Demystifying Revenue Management - Three most common myths

Given its widespread adoption, revenue management (RM) approach is now an industry benchmark in airline, hospitality, and car rental industries for pricing. Over the past decade, revenue management approaches have gained popularity in other industries, most notably electricity (for dynamic pricing in conjunction with adoption of smart grids and smart meters), sports tickets (for pricing of both seasonal passes and individual game tickets), restaurant (for dynamic menu pricing to adjust for demand variations), and digital advertisements (for dynamic pricing of digital advertisement space in alignment with the demand across advertisers).

While there is a consensus on the potential offered by revenue management (RM) in achieving revenue goals, however in my interactions with business leaders across industries I have encountered few myths associated with RM approach. The three most common of these are:

• Myth 1: Revenue management increases the average price paid by customers 
• Myth 2: Revenue management is useful only in competitive markets 
• Myth 3: Revenue management systems reduce the significance of the role of the revenue managers

 In this and the next couple of articles, I will address these myths and separate facts from friction, so that business leaders can put their concerns at ease and make the best of the opportunities offered by RM.

Myth 1: Revenue management increases the average price paid by customers

Whenever the available inventory (of airline seats, hotel rooms, etc.) is greater than the demand at high price, revenue management will allocate a portion of the inventory for selling at low price. This maximizes the capacity utilization, and also brings down the average price paid by customers.

Revenue management dynamically allocates the available inventory for selling at different price points. As a result, if the future demand at high price points is lower than the inventory available, RM will allocate a part of the inventory for selling at lower price points, which will pull down the average price paid per customer.

For illustration, let’s consider an airline ticket pricing scenario for a flight on July 2^nd, 2015 from NYC to SFO, with 100 seats in the aircraft, which can be sold at the following four price points: $360, $440, $520, and $600. Assume that the airline starts accepting reservations from one year in advance, and the demand is uniform over the one year booking horizon. The total demand forecast over the year and the corresponding revenues at each of the price points in consideration are shown in Figure 1 below.

(Capacity = 100)

 

If the airline adopts an optimal single price policy for the July 2^nd flight, it will pick $440 because at this price its revenues are maximized at $37,840. However, notice that only 86% of the flight capacity is utilized at this price. If it prices at $360, it will fill-up all the seats, however it will generate only $36,000 in revenues.

If the airline adopts a simplistic revenue management approach, and for the first 237 days in the booking horizon (from July 2, 2014 to Feb 25, 2015) sells July 2^nd, 2015 flight tickets at $360, and for the balance 128 days (from Feb 26, 2015 to July 1, 2015) sells the tickets at $600, it can expect to sell 78 (=237/365*120) seats at $360, and 21 (=128/365*60) seats at $600. In this manner, for the July 2^nd, 2015 flight the airline can expect to generate revenues of $40,680 ($360*78 + $600*21).

In comparison to the optimal single price policy ($440), the RM approach here has contributed 7.5% higher revenues ($40,680 vs. $37,840), lead to a better flight capacity utilization (99% vs. 86%), and lowered the average price paid per customer from $440 to $411 (= $40,680 / 99).

Truly a win-win proposition!!

Pricing blunder, but a political masterstroke!

According to UNDP statistics, average daily water consumption per capita in India stands at ~130 liters. At an average household size of 4.51, monthly household water consumption in India is around 17,500 liters.

AAP's Delhi government recently announced 20,000 liters of FREE water per household per month for the residents of Delhi. This is almost 15% higher than the national average consumption.

The gift of FREE 20,000 liters of water per household per month on one side is certainly very appealing to the masses, but let's understand how harmful such a move is. There are essentially three issues to consider:

1. Natural resources are scarce, and world wide countries are focusing on ways to reduce their consumption. To control misuse of limited natural resources, governments should look at putting penalty on misuse. Giving a free allowance, which is 15% higher than the average usage is nothing but permission to waste.
2. When politicians win elections by a landslide on such promises, it will motivate other politicians to use same or similar approaches. Essentially making the entire system hollow. Such approaches are nothing but bribery and should be punishable under the court of law.
3. It's always easy to lower down the prices than to raise it. Giving away water for FREE is easy, but reversing this move would now be a nightmare for any political party now, including AAP.
4. When the entire focus is concentrated on giving away huge amount of water for FREE, essentially the focus is on quantity. The focus and efforts that are required to be put on quality will take a hit. People need both better quality and reasonable quantity of water. Lopsided approach is a lose-lose situation.

