PWYW: Honor code or fear of embarrassment?

Last week I decide to verify the hypothesis that I had put in my last month's blog entry "Pay What You Want - Is it Honor Code that makes this work, or is it something else?", which was "It is the fear of embarrassment that makes most people pay a fair price, honor codes were buried way back in school days!!"

I picked two groups of students, and gave the following problem to them:

Group 1 got the following problem:

"Let's assume Sweet Evenings is a fine dining restaurant in the Juhu area. This is a special restaurant that does not have fixed prices for its menu items. In fact, it allows the customers to pay whatever they want for the food and beverages they have consumed.

You love this place for the live music played here and the impeccable service. Today, you have taken your long time friend from work to this place, and together you consume a bottle of wine, two-entrees, salad, bowl of soup, and a dessert. How much would you pay for both of you?"

Group 2 got the same problem, except for the last statement:

"Let's assume Sweet Evenings is a fine dining restaurant in the Juhu area. This is a special restaurant that does not have fixed prices for its menu items. In fact, it allows the customers to pay whatever they want for the food and beverages they have consumed.

You love this place for the live music played here and the impeccable service. Today, you have taken your long time friend from work to this place, and together you consume a bottle of wine, two-entrees, salad, bowl of soup, and a dessert. How much would you pay for both of you? Sweet Evenings has a small display screen behind the bartender where they display the table number when a payment of Rs. 1200 or more is made."

Since the only difference between the two groups is that small screen behind the bartender, which just displays the table number, both the groups should be looking at paying about same amount of money to Sweet Evenings. The office colleague won't know the price paid in either of the situations. In both the situations, the person paying low price is not getting singled out.  But still, just this minor, probably irrelevant, difference lead to first group of students averaging at Rs 1,155(~$23.11), while the second group averaged at Rs. 1497(~$29.95). That's a difference of 29%. In the first group, only 36.84% of the students responded with payment of Rs 1200 or more, while in the second group this number is 75%.

Fear of Social Embarrassment at work here!!

Windows 7 Professional Pricing: No mistakes here...

I was checking out the price of Windows 7 Professional for my new laptop, and I was pleasantly surprised to see that Microsoft has put some nice thoughts into Windows 7 pricing. Microsoft has listed the following options for Windows 7 Professional on its website:

Do you think Microsoft is making some mistake here and selling the Windows 7 Professional and a 4GB pen drive for the same price as it is charging for just the standalone Windows 7 Professional? I am sure that's what Microsoft wants people to believe!!

A 4GB pen drive costs around Rs. 250 (~ US$5.6). So on a purchase of Rs. 10,690 (~US$237), it represents a small discount (2.3%). Although the discount is so small, I can guarantee that majority of the people looking to buy Windows 7, after looking at these options will opt for the fourth option, which is Professional + Pen Drive.

Microsoft is doing an amazing job of putting the pricing best practices at work. By striking off Rs 14,760, and putting Rs 10,690 instead, Microsoft is implying huge discount. Notice, they are not using the term 'Sale' or 'Discount' anywhere, but this option gives an impression of discounted price. Did you notice the Red color and the bold font? Did anyone get an impression that this must be a limited time option, although Microsoft is not saying it is?

Next, Microsoft is using the powerful term 'FREE' in the best possible manner. 'Get a 4GB pendrive, absolutely Free'. Also in the display, the pendrive's size has been zoomed to make it appear big (if you are using the box size for reference). Although, a free 4GB pen drive represents a very small price discount, but here this discount will appear as big enough for customers to spend Rs 10,690 vis-a-vis spending Rs. 6,590 on Home Premium, or Rs. 5,690 on Home Basic. Prospect Theory too is at work here. Prospect Theory says that customers have a tendency to exaggerate, be it rewards (as with lottery tickets) or penalties (which makes them spend money on insurance).

Customers have a tendency to purchase between the top (advanced) two options available to them. By creating a variation in the top option, making one variant of the top option appear markedly better, Microsoft has increased the customer likelyhood to purchase the top option.


Nice job Microsoft!!

Pay What You Want - Is it Honor Code that makes this work, or is it something else?

95%+ students participate in some form of Plagiarism during their academic careers. This statistic holds across the globe. Some even argue that this number is in excess of 99%; honor codes exist in books, in real life it's a wishful thinking.

