The beginning of 2016 has proven to be a challenging time for many businesses. Growth forecasts are being taken down across the board and the turmoil in the oil and stock markets point to a challenging business environment in 2016.

But there is something you can do: review and optimize your pricing to make sure it is optimized for maximum value capture. Why pricing? Because it is the fastest and most effective lever for improving revenues and profits:

FREE PRICING DIAGNOSTIC – We are so sure that we can help you improve your pricing, that we would like to offer the first 10 callers a Free Pricing Diagnostic – you only pay for our travel. During this diagnostic we will identify price improvement opportunities and outline next steps.

If you are interested, please call Bert Schefers at 203-722-3232.

Also, please visit our website and download our whitepaper on “Pricing in a downturn:” https://abbeyroadassociates.com/resources/hot-pricing-topics/

Best wishes for a successful 2016.

Your Abbey Road Team

“How much shall I charge?” is probably the most common question we get asked. After all, most people think that’s what pricing is all about. As pricing professionals we know better. Price levels are an outcome of many factors, including strategic objectives, value creation, competitive positioning, segmentation, price structure, etc. However, at some point of the journey, price levels have to be set.

Over time we have collected the following list of tools that can be used to do just that – we call them “price engines.” Use the following list at your own risk or call us to help you figure out which engine is right for you.

Demand Curve

• A demand curve measures the markets cumulative uptake of a product or service at particular price points, thereby guiding price level decisions
• Demand curves usually show distinct plateaus at signature price points  

Value Analysis & Value maps

• Involves determining how much value is being created and how much we can capture ourselves = value based pricing
• Requires understanding of customer economics and price/value drivers as well as competitive offers/substitutes
• Value can be expressed as “Value = Product Performance/Price”, or “Value = (Brand Equity + Product Performance)/Price”
• Value maps show relative positions of competitors; axes are price and value

Cost-plus Pricing

• Frequently used. It is inward looking and the downside is that it does not reflect willingness to pay or varying price sensitivities, thereby potentially not capturing full value
• Comes in two flavors: Full cost-based pricing and Variable-cost based pricing. The latter focuses on capturing marginal revenue when marginal cost of additional unit is low. Works best when fixed costs are high. Stimulates demand via low variable price

Historic Pricing

• Takes last year’s price and adds a price increase on top
• Very common, since it is easy to implement and does not require any work
• Downside is that it assumes last year’s price levels and this year’s increase are the right ones – usually leaves money on the table

Benchmarking against Competitors

• Key is to determine price delta that can be sustained
• Competitor prices often not well understood (incl. rebates, promotional specials, etc.)

Pricing Primary Research

• Van Westendorp PSM – Four-question battery created by Peter Van Westendorp used to identify prices that are considered too cheap, cheap, expensive and too expensive by respondents. Very well established technique with good track record
• Conjoint Analysis – Used to test different product or service configurations, as well as price. Caution: pricing can confound conjoint studies, as the price listed is often used by respondents as a proxy for quality. Conjoint is not appropriate for all categories. However, such studies are great for producing market simulators that include brand references and can be used to model competitive pricing changes
• Gabor Granger method – It asks a series of priced purchase interest questions, such as “Would you buy X at price Y” for a single product or concept. The price goes up or down depending on the response to the first purchase interest question. The series continues two to three more times until the consumer will not go any higher or lower on their interest price.

Elasticity Models

• Uses purchase data as inputs into pricing models designed to account for rises in commodity prices, category elasticity, item elasticity, different retail channels and more
• Requires robust data sets, e.g. Nielsen, IRI

Supply and Demand Curves

• First cousin of demand curves
• Good to figure out broader industry shifts, including industry pricing

Economic Models

• Yield management as used by airlines. Or parametric pricing: marriage of statistics and economic models
• Requires fully understanding price drivers and elasticities

Expert Opinion

• Not very scientific, but can be effective
• Sales reps often have a good “feel” for the right price levels

War Games and Scenario planning

• Effective but resource intensive
• Oil companies routinely use these techniques so they have a response ready when a particular situation arises

Negotiations

• Also very effective. Best in complex business-to-business markets
• Requires good understanding of price drivers and buying processes

Auctions

• Very effective – think ebay.com
• Not very effective in high value, opaque markets

To find out more about price engines and strategic pricing in general, call us at 203-722-3232.

