The internet has ushered in a lot of innovations, but many businesses are still having trouble answering an age old question: How much should their products cost?
As prices get ever lower online, this question becomes even more fraught. But Jagmohan Raju and Z. John Zhang have a few theories. The Wharton business school professors have a new book out called Smart Pricing: How Google, Priceline, and Leading Businesses Use Pricing Innovation for Profitability.
The book draws on both high tech and low tech examples to prove how innovative pricing strategies can help companies create and capture both value and customers.
Zhang took a moment out of his trip to India this week to explain to me some common mistakes that companies make when pricing products and how retailers can combat the ongoing "tyranny of free."
Q: What is the main idea behind “smart pricing”?
A: There are two motivations for writing this book. First, the pricing environment for most businesses has been drastically changed because of new information technologies and because of the Internet. For instance, consumers have a lot more price information and they are much more active in searching for pricing information. If you are a pricing manager, if you are not becoming increasingly anxious because of all these, you are not paying attention. In the book, we show through examples that there might be more opportunities in this pricing environment than threats if you know how to leverage those new technologies. Second, to leverage your pricing, you need to have the confidence and know-how in pricing. The book uses many examples to illustrate some of the principles that can help a manager to make their pricing decisions.
Q: Can you explain your concept of pulling the price lever?
A: Price is a lever for a firm’s profitability. By doing smart pricing, a firm can significantly improve its profitability in the short-term and long-term. However, unlike cutting costs and increasing sales, the effect of the price lever is more immediate and effective.
Q: Why do you think many companies aren’t “smart about pricing” today?
A: The truth is that if a profit lever is too sensitive and has a big impact, you probably do not want to pull it unless you have the confidence that pulling it will do some good for profitability. Unfortunate, the price lever can cut both ways: it can do a lot good as well a lot of damage. It does not help that good pricing intuitions do not come easily from work experiences. For those two reasons, most managers would choose to follow convention and stay in the pack to be on the “safe” side!
Q: What is wrong with many common pricing practices today?
A: Cost-plus pricing (putting a fixed markup on your cost), Competition-based pricing (setting your price at the competition’s level), and Consumer-based pricing (pricing to a consumer’s willing to pay) become a problem when a manager loses the sight of the big picture and focuses too much on the information he or she has or is familiar with in setting prices. The marketplace is complex and a cookie-cutter approach will price out many opportunities no matter how successful a particular approach was for the manager at one point in time. Indeed, each of the three approaches can have some serious side-effects as discussed in the book and indeed many familiar problems in many industries, such as margin erosions, commoditization, etc., can also be traced back to those side-effects!
Q: How has Google changed the way things are priced online?
A: One of the business models for Google is to sell attentive eyeballs and interested buyers to advertisers and sellers. For that reason, its free search engine maximizes its market penetration. Of course, Google also has valuable information and business insights from the information to sell, which are all helped by a huge customer base.
Q: If information wants to be free, how will anyone other than Google profit from it?
A: Google provides free lunch to consumers because someone else like advertisers is paying for it. To compete with Google, you need to find a payer for your free lunch, or provide better lunch and charge for it. In addition, no company can be good at everything for every customer everywhere. You just need to find your market niche!
Q: Why is the good old fashioned price war still alive?
A: Just as mankind cannot get rid of wars, businesses will fight price wars in the right conditions. In fact, Chinese examples in the book show that you handicap yourselves if you swear off price wars under any conditions. Once you recognize that price wars can be a legit marketing strategy, you may want to read the book to learn something about the art of price wars.
Q: What can companies learn by being pennywise in their pricing?
A: A Chinese saying goes, “an ant’s hole can lead to the collapse of a big dam.” In pricing, you’d be wise to plug ant’s holes because they can become bigger and bigger drains on your profitability. Similarly, being penny wise in today’s global market where a business can achieve unprecedented volume can pay off handsomely!
Q: What about group coupon and high-end discount sites that are popping up online (Gilt, Groupon, etc)? What can they teach us about pricing?
A: All they mean is that pricing innovations can pay off handsomely and the principle behind those innovations is to target the right people with right prices to generate the right volume. As simple as that! Of course, it is easier said than done.
Q: What is the most important thing to keep in mind when pricing a product?
A: To do smart pricing, you need to start with good customer insights; you need to realize that there are more than one way to skin a cat or price a product; and you need to have lots of street smarts to engineer a smart pricing structure. The book gives many examples to show you how all three can come together to work wonders.
from：Econsultancy by Meghan Keane