When people can afford to spend Rs. +50 for a bottle of beer, Rs. +30 for a bottle of Pepsi, and Rs. 200 for a spirited evening, what are we trying to do here Mr. AK?

Customer Service Best Practices - Wish Domino's Pizza gets this

Sequence of real events (Home Delivery Order number 250, dt. 19-12-2015 at Domino's, Siddhivinayak Residency, Kharghar, Navi Mumbai):

• 9:21:53 pm Pizza order is placed with Domino's
• 10:14 pm Customer calls up the store to check on the order status; is told that deliveries were getting delayed today, Store Associate says that although there is a delay, but a proper product will be delivered, requests customer to bear with the situation and customer agrees - while still on the call Pizza delivery boy shows up (finally)
• 10:18 pm Pizza delivery boy brings COLD pizzas to customer; note this is after almost an hour of placing the order (what happened to promising a proper product delivery, BTW this is not the  first time this is happening -- see the note below)
• 10:18 pm Customer while still on phone with the store associate tells him about COLD delivery, but instead the store associate says it's a) a normal delivery, b) pizza got cold because of the time that got spent in checking the pizza by the customer, c) uses different false names (Shantanu/Sandesh) for himself over the course of conversation (so much for customer service and credibility, not to forget the UBER incidence!)
• 10:19 pm Customer says 'thank you' to the delivery boy, refuses to take delivery (who wants to eat a COLD pizza)
• 10:20 pm Customer takes its family out to dinner elsewhere (matter is closed, what a waste of time in the first place in placing an order with Domino's)

Next day:

• 10:12 am Store Associate calls to inform that his name was used wrongly by another associate (it doesn't matter to the customer any more what name was used by who, stop wasting customer's time), and on the problem faced he says that they didn't tell last night to you but store would have been willing to send a proper pizza later in the night (willing, sure!! wait till eternity for you to do your work properly). Customer tells him he is not interested in discussing this matter any further.
• 10:49 am A person claiming to be District Manager (not sure after false identity episodes) calls up the customer and repeatedly mentions that you (customer) had faced a problem last night with Domino's delivery (yes, CUSTOMER ALREADY KNOWS IT FACED A PROBLEM LAST NIGHT WITH DOMINO'S, why are you wasting his time telling him this over and over again), and finally as a solution to the problem asks customer to place the order again today itself and this time he is personally willing to ensure that it'll be delivered on time (willing again!! why does he expect customer to go through the ORDEAL all over again). Customer tells him he is not interested in placing any order and for that matter dealing with Domino's, Domino's manager says that he offered a solution, but since customer has declined it, the matter is closed. For whatever it means, thank you finally the matter is CLOSED! 
• 2:02 pm But wait ... another call from another manager from Domino's. 

Please note:

• There is one consistency in the entire episode. The previous home delivery order with Domino's which was about 2 weeks ago, the exact same COLD and DELAYED delivery episode took place. (All the talk about customer service and learning from mistakes is a joke!)

Lessons for those who care about customers:

• At least don't make a poor service issue worse by calling up customer over and over again, when all you are interested in is only selling and not service
• If you have failed on service, accept it and fix it so that it doesn't repeat again in future

Private School Pricing -- Prospecting, Positioning, Pricing

Recently, my family relocated to Navi Mumbai, and we were searching for a private school for our son. I stumbled upon a very insightful pricing scenario...

After lots of R&D, we narrowed down our search for our son's school to two, lets call these schools as ABC and XYZ. Both of these schools follow same ICSE board curriculum, are located close to each other, and are very well known for their academic results, student placements in top undergraduate programs, comparable facilities available to students (both in terms of infrastructure -- e.g. swimming pool, football and basketball courts, auditorium, AC in every classroom, etc.; and also other extra curricular programs -- e.g. dance, karate, elocution, singing, etc.), as well as quality of faculty (and I learned from an acquaintance, who is a teacher at another private school, that both these schools pay comparable salaries to its teachers.)