Your Abbey Road Team.

I live in New York City where owning a car is a very expensive proposition.  Fortunately, for those of us who don’t leave the city for work every day, there are plenty alternatives for getting from point A to point B, so that owning your own car isn’t really necessary.  There has always been great public transportation and plenty of taxis available – except of course when it’s raining.   Now there are even more options with hourly car rentals like Zip Car, internet-based limo services like Uber and even Citibike, the city’s short term bike rental program.

A similar proliferation of pricing models has emerged in the software industry.  For decades the only way to acquire enterprise software was to purchase a perpetual license and then pay an additional 18% – 20% of that purchase price every year in maintenance.  The owner of that software license would then have to buy the computers, housed in their own data centers on which to run the software.  They also needed to hire and train staff to maintain that hardware (upper left quadrant of Figure 1).  All these costs added up – like owning your own car in New York City.

With the rapid growth of the internet, the cost of data of communications dropped precipitously, making it economical for companies to outsource their data center operations and run their licensed software remotely.  Companies started by renting space in data centers, but over time more and more of the computer infrastructure and maintenance services became available for rent by the month or even by the hour (upper right quadrant of Figure 1).

As internet browsers evolved into sophisticated user interfaces, a few forward looking companies realized they could rent the software and hardware to their enterprise customers both simplifying the sale and shortening implementation times (lower right quadrant of Figure 1).  This was a particularly good option for applications like Customer Relationship Management Systems (CRMs) that required easy access to a common database by remote employees such as salespeople, which is how an upstart called Salesforce.com rapidly overtook Seibel the CRM industry leader.

With Software as a Service (SaaS) gaining popularity across a broader range of enterprise applications, software market leaders are scrambling to protect their position against upstarts like Salesforce.com by launching their own all inclusive SaaS offerings.  Some are providing customers even greater choice with a third option, a software subscription, where customers rent the software and can run it either on their own hardware or in a third party data center (lower left quadrant of Figure 1).

So how does a software company with three licensing models set a competitive, yet profitable price for each?  That really depends on where the competitive pressure is coming from.  If a company that traditionally sold perpetual licenses plus a maintenance fee is losing market share to a SaaS provider, it makes sense to start with setting a competitive SaaS price to address that threat.  Faced with a competitor pricing their SaaS offering at $100 per user per month, the incumbent will need to use that as an anchor, pricing theirs at perhaps $120 per user per month assuming the premium is justifiable.  Since the SaaS price includes the computer infrastructure, the software only subscription should be somewhat lower, say $80 per user per month, depending on the value of the infrastructure component.

Finally, setting the perpetual license price should start with the maintenance fee, which would be substantially lower than the subscription only charge.  Setting the maintenance fee at $30 per user per month implies a perpetual license price of $1,800 per user assuming an annual maintenance charge of 20%, since 20% of $1,800 = $360 / 12 months = $30 per month.  The buyer then has the option of paying $1,800 up front plus $360 per year per user or $960 per year per user ($80 x 12).  Since the breakeven point with these prices is exactly 3 years, all other things being equal, a buyer who expects to use the software for more than 3 years would choose the perpetual pricing option.

Pricing in the real world is never that simple.  Many other factors will influence the pricing decision including the average life of a customer, the cost of capital for both the seller and buyer, buyer preference for using its operating or capital budgets to acquire the software, and of course, discounting.  At Abbey Road Associates, we consider all of these factors when helping a software vendor navigate the re-pricing process.  We also create a clear transition to the new pricing plan for existing customers who might otherwise feel left out and be more apt to defect to the competition.  If the complexity of software pricing is keeping you up at night, give us a call.   We may be able to help you get some sleep and stay competitive.

With the summer travel season behind us, we thought it would be interesting to analyse the pricing strategy of Spirit Airlines. Here you have an airline that defies common sense: As Business Week* puts it, “the most hated airline is also the most profitable.” How can this be?

