Market Share At Any Cost

Going after market share with a low price strategy may look attractive in a competitive environment with no clear differentiation between the products. But when price is the only appealing factor, companies stand to  lose value in a spiraling price war.  The lure of market share is more prevalent in consumer products where companies are destroying value and commoditizing their premium brands with price cuts.

The newly appointed CEO, Paul Polman, of embattled Consumer Products maker, Unilever, has this to say about his strategy:

We are not going to have a mentality to grow at the expense of others

He was quoted as saying that he would avoid fighting for market share at any cost, a trap that lead companies to cut prices too steep or chase low-margins products.

Mr.Polman nailed it.

Branding Transit System

In the Nokia World 2007 (Webcast), Chris Anderson of Wired gave a keynote speech on "Free". He described a scenario in which an entire subway line is made free through corporate sponsorship. Corporate sponsorship has enered public transit system, in Dubai. The WSJ talks about the city state auctioning off naming rights