The difference between these schools was in their annual FEE. School ABC was charging Rs. 24,000 for an academic year, while School XYZ was charging Rs. 70,000 for an academic year. When I investigated these schools further, I learnt that School ABC was having 54 students in every classroom, while School XYZ was having 30 students in every classroom. When I triangulated the numbers, I realized that at school ABC, student to teacher ratio was 36:1, while at school XYZ it was 15:1. In every other aspect, both these schools were at par.

How much, if at all, would be a fair premium for a better student to teacher ratio?

By having a better student teacher ratio, the cost of the academic program per student at school XYZ is certainly higher. One approach to pricing can be a cost plus approach. Costs are higher, therefore higher fee. The other way would be a value driven approach. Better student to teacher ratio can be viewed from a value aspect also, and can be translated into higher average time available per student with each teacher. The perceived value of the program, due to better student to teacher ratio is higher, therefore it is ok to charge a higher fee.

It might be a bit difficulty to quantify the differences in the delivered value at the two programs, but there seems to be a much stronger perceived value differentiation. As a result of which, different profile of customers will be attracted to the two programs, which is what I found at these schools as well. I also noticed that School XYZ was further highlighting the better student to teacher ratio in other aspects of school operations as well -- more space in canteen for students, spacious classroom with wider desks, larger closets for students to keep their belongings, etc.

If we do a little arithmetic, we will notice that School XYZ was actually making higher contribution margins vs. School ABC, as can be seen below (assuming all infrastructure and facilities charges are sunk costs):

School ABC
Number of students per class = 54
Number of division per class: 3
Number of classes (Junior Kindergarten to Class X): 12
Total number of students (N) = 54*3*12 = 1944
Number of teachers (T) = 54
Student to teacher ratio = 36 : 1
Average tuition fee (F) = Rs. 24,000
Annual gross revenue (A = F*N) = Rs. 46,656,000
Average teacher salary (B) = Rs. 4,00,000
Contribution margin (C = A - B*T) = 25,056,000

School XYZ
Number of students per class = 30
Number of division per class: 2
Number of classes (Junior Kindergarten to Class X): 12
Total number of students (N) = 30*2*12 = 720
Number of teachers (T) = 48
Student to teacher ratio = 15 : 1
Average tuition fee (F) = Rs. 70,000
Annual gross revenue (A = F*N) = Rs. 50,400,000
Average teacher salary (B) = Rs. 5,00,000
Contribution margin (C = A - B*T) = 26,400,000

Does it mean that School ABC is undercharging and it will be better off if it started charging Rs. 70,000 per student per year. I think the answer is NO. In this scenario, School XYZ positioned itself for high willingness to pay parents, and it turns out to be the case that there were just the right number of parents in the neighborhood that were capable of paying the higher fee and appreciate better student to teacher ratio. If the supply of seats at higher price programs increases, it will lead to a mismatch with demand. Such situations are not sustainable. There are sufficient number of parents who can only afford lower prices for school programs and there are enough of those to fill up all the seats available at ABC. A Robust pricing strategy integrates Prospecting, Positioning, Pricing. There are no magic optimal price numbers!

And now Price Match Guarantees at JCP

JCP recently announced a change in its pricing strategy, which now includes a price-match guarantee.

I see two basic issues in taking this approach:

> I don't know how much the customers will trust Price match guarantees, especially when the items you are dealing with are NOT "signpost" items. Certainly such guarantees work very well with competition, as you want to signal to your competition that any price reduction war by the competition will be matched. It's a clever strategy when you yourself don't want to go low price / price war route. But hey, here JCP is the company that is going the low price route.

> With Price Match guarantee, JCP is making a conscious choice of attracting price sensitive customers -- who rank very low on loyalty. The stores will have to rely on volumes, and PMG will probably assist towards it. But now the stores will get crowded with not so profit generating customers, and due to factors like "butt-brush" effect, the experience conscious customers will seek other avenues.