Let’s first look at the profitability part of the equation. Spirit is a disrupter, the ultimate un-bundler of the airline industry. While most airlines sell you a bundle of transportation, luggage, non-alcoholic beverages, etc., Spirit charges a la carte for everything, including carry-on bags and bottled water. So why is this so profitable?

Because if you don’t bundle, you don’t need to give a bundle discount. Bundle discounts are given to compensate buyers for “forcing” them to buy elements in a bundle they don’t really need or want. The motivation for companies to bundle is usually to crowd out competitors and to generate more sales volume and revenue, but at lower profit margins.

As the below illustration shows, most traditional airlines sell you a bundle. Bundles have a taxonomy, with a core (airfare), strong add-ons (luggage) and marginal add-ons (Beverages/food, legroom, etc.). These components have a stand-alone value, but when sold in a bundle, often need to be discounted (in this illustration by a total of 20%) for the reasons given above (example: “I don’t have luggage and bring my own water, why pay for it.”)

Spirit Airlines decided not to bundle and thereby provides a cheaper airfare ($400 vs. $496 at traditional airlines) while generating highly profitable add-on sales for other parts of the traditional bundle. These fees make up 38.4% of total revenue, most of it from luggage fees**.

Why is Spirit so hated? Besides the well documents poor levels of service and on-time performance, we believe it is because its pricing is not communicated clearly enough at point of purchase, thereby resulting in ill-informed customers ending up paying more than on full service airlines.

The lesson is that transformational pricing requires exceptional communication efforts. This is especially important when the pricing is radically different from industry norms.

If not done right, you may be highly profitable (on the backs of unsuspecting customers), but also earn the title of the “most hated airline.”

Safe travels, everyone.
*http://www.businessweek.com/articles/2014-04-10/the-most-hated-u-dot-s-dot-airline-is-also-the-most-profitable
**http://www.telegraph.co.uk/travel/travelnews/10980310/Wizz-Air-and-Jet2.com-worse-than-Ryanair-for-extras.html

One of the toughest pricing decisions faced by companies is how to trade off the long-term benefits of customer seniority versus the short-term benefits of immediate higher marginal profit by auctioning inventory to the highest bidder.

In this newsletter we’ll explore the impact of these decisions with two industry examples, and under what context favoring loyalty or marginal revenue makes sense.

Airline Industry
The airline industry tackles this problem daily, and the players use different strategies. Most established carriers have frequent flyer programs, which reward flyers with various perquisites, mostly notably the opportunity to be upgraded through a combination of loyalty tier and seniority.

The execution of these programs reveals stark differences, however. Delta Airlines, high tier flyers can secure business class upgrades well in advance of a flight. United Airlines (UAL) contrarily holds business class seats open until much closer to flight departure, allowing less frequent flyers to purchase upgrades, thereby jumping the queue.

Loyal and frequent UAL customers detest this as they watch themselves being set aside in coach class for small incremental revenue to UAL. Making matters worse, UAL price discriminates; they purportedly charge the frequent flyer more for the upgrade than a far less frequent flyer because UAL believes the former can pay more! This raises in their minds the value of being a frequent flyer altogether.*

The recent operating results of the two carriers could arguably shed some light on effectiveness of the different philosophies:*

Whilst there are many factors impacting revenue, re-thinking their frequent flyer approach is the major change in the period studied, so it seems that Delta’s approach of rewarding the high frequent flyers may be paying off.

Directory Business
In another example, traditional directory businesses are shifting to a more digitally centric business model. In most cases, online directories do not translate perfectly to print, as users will thumb through print, but are less inclined to scroll through web pages (research shows that the top 6 Google results typically account for 90% of subsequent click through.

Directory businesses thus face the decision on how to award the top listings.

ThomasNet, the well-known industrial directory business, uses an annual auction approach for listing positioning. That is more useful when buyers are sophisticated and have agencies or in house capabilities to manage the Ad Word purchasing cycle. In this approach, marginal revenue is the highest since the market aligns value to inventory.

Alternatively, for less resourced companies, a single top tier price is set, and seniority drives the placement. This leaves marginal income on the table though as buyers willing to pay more for a top listing can’t.

A hybrid approach would be a “pseudo-auction” where the directory company sets a very high price for top tiers which would by means of high price limit the number of takers, making a short “first page.” In this hybrid approach, marginal income is captured, but senior advertisers may feel the way UAL frequent flyers do.

