Marketing Expert's Corner

This article written in 2010
 

Broken

Nope, I'm not talking about the haunting song by Seether. This time, we're putting pricing models under the microscope.  As I wrote a couple of months ago, pricing models are more important than price points, and small changes to your average selling price can mean big improvements to your profitability.

While I've already covered the basics of standard pricing and business models, we need to go deeper -- looking at businesses that depend on breakage. 

Gotcha!

Breakage is the idea of charging a customer for something they may not actually consume.  Bob Sullivan's book, Gotcha Capitalism, describes how companies spend a lot of effort to develop pricing and contractual terms that are designed to fool customers.  You may not like his credulous tone or the political spin, but you have to admit that a lot of businesses use economic trompe l'oeil to increase their profits.

Let's look at some examples, and see how the underlying techniques might apply to your products or services.  NOTE:  Please read the disclaimer at the end of this article!

Subscription Services:  In the old days of physical media, every magazine or CD shipped actually cost the seller.  If you sold a magazine subscription but the reader never read 30% of the issues, you didn't make any more money.  But in today's world of downloads, the cost of fulfillment is essentially zero and usage is easily measured.  So if you sellthe right to access content for a period and the customer forgets to exercise that right...well, you've got a 99% profit margin.  It really pays to devise pricing models, charging systems, and fulfillment that optimizes the customer's forgetfulness.  Techniques such as hiding subscription charges in out-of-the-way corners of cell phone bills, putting credit card charges under obscure company names ("XYZ Enterprises" rather than "Bob's Porno"), having the service auto-renew without an invoice, or setting up cancellation penalties, are rampant in some businesses. 

These tricks most frequently show up in vendors of consumer content such as ring tones, music, and games.  But you'll find milder forms in software maintenance ("update service"), customer support ("service contract"), and several forms of insurance.  A variant of this, take-or-pay pricing, is found in commodities where price points tend to move around frequently.

Athletic Clubs:  In a wide range of sports and exercise facilities, the standard pricing model works because the customer is delusional. For $XX (or is it $XXX?) a month, the customer gets unlimited access to the facilities.  The heavy promotions happen in late winter, when everyone wants to work off the holiday pounds and get ready for swimsuit season.  The sales pitches are highly motivational, getting you all jazzed for jazzercise (or spun up for spin sessions, or... what's that new fad this year?).   Within 6 weeks, every club owner knows that the couch will beckon and their facility will be way under-utilized.  They can easily over-subscribe by double without any fear of lines at the exercise machines.

This technique is used to less effect at spas and even Massage Envy (shameless plug for my favorite masseur).  But it can be used for many kinds of products or services that appeal to people's vanity.  It can work well for certain kinds of training, certification, and information services.  And of course, NetFlix has made a fortune with this one.

Cell Phones:  In the US, almost nobody buys a cell phone from a store at a standard retail price.  Unlike Europe, the cell phone market here developed with the telecom service carrier heavily subsidizing all phones.  Around 80% of the cell phones sold here come with at least a one-year contract, with heavy penalties for early termination.  While this pricing structure gave the carriers too much power (which, until Apple turned that tables, had tended to retard handset innovation), it was quite profitable for all concerned.

This technique is used to a lesser extent with satellite TV, cable TV, and other content/ hardware bundles.  It can be nicely applied for certain kinds of information appliances, software packages, and other products whose value depends upon a companion service.

incomparable SKUs:  This isn't so much a pricing trick as a price list trick, and it consists of offering several different SKUs or product names for essentially the same product.  Each store, outlet, or website gets a SKU that is unique to them, even if the product is essentially a commodity.  By doing this, every seller gets to claim "you can't beat this price."  It also lets vendors cut "most favored nation" deals without arbitraging their average selling price.  Of course, the FTC lawyers tend to be very cranky about false advertising if exactly the same product with a different SKU is represented as different or new.  So make sure to put in something different (it can be an extra feature, or better docs, or a cheap consumable) to justify your multiple SKUs.  

Dynamic Pricing:  Way back in econ 101 (actually, it was 104 but let's not have that get in the way of a good cliché), we learned that the highest profits and the greatest social good come when every single customer pays a different price.  Essentially that's a silent auction...not very practical, back in the day.  Prior to the internet, the only industry that actually operated that way was the airlines, particularly using the SABRE and APOLLO systems.  Now, of course, everyone has access to eBay or can set up a dynamic pricing system in their eCommerce engine.

The trick, of course, is controlling the flow of information.  If your customers know the current going price, they can game the system.  Dynamic pricing works best online, in some form of "gated community."  It also works far better with services or virtual goods, as dynamic pricing can have some nasty side implications for COGS and inventory effects. Work as closely with your lawyer as you do with your engineers, though, as you may have to work around regulatory or contractual stipulations.

Financing Plans:  In the early days, you couldn't buy an IBM computer or Xerox copier...you could only lease them.  Now, of course, almost all IT goods are purchased.  But there are good financial reasons for PCs to be leased.  And part of the SaaS model is that you pay a recurring fee for the use of software you don't own.  Even if you don't have an explicit financing plan, your pricing may amount to the same thing.

Financing plans only really work when the price point of a purchase is significant from the customer's perspective.  While they are easier to execute internally, financing plans tend to drive up your company's capital needs and drive down metrics from an investor's perspective.  The last couple of years have wreaked havoc on the external firms that specialize in equipment financing -- and I'm not sure that anyone who finances software is still around.  But even in IT, IBM and GE still make a bundle on financing big deals.

Disclaimer -- Read and Take Note

While some of these techniques are fairly innocuous, you have to admit that taken to the limit they are unethical and just plain bad business.  For all I know, some of the tricks here may be illegal, particularly outside the US -- don't construe this newsletter as legal advice (yes, my lawyer made me write that).  Check with your attorney before doing and of these techniques!

Also, seriously think through the impact any of these techniques would have on your customers and their perception of your company before you consider applying them.  Don't blow trust.  Be aware of the brand risk

Finally, note that these techniques must be tightly executed to avoid backfires, and they need continued attention over time.  If market conditions change sufficiently, they'll simply blow up...making you quite uncompetitive and irritating to your customer base.

 

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