
Constraints often look like challenges, but pricing power is frequently a silver lining
If you think of any other constraints I haven’t mentioned, please share with the community.
Photo by Hanna
This question was asked by a startup company this past week. They have the majority of a pretty broad software application already completed. How do they decide what to cut or add when determining the good, better, and best offerings?
Here are three steps to get them there:
1. Identify all pricing levers. This is a brainstorming exercise. Of course you can add or delete features to create the different levels, but don’t stop there. Which features can you decrease or increase? Can you alter the number of users? Alter the speed or memory? Control the number of uses per week? You get the idea. Think of every way you could create different products. Don’t worry about how valuable they are in this step. Just brainstorm.
2. Go talk to your market. Create (or mock up) a product and find out what they value. What do they not value? Start by asking open ended questions and then ask specific questions concerning the levers you identified in step 1.
You should also ask which features are required to make a useful product? You’re looking for the smallest set of functionality that someone would still consider useful.
Finally, you need an estimate of what they would be willing to pay. Ask the question this way: “What do you think is the most that other companies like yours would pay for something like this?” You can interpret the answer to this question as how much they would be willing to pay.
3. Look for correlations between how much customers are willing to pay and which of the pricing levers they value. You are looking for the levers that are not highly valued by those with low WTP (Willingness to Pay) but are highly valued by those who are WTP more. Obviously, your good, better, best products are created such that the good has the lowest capability but is still useful to those with very low WTP. Then add capabilities based on the amount of value they have for the better and best categories.
Of course it’s never this simple, but it’s not that hard. Remember your goal in creating good, better, best packages is to create a good that is good enough, and then add enough additional value that those with higher WTP choose to buy the better and best.
Photo by Flowizm
Pragmatic Marketing is sponsoring a lunch and learn event on pricing in Scottsdale on November 13. The lunch starts at 11:30 and the learning starts at noon.
If you’re in the area, come learn about value based pricing, price segmentation and pricing a product portfolio. There will be time for Q&A where you may have the opportunity to have your toughest pricing questions addressed.
Space is limited, so please register early at www.pragmaticmarketing.com/luncheon
Wednesday, November 13th from 11:30 to 1:00pm
Arizona Ballroom at Hyatt Gainey Ranch
7500 E. Doubletree Ranch Road
Scottsdale, AZ 85258