The choice of seniority, auction, or “pseudo auction” is a difficult one, and largely depends on the options buyers have.

In the case of airlines, loyalty will switch in the cities where viable competition prevails (which, in hub cities, is less and less seen). In the case of directories, being found is critically important to revenue, and unless there are clear substitutes, the market economics will drive to pay higher prices to secure top positioning.

Seniority can still be a factor in the pseudo auction, which could mitigate some senior buyer ire. Other key factors involve of course the extent of the marginal revenue, the “loyalty elasticity factor”™ (i.e. the likelihood of losing highly valued customers), the business’s immediate cash flow needs, offer complexity and communication requirements, and other dynamics.

Abbey Road has extensive experience in helping companies make these trade-offs across many business and industries. The process requires evaluating revenue potential, loyalty elasticity, and other deep pricing techniques.

Even in the post-Steve Jobs era, Apple is thinking differently from its main competitors – in this case relating to pricing. While at first blush Apple’s rumored pricing for the new iPhone 6 seems to be going against the grain, it is actually following best pricing practices. Judge for yourself….

The media reported that Apple is looking to achieve a $100 increase on the iPhone 6 vs iPhone 5. This seems like a strange move, at a time when its rivals are going down in price.

There are two ways to look at this if you’re Apple: On the one hand, consumers around the world want cheaper phones with bigger screens. This suggests it needs to cut the price and bump screen size. On the other hand, Apple believes (and has shown) to be somewhat insulated to the pricing pressure of Android phone makers. The iPad, for example, was originally going to sell for $400, but Apple figured people would pay $100 more, and it was right.

Apple realizes that price level is an outcome of the following three “ingredients:”

The company is masterful at understanding and quantifying the relationship of its own value created versus competition, and most importantly, the premium value of its brand (brand representing the present yield of previous value creation).

The lesson here is that it is essential to consider ALL elements of value when pricing new products or adjusting price of existing product, not just simplistic comparisons to competitors’ pricing.

One tool we often use to determine price level is a price value map, which compares relative value delivered to price both for your own products and competitors’ Sounds easy enough, except that determining “value” is hard. To understand the true value delivered requires in-depth qualitative research and quantification through analysis of purchase and usage data.

But the effort is usually worth it as it will avoid unnecessary discounting or market share loss due to over-pricing, or identify opportunities for price increases, as in the example below of a European tax research provider.

For this European content/software provider, a key value driver was the number of hits/against speed of additional filtering. The client company x was determined to be well above the “value line” established by the competitive offers and therefore could  (and did) increase price 15% from 1300 to 1500 euros without losing market share.

To find out more about how to construct and use price/value maps, call us at 203-514-0515.

Your Abbey Road Team.

We are getting a lot of questions lately about Freemium and whether it is a good idea for selling B2B digital content. Also, we find that often the term Freemium is being confused with Free Trial, i.e. giving someone a limited time to try a product or service for free, before charging. So let’s take a look at Freemium.

Freemium is a pricing strategy by which a product or service (typically a digital offering such as software, media, games or web services) is provided free of charge, but money (premium) is charged for advanced features, functionality, or virtual goods. (1, 2) Examples of Freemium include smartphone apps and high-profile names like Dropbox, Skype and Linkedin.

At its core, Freemium is an “introductory” pricing strategy. The core assumption for using a Freemium pricing strategy is that the user will start using the free version of the service but later, after extended use, will desire more functionality for which he is willing to pay.

According to Vineet Kumar, a professor at Harvard Business School, “Start-ups are attracted to the freemium model because it is “deceptively simple”—lure users with free services until they’re hooked, then charge for extras. The problem is, it’s not always obvious what features should be free and which should be paid.” Offering too many features in the free version risks “cannibalizing your paid customers,” while not offering enough might generate little interest all around.(3)

Besides the above issues, the main reason why Freemium is not a good strategy for most B2B companies is that the numbers don’t work: “Typically only 1% or 2% of users will upgrade to a paid product,” according to David Cohen, founder and CEO of TechStars, a start-up accelerator since 2007 with five U.S. locations. (3)

It is very hard to build a profitable business with those conversion rates. Besides, corporate customers usually have defined information and service needs that are willing to pay for.