Some of the pricing experts have expressed that JCP's strategies are turnaround, courageous, revolutionary, decisive, etc.; certainly JCP's strategy is very bold - as it challenges some of the traditional wisdom. I am now very curiously looking forward to Q2 and Q3 results.

Making Your Prices Work Against You... CocoBerry!!

Day before y'day, I took my son to CocoBerry's outlet close to Juhu Beach. For the first time I noticed their menuboard carefully, and was left completely surprised by their prices.

 

CocoBerry is a Frozen Yogurt chain operating in India since 2009, and has about 40 outlets in 9 major cities. Along with Frozen Yogurt, they serve Smoothies, Sandwiches, Parfaits and Beverages. They were recently in news for having acquired more than 1 million Facebook fans.

Currently, CocoBerry has priced its Small size frozen yogurt serving at Rs. 58, Medium size at Rs. 122, and Large size at Rs. 197. I am sure on a per ounce basis, Large size must be the most attractive deal, followed by Medium and Small sizes. Given that the Large size is not over priced at Rs. 197 (less than $4), there should be many more customers buying Large size serving vis-a-vis the other sizes. However, this was not the case. I spent about 20 minutes at the outlet and during this time noticed that, out of the 12 customers who visited the outlet, every single customer ordered small size serving.

Sure my sample size is small, but I am sure their sales mix distribution will be way off than the industry, which runs around 40%: 40%: 20%. By pricing their Small size significantly lower than the Medium size (Medium size is more than 2x the Small size price; 3 digit vs. 2 digit pricing), they have created a big hurdle in the minds of the customers. Now the customers are not even bothered about comparing the sizes anymore, and see if there is any price per ounce benefit. CocoBerry doesn't even mention the sizes of the cups on the menuboard, so even if a customer wants to compare the prices he or she will have to ask the person at the counter!

Instead, if CocoBerry raises the price of its small size serving to 80, and drops the prices of medium and large sizes to 97 and 115 respectively (and maybe reduce the sizes of the medium and large size cups a bit), they will be able to get the customers to spend much more money with them, and see better revenues and profitability. 

Until then they are just making their prices work against them!!

Best Faculty Award, at the hands of Prithviraj Chavan, Chief Minister - Maharashtra

Experiential Learning @ the Bottom of the Pyramid

(Contributed by:

Preeti Mathews & Megha Bagaria

Students, II^nd Year FT MBA, NMIMS, Mumbai)

The Ambernath fair is an annual fair organized on the day of Maha Shivratri, when the Ambernath temple is overcrowded with pious devotees who come there to seek the blessings of Lord Shiva. This was the venue for the field activity in the “Business at the Bottom of the Pyramid” course, and the objective was to experience the art of selling to rural and semi-urban customers. A brainchild of our professor, Dr. Anshu Jalora, all the second year students of NMIMS’s MBA Core program, who had taken up this elective, were divided into a total of 9 groups each comprising of around 6 students. The task given to each group was to choose a product which could be sold in a rural market, pool money within the groups, buy items from wholesale markets, and sell the same in the fair. An experiential marketing campaigm was deemed a must. The groups chose products like food products, stationary items, sports goods and games, while one group chose a service of applying mehandi and nailpaint.

At 5:30 am on 20^th Feb, the students left for Ambernath in an attempt to reach early and catch the customers while they were on the way to the temple. However, on reaching the venue, they found that all the stalls had been taken and there was no place for them to sell their products. So, they had to resort to techniques such as collaborating with the other stall people to share space and revenue. Some groups found places in stalls which were not occupied and set up their shop there temporarily.

The students also faced many challenges on the way. Food and water had to be carried on the trip as it was hard to get these things at the fair. Washrooms were scarce and students had to walk some distance before they could access one. Also, the customers were predominantly Marathi and spoke in the local language. Students had to learn few words of the local language to engage the customers in a more meaningful manner.

After this, began the hard task of convincing people to buy the products and service. Initially, people were sceptical of buying the products as did they not associate much value to the products the students were trying to sell. This activity was an eye opener as most teams found that their initial strategies they had come prepared with were not working in the field. They were compelled to think on the fly and make sure they didn’t lose their own investments. 

