SPMG April - May 2012 Newsletter

PRICING TO CUSTOMER EXPECTATIONS

Article in the World Economic Journal - Nov. 2011

Written by Michael Hurwich and Julia Reshetnikva                                                                      

(EDITED 2012)

Price consulting is mostly all about understanding what drives purchasing behavior. In interviewing a thousand people we can find various commonalities. For example some people may have similar value expectations for a product or service. Perhaps, for some the driver is brand name, while for others it could be price. After collecting appropriate data, we can then construct a value proposition for people seeking brand loyalty.

Measuring the psychology of purchasing behavior is very important. With so many competitors worldwide, it is very important to understand how customers trade value for price. Furthermore, a 1% change in price typically represents an 11% increase in net revenue.

Price is a very powerful lever to improve profitability.

STRATEGIC PRICING MANAGEMENT:

Previously, adjusting price was a decision left to only one individual (known as a "Price Czar"). Usually this individual works in the Finance or Accounting department. This person's unilateral decision was basically the one adopted by the company to establish the price. However this specific process represented an inside-out approach. In those days, companies always looked at cost involved in producing a product or providing a service to a customer. This traditional form of pricing involved adding a fixed-markup to a product's cost to ensure a target margin. From  here, companies traditionally went to market with a margin markup strategy. If customers found the price unattractive, the company would be forced to discount their products and services or fear a rapid decline forecasted sales.

Today, most companies in well developed countries have adopted what is commonly known as value-based pricing strategies. This outside-in approach is more complicated but much more effective. The price is not set from inside the company, but rather is set in learning and understanding a customers use of products and services and their willingness to pay for the derived benefit of the product or service. Some companies have known to measure customer decision selection criteria and purchasing behavior by the hour or minute to determine the price-benefit equation. This tactic is known as dynamic pricing.

THE ROLE OF THE PRICING CONSLTANT:

Pricing consultants are typically used today to look at the historical data of unit sales of companies by reviewing the nature of what has been sold in the past. The process is typically known as regression or cluster analysis and is used to determine the nature of purchases and the consistency of pricing performance. Past volume and prices obtained can often be used to determine future prices in the absence of external market research. When historical data is insufficient companies often conduct a primary field research by talking to a select group of respondents with prior experience using a similar product to determine the demand based on the suggested price and value proposition of the new product or service.

Price affects everyone. There is not a company in the world that doesn't talk about price at some point during any given day. Interestingly, most of the focus of price consultancy firms is not around price, but rather in understanding a company's value proposition to customers. Price is merely the reward for creating, capturing and communicating value into the marketplace.

THE RESEARCH PROCESS (McDonalds Case Study)

McDonalds was an interesting client, in that they asked us to review their pricing and value proposition for the Big Mac and Happy Meal for the US market versus existing competitive products with equivalent value propositions. In the USA the Happy Meal was $5.99. McDonalds sought to understand if they have the right price relative to competitors.

We [SPMG] decided to use a customer segmentation model to understand the McDonalds customers pricing pain threshold relative to their value proposition. There are 4 types of customer segments. Price sensitive customers segment usually representing 33% of the marketplace. The convenience customer is typically represented by 15% of the market, while loyalty customers represent 25% of the market. Finally the value customer segment is always looking to measure value in relation to price.

The research for McDonalds unveiled different price thresholds for different customer segments using diverse delivery channels. McDonalds conducted the price research across the contiguous United States and Canada with 1600 customers. What was interesting is that most customers represented by 75% of the sample didn't even know the right price of the Big Mac and Happy meal. They actually thought that it was 20% higher. The message here: if customers fail to know the right price, it is implied that McDonalds was leaving money on the table. If customers didn't know the price that they suggested, there is a lot more value as perceived by the customer than the price that was being charged. McDonalds had to rethink their price-value strategy and what to do with their price.

There was a different price-point threshold across different channels. Because McDonalds avoided charging different price across their four channels we took an average of all the channels and arrived at a new price that would be optimal for drive-through clientele as well as for customers that dined-in.

CONCLUSION: The benefit to McDonalds was roughly $80 million dollars to their top-line revenue merely by adjusting price to more adequately reflect current market and competitive conditions.

PRICING EXCELLENCE

Science-based segmentation utilizes data analysis and statistical methods to group customers into "significantly similar" groups. The object is to create segment optimized pricing given particular buying behaviour of that segment.

Today companies use sophisticated pricing tools to derive price and measure the psychology of purchasing behavior in what is an important and key attribute of price-value consulting.

Another tool used in pricing is called Monadic testing which only tests price in the absence of other product or service characteristics. In Monadic testing you are attempting to test different price points. If you get a large enough sample you can determine acceptable price points that represent the majority of market share.

Another useful tool that is commonly used is called Price-Value mapping. This tool shows your company how a customer evaluates specific product and service attributed to price. The tricky part of constructing a Price/Value Map is estimating the product & service value to the average customer. We recommend the identification of a handful of product or service features that your customers care about most and then try to determine. You would plot the price and value on a price value map. The Price-Value map is one and most important, most often used pricing tools in the industry today.