In our experience, more effective B2B introductory strategies are “Free Trial,” and, to drive actual usage, “Negative Pricing.” The latter refers to a customer paying less, the more they use a product or service. In practice, a customer may be offered a 6 month or even a 1 year period during which it can reduce its subscription cost proportional to the usage of a product or service. This drives training initiatives and advocacy into the organization, and therefore is best used when widespread and quick adoption is critical to realizing value.

We only scratched the surface here, so please call us at 203-514-0515 if you would like to discuss how to gain traction with your new digital product or service.

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(1) JLM de la Iglesia, JEL Gayo, “Doing business by selling free services”. Web 2.0: The Business Model, 2008. Springer
(2) Tom Hayes, “Jump Point: How Network Culture is Revolutionizing Business”. 2008.
(3) The Wall Street Journal, “When Freemium Fails” by Sarah E. Needleman and Angus Loten, Aug. 22, 2012 6:43 p.m. ET

Last March Abbey Road Associates shared a point on view on the merits and drawbacks of surge pricing.

We pointed out Uber’s poor communications about their surge pricing policy, and their failed attempt to recover from customer blowback, with an overly defensive response replete with fancy graphs and analysis. We suggested that better communications up front would have preempted the sticker shock and member resentment.

In this update, we examine what worked and what didn’t with their latest surge pricing communications strategy.

If the volume of complaints and news coverage is any measure of success, Uber’s new approach had decidedly mixed results. The blogosphere and the Uber Twitter feed were ablaze over the holiday season with the sticker shock and complaints. Two new competitors – Lift and Sidecar – gave Uber a bloody nose by imposing a 200% cap on prices, while Uber’s went as high as 800%.

This is a shame since surge pricing demonstrably raises supply, an important consumer benefit. Compare this to hotels or restaurants, which have fixed supply, where surge pricing simply extracts more value from higher demand.

The key for Uber – or any firm grappling with the risks of surge pricing – is to understand the source of consumer discontent, in addition to being transparent.

So how transparent was Uber? Very. It was impossible to order a ride on Uber and overlook the alerts about surge pricing during peak periods. After placing an order, there was simply no way to honestly experience sticker shock post ride. Comments in about post-ride sticker shock were either dishonest or posted by those suffering from serious short term memory loss.

But: transparency per se is insufficient to counter consumer’s perception of being gouged. Uber’s rather tone-deaf responses to tweets was ineffective. The company did not explicitly apologize, – and should not – but their “just the facts ma’am” attitude was unhelpful.

What Uber should have done is to explain why surge pricing helps (= it increases supply of cars) and who is benefitting from the surge prices (= the drivers, NOT Uber).

In our view, most customers would grudgingly accept higher pricing if shown the benefits to supply and if they understand that surplus goes to the “little guy” and not an “evil, price-gouging corporation”.

In short, if you are going to use surge pricing, we strongly recommend that you:

1. Explain the benefits to the consumer – be customer empathetic
2. Articulate who benefits from the price increase. Customer’s sense of social justice will be appeased
3. Deploy a sympathetic post period social media strategy

In all of our pricing assignments, Abbey Road includes a thorough and comprehensive assessment of, and recommendations for, messaging and market roll out of any pricing changes, so your post price-change Twitter feeds are as positive as possible.

Are college costs reaching a breaking point?  That’s the headline of a Businessweek article from this past summer, published just about the time when fall tuition payments were due.  With two kids in college and a third starting next fall, these types of headlines usually get my attention.

It’s no secret that annual tuition and fees alone at top universities are approaching $50,000, with Columbia University leading the pack at $49,138 for the 2013-2014 school year.  According to The College Board, average tuition and fees for four year private non-profit and public colleges increased at an annual compounded rate of 2.5% and 3.1% respectively above the rate of inflation since 1971 (see chart)!

2.5% and 3.1% per year don’t sound like big numbers, but inflation adjusted household median income over that time period only grew from $45,641 to $51,156 or 0.3% per year. For that median wage earner the average private college cost grew from 23% of his/her pretax income to 59%! I would call that a breaking point!