For instance, one of the groups which was finding it difficult to sell its food products had to change its strategy to one in which they convinced people to play a game of darts at a certain price and then gave away their food products as prizes. This worked well because customers attached more importance or significance to winning and paid less attention to the prize that they received. This change in strategy was an immediate success as it played well on the consumer psyche and the group was able to sell all the products it had.

Other groups followed suit and played games like snakes and ladder, pencil sharpening etc. Each one customized their offerings to the public to make it more attractive and appealing. For example, the group playing snakes and ladder customized their game by asking questions every time a player proceeded to the next stage. The questions were mostly from Bollywood films and movies, which greatly appealed to the audience, so much so that they were more eager to answer the questions rather than playing the game.

The sole group which was trying to sell its services of applying mehandi and nailpolish was also an instant success. The target group of women was kept in mind. The group did adequate preparation and took posters and pamphlets to distribute among the customers. Bright and colourful nail paints were brought to appeal to the customer segment. The group found that ladies were mostly shy and it was their husbands who were coaxing them to apply nail paint and mehandi. Also, the group realized that customers were paying them for the whole experience of someone applying nailpolish for them, being able to choose the nailpolish/design of mehandi and relaxing. Hence in the end, when the group tried selling off its nailpolish bottles in bulk, it did not meet with much success. People were willing to get nailpaint applied for Rs 5, however they were sceptical of buying a nailpolish bottle for Rs 10 even though they could have applied nailpolish 10 times over with that bottle. Hence, the lesson learnt was that an experiential campaign is very important to engage the customers at the BOP

The popularity of each of the activities organized by the students was stupendous. The games played by each group attracted huge excited crowds. One group attracted so many people that they actually blocked the flow of traffic. This resulted in the interference of the local cops who asked them to shut down their stall or move to a more suitable location.

The trip to Ambernath also saw the active participation of the french (exchange) students. The enthusiasm and commitment showed by them was commendable. They mingled with the crowd, tried learning the local language and shouted slogans like “das ka maal paanch mein” and “dah ka paanch, chamki shiny pen” along with the other group members.

As a class, the students realised that the customer at the bottom of the pyramid is no different from any other customer. The spending capacity of the local people was more than the students expected. People had no hesitation in paying Rs 20-30 to play a game of snakes and ladder. However, they are not willing to compromise on the quality of the product/service. They want value for every penny of their hard earned money. While they are shy and difficult to approach, once you have them at your stall, they examine everything with an eagle eye. They are particular about the products and services they use and make sure nothing is of sub-standard quality. Also, the students realised that language is a big factor while selling to this segment of the population. If you can speak to them in their own native tongue, it establishes some amount of instant credibility with them and gets them to atleast hear you out. Many are brand conscious, as consumerism and advertising are causing this information to seep into their psyche, and they compare what you have to offer to established brand offerings.

What the students learnt in that half a day was far more than any number of classroom sessions could have taught them. There was a marked change in the body language of the students as the day progressed. Students who started out with soft voices, hesitantly approaching customers were soon shouting slogans that overpowered that of the local vendors.  Initially unsure about the viability of their selling proposition, students were soon managing crowds at their stall and employing different methods of customer engagement.

In a particular instance, a group actually collaborated with the stall setup by a political party and used their loud speakers to promote their offerings. This just proved how the students used the whole experience to showcase their innovative skills, passion and zeal for what they loved doing.

The whole experience was one of its kind. It turned the students into professional sellers and marketers. It filled them with enthusiasm and passion for selling their products. They changed strategies according to consumer sentiments. They persevered till they sold their last product. They approached customers with zeal, passion and confidence. Some students even realized their hidden talents. Almost every student in the class felt that he or she was now better prepared to develop marketing strategies for serving BOP markets.This exercise in experiential marketing truly resulted in experiential learning for the students!

At the end of the activity, out of the 9 student teams, except for one team that went into a loss of 50 rupees, every other team either broke-even or ended the activity with profits. Each team felt that they could have sold double the quantity they had planned and saw tremendous opportunity in the market there. They regretted not carrying more inventories as few teams had sold out all their products within one hour of reaching the fair.

Ultimately the success lay not in the profits but in the sheer pleasure of being able to sell to the customer at the bottom of the pyramid.

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!!