Wait a minute, I am not saying that Name your own price, which is more commonly referred to as pay what you want (PWYW) is a bogus concept. There are several examples of companies that have successfully used this approach; certainly there is more than honor code to it. Restaurants like Little Bay and Just Around the Corner in London, Pay As You Please in Ireland, SAME Cafe in Denver, One World Everybody Eats in Salt Lake City, or Annalakshmi in Perth, or Apparel stores like Brand Alley and LastWear, and many more companies across industries are successfully practicing the PWYW model.

People give money in charity, but not any charity. People always help each other, but not anyone who needs help. When buying a house, if the seller is asking for $500K, there will be many buyers who will try their best to have the seller lower the price down to $490K, even when the fair market price of the house is $510K. But a large majority of the buyers will not pick a $100 bill lying on the floor of the house being sold during one of their visits. These same people were trying to underpay by a much larger amount that $100, but this $100 bill that comes with no strings attached does not attract their love. Why?? (of course there will be some exceptions who will quietly pocket that $100 bill and will never show up again at that house, but we are taking about the majority who will not)

Honor code and personal references are very confused subjects. I showed the following set of gymnasium membership options to my students (Weights only for $20 per month, Classes only for $40 per month, and Weights and Classes both for $40 per month), and majority of the students opted for Weights and Classes both for $40; no one opted for Classes only for $40 per month. When I showed another set ofgymnasium membership option (Weights only for $20 per month, and Weights and Classes both for $40 per month) to another set of students, taking out the Classes ($40) option out as no one opted for it in the first set, this time majority of the students opted for the Weights only for $20 per month. What happened to their personal references???

More than the honor code, it is the embarrassment of being seen as misusing an offer that makes people pay an non-unreasonable price at PWYW avenues. Let's say you go to one of these restaurants on your first date, you don't want to be seen as a mean person, so you'll try to be fair. If You know that the place gives money to charity and at the time of payment people are watching you (some of these places even announce your name when you pay a good price), you don't want to go through the embarrassment of being seen as a mean person in society. I bet, at the very same place if no one is watching, customers will pay much less amount than what they pay when they feel that someone is watching'em.

It is the fear of embarrassment that makes most people pay a fair price, honor codes were buried way back in school days!!

Retail Pricing 101

Retail pricing is one of the most challenging pricing arenas. Here one has to simultaneously deal with huge amounts of investments in inventories, limited display space, seasonality and fashion trends, macro economic factors, competition, and consumer behavior. Those retailers that have mastered pricing have a strategic advantage over competition and are better positioned to weather fluctuations in economy.

Here are three rules of thumb for excelling in retail pricing
a. Beware of the FISH!!
b. Use signpost items as ambassador
c. Drive consumer choice through price optimization

In retail, FISH is first-in-still-here. Retailers need to churn their inventories quickly to maximize their GMROI and GMROF. If there is inventory that's moving at a rate slower than originally planned, it leads to blocked capital and blocked shelf space. A proper markdown pricing strategy ensures that inventory is clearing at the right rate.

"Signpost" items are those handful of items that are bought most often and carried by most retailers, and consumers have a good price recall on these products across retailers. Consumers will typically associate a retailer's price competitiveness across products based upon the how the prices on the signpost items compare against other retailers. Retailer have an opportunity to drive a value pricing message through these signpost items. Wal-mart is one retailer that executes this strategy very well. It has identified some 25 items (Milk, Bread, etc.) and it ensures that its prices on those items are lowest in the market. This helps Wal-mart strengthen it's "Every Day Low Pricing" positioning in the minds of the consumers.

When a consumer makes a decision to purchase an item, not only that particular item's price plays a role in shaping his/her behavior, but his/her behavior is also influenced by the prices of the other similar products available at the retailer. In this situation it is very important to make sure that your low profit products are not cannibalizing the sales of high profit products. Price optimization here focuses on pricing the entire portfolio of products simultaneously, thereby taking into account the resulting relative prices and substitution effects, with the goal of maximizing the overall profits.