In their recent New York Times column, authors Clayton Christensen and Michael Horn, predict disruptive change coming to higher education in the form of Massive Open Online Courses (MOOCs), which use the internet to deliver classes to thousands of students. Most MOOCs are currently free but don’t provide college credit to participating students. However, that model is gradually changing, as both public and non-profit private colleges have begun offering credit bearing online courses and even full degree programs. As these programs prove their value, we think this trickle of courses will become a torrent of online higher education with cost efficiencies and competition causing prices to drop precipitously.

How should colleges prepare for this impending deluge and avoid getting washed away by price competition? One obvious path is to stop resisting the inevitable and launch their own online credit bearing courses and degree programs. Early adopters will benefit from a lead on the cost reduction learning curve and be better prepared for downward price pressure as competition grows.

Facing only limited competition in the credit bearing online course market, some colleges and universities such as SUNY Empire State and The University of Minnesota are charging the same for online course credits as for their on-campus courses. A more common model is to discount from 25% to 50% off the price of on-campus courses as have Arizona State University and University of Wisconsin. Some of the more aggressively priced programs such as Georgia Tech’s newly announced online master’s degree in computer science are as much as 80%+ less expensive than their on-campus counterparts.

As with any business facing pricing decisions for a new offering that could cannibalize its core business, a college or university choosing the right online course pricing strategy must consider a number of factors including:

• Current competition for both online and on campus students
• Cost structure of the new offering and plans for cost reduction over time
• Selection of courses/degrees to be offered online
• Whether online course pricing will follow the same differential pricing policy as on campus tuition for in state and out of state students (for public colleges only)
• Whether or not the online courses will be offered to international students overseas

If you are dealing with similar pricing challenges, whether you manage a college, a business or a non-profit organization, we can help you navigate your alternatives. Please contact us to discuss how.

Recently I decided to shift a domain name that I’ve parked for years from one of the largest name registrars to a smaller one. The reason was a major price difference of $25/year – the larger one charged $35/year, the smaller one $10/year.

So why have I waited so long to switch? The answer is simple: inertia and sloth. I had convinced myself that it was worth spending $25/year more to avoid the pain of moving the name, a complex and annoying process. But it was finally time to do what I had put off for so many years.

Well lo and behold, as I was half way through the switching process, having already signed up and pre-paid the new registrar, the incumbent registrar suddenly pops an offer for me to retain them for $10/year, the same price I would pay at the new registrar.

Nice try, but it was too little too late. Since in order to renew and take advantage of this sudden lower price, I would need to revoke the prepayment to the new registrar, which would then need a call to the credit card issuer to halt the payment.

This entire episode illustrates bigger operating paradigms at work here: when does it pay to really charge for inertia, what is the value to the customer in the short and longer terms, and what is the value of the sudden promotion to retain business?

At Abbey Road Associates we recognize there is real value to switching barriers, and businesses should leverage them. However, over-stretching them is a real risk to the long-term retention of customers. In the case of the incumbent name registrar, had they charged $15/year instead of $25/year, it is unlikely many people would have considered switching: $5/year is just not enough incentive to go through the hassle.

Flashing a last minute offer of $10, is whiff of desperation and a blatant admission of overcharging guilt. This gives rise to our view of when and how to use switching barriers. Below are a few rules, among many more which are situation dependent:

1. Use high switching costs if there is a harvesting strategy in place; there is no doubt that short-term inertia is your friend. But over time, undifferentiated services with high prices will ultimately lose enough share to no longer remain viable.

2. Switching barriers are best paired with long term contracts.

3. Do not use high switching barriers when a customer has multiple lines of business, as once they’ve decided to switch, they will learn to switch all product lines. Conversely, for large, episodic purchases such as a large ERP system, switching barriers make more sense.

4. If prices are very public, switching barriers make less sense. No one wants to be frequently reminded that their provider is overcharging.

5. Last minute offers can be viewed as pathetic, and denigrate the higher pricing position which hopefully is built on a reputation of quality/service.

6. Switching barrier premiums can range dramatically based on each situation, but premiums should not exceed 35%-50%.

For more thought on the value of switching barriers, call us at +1.203.514.0515