Kumar's Blog

I'm an advocate of pricing products based on the value they offer. It makes rational sense to ask the customer to pay an amount that he is likely to rather than a little above what it costs to make the product available for that customer. Usually, the best way to identify what a customer is likely to pay is by understanding what value the product offers her.

But there are certain kinds of products that make people take seemingly irrational decisions about the price they are willing to pay that have little relation to the value they get out of it. Whether it be the decision to buy jewelry, or buy a house, or work for Goldman Sachs, people don't seem to decide on the price they are willing to pay based on the value they derive. They just have a threshold limit up to which they are willing to spend.

When I see people buying houses for prices that they can never hope to recover in thirty years through monthly rental income, I feel that the decision to pay the over-valued amount is not based on value derived. This doesn't mean that people who do this are foolish, though. Quite the contrary. They define the threshold because they know that anything acquired at a price up to that threshold will give them a certain standing in their social circle that they aspire to have.

It should be the target of every brand to achieve such a place in the consumer's mind that they are willing to define a fairly high threshold price at which they are willing to buy the product. This gives the brand immense power when it comes to pricing. 

As Big Data continues to get traction, a lot of possibilities are cropping up for companies to target customers and potential customers. Better targeting of advertisements is being adopted quite aggressively. But this only marks the beginning of the possibilities.

Big Data can be used for a host of other things, including differential pricing, product bundling, product/service enhancements and so on. Amazing things can be done with the data that is so easy to collect and is only getting even easier to do so. But for every amazing thing that can be done, there is a bit more of that privacy that you so covet that you will have to give up.

Brands have already experimented with differential pricing based on health records, criminal records, job profile, sexual orientation, salary-day spending pattern and so on. Targeting advertisements and pricing based on salary-day spending pattern seemed really sinister to me. Imagine having to pay a little bit extra for a movie ticket or a dinner booking because it happens to be your pay-day, or even your birthday or anniversary.

Amazing things can be done with Big Data. You just have to decide whether you want to do amazing things for your consumers and enhance your brand equity for the long term, or do amazing things for yourself (as a company/brand), and enhance shorter term profits. More often than not, these two do not overlap.

In the last couple of days, I have been to two different retail stores and several websites in order to evaluate my options, compare features and prices before making the final decision to buy a TV (and I might visit a few more stores and websites before the actual purchase). This is a fairly common process that any diligent customer will go through before making a purchase.

While the retailer has to pay for a lot of overhead in maintaining sales staff and store rent and so on, e-commerce sites selling the same wares have lesser overheads allowing them to price their offerings more competitively. This is a problem that retailers are doing their best to overcome with better in-store experiences, service guarantees and the like.

In my research for options to purchase a TV, I realised that the key advantage a retail store offers me is the chance to physically interact with the product under consideration. I could read a hundred reviews and product descriptions, see photos and videos online, but it is still no match to actually handling the product before purchase. So, the retailers still provide good value to the customers that make the effort to go to their store, and this value is worth the 3-8% premium customers pay (over e-commerce alternatives).

But, the biggest risk to retailers is showrooming. This is when a customer goes to a retail store, handles the product, compares it with other options (all physically), solicits advise from the sales representatives, but finally makes the purchase on an e-commerce site for a lower price. This way, the retailer is taking the overhead for a sale being made by an e-commerce store, on which he earns nothing.

So, when a specialty food store in Brisbane, Australia posted a notice on its door saying "As of the first of February, this store will be charging people a $5 fee per person for 'just looking'. The $5 fee will be deducted when goods are purchased.", it came as no surprise to me.

But, it is simply not possible for every retailer to charge a fee for 'just looking'. The store has to provide some experience of value to the customer (like the TV retailer that allowed me to physically inspect the features and do a physical comparison with other alternatives) in order to justify the fee. Otherwise, its just shunning away potential customers. 

During my exchange term at Bocconi University in Milan, I took up this wonderful course called Pricing Management. The Professor teaching the course, Federico Rossi, had to convince the Bocconi administration to let him teach that course in his first year at the University. Lucky for me they agreed.

The entire course revolved around the idea that every product ought to be priced based only on the value that a customer derives out of that product. I will not go into the nitty-gritties of how to identify the value a customer will derive from our product, and how to handle different segments of customers of the same product that derive different values, in this post. Each product commands its own analysis to go down this path of value based pricing.

But the key aspect every marketer needs to keep in mind is the beauty of value based pricing. Since it is a difficult process to undertake, most marketers are satisfied to price their products in the same range that competing products are priced. Though the number is falling, some marketers still price their products a little (pre-determined margin) over the costs incurred. While this is very easy to do, it has the potential to be a hindrance to the business as price is one of the big driving factors of demand.

While I enjoyed the course from an academic perspective, I came across this article about Honda looking to shut down Jazz, and started smiling when I recollected that this is precisely what we (those part of the Pricing Management course) predicted during the course.

While we might still read outdated textbooks that list cost-based pricing as one of the pricing techniques, it is time for marketers to shun the old and ineffective way and focus on value-based pricing.