Retail pricing practice needs a robust system support to manage and execute the entire strategy. The systems typically focus on three key areas:
- Data management (product attributes, competition prices, landed costs, product hierarchy management, etc.)
- Analytics (trends and predictive modeling/forecasting, supply chain snapsnots, customer voice, sales history, etc.)
- Work flow / Execution (Approval processes, Price publication, etc.).

In my next blog I will expand upon the different functional elements of pricing systems.

And the fair price of the GPS is?

Pricing often generates emotionally charged responses from customers. Customers will look at a price and something tells them whether the price is fair or not. It is very intuitive to assume that customers have a good idea of the fair price of the items of their use. Right?

Let's check out if it is so. To understand customer fairness scale, I carried out a small experiment with my students. I showed them a GPS unit listed on Amazon at $249, and asked them what would be the fair price of this product in India. I told all students that the currency conversion rate is $1 = INR 44.5. I further divided the students into two groups. I showed the first group the prices of Papa John's 12" Large Pizza in Seattle, Washington ($17.99) and in Bangalore (INR 259). The second group was shown the prices of Toyota Corolla in US ($18,000) and India (INR 1,450,000).

The two groups were intentionally anchored with prices of products that have little to do with prices of hi-tech/electronic products. QSR and Auto pricing don't have much to do with electronic product pricing. So logically, the participants will use their fairvalue meter and ideally both groups should give almost similar levels of fairvalue for the GPS unit in question.

Here's what happened. The group that was shown Papa John's prices, the fair value responses were in the range INR 1,000 to INR 8,000, averaging at INR 6,000. The group that was shown Corolla prices, the fair value responses were in the range INR 9,000 to INR 60,000, averaging at INR 20,000. Comparing the averages between the two groups, one group values the same GPS unit more than 3 times the value placed by the other.

The Pizza group was anchored on lower conversion rates in practice, and was shown smaller number (2 and 3 digit numbers). This lowered their reference prices and this group was biased towards the lower side of the scale. The Corolla group was anchored on higher conversion rates in practice, and was shown larger numbers (5 and 7 digit numbers). This raised their reference prices and got them biased towards the higher side of the scale.

When I shared the results of the experiment with the students, they had difficulty believing the fair value estimates of each other, and were fully convinced they had the right estimate. And we are told to believe that customer is ALWAYS right! Really??

Netflix 2011, oh boy!!

Last week Netflix announced it's new pricing structure, and within a day it received 60,000 + negative comments from its fan community on Facebook. That's about 4% of it's fan base. A BOTE calculation, equating every negative comment received within the 24 hours of the announcement with losing 10 subscribers will tell you that about 40% of their business is at stake. Now, that's a lot!!

If you look at the new pricing structure, it is not so bad as it appears. Customers who were subscribing to Netflix for mail-ins and paying the price of the combo deal, now will get a chance to pay just for the mail-ins. Mail-ins business is the real strength of Netflix, and customers anyways didn't like the streamings from Netflix for several reasons. Now they have an option to chose a better streaming service provider and use Netflix just for mail-ins. Certainly not all that bad for the customers. But the value of the pricing structure is lost somewhere, and the company is noticing a strong backlash from the fan community.

Now let's look at Netflix's communication strategy in context of this price change. Netflix is telling the customers that if they opt for both mail-ins and streaming and pay $15.98, it is an increase of about $6 and it is same as the price customers pay for a cup or two of latte. This is where Netflix is missing the point. First of all not every old $9.99 combo customer is going to opt for both mail-ins and streaming; customers will probably stick to Netflix for DVD mail-ins, while many will opt for Amazon or Hulu streaming services. More importantly, that's a pretty lame argument to give to the customers for raising prices. So what if the price increase is same as the price of a cup of latte, what's that got to do with movie rental price.

Netflix had a wonderful opportunity to push a value message to the customers, stating the customer benefits of the new pricing structure. It could have told the customers that now they won't have to pay the combo price if they were only interested in the mail-in rentals. I think customers would have appreciated that thought. Netflix should have kept the combo offer, albeit at a higher price ($11.99 will be the best price for combo), and made the combo offer look attractive given the separate subscriptions costs $7.99 each.

If Netflix decides not to change it's pricing structure, there will be a great case study for me to include in my pricing strategy course outline for next year, on how poor pricing destroys established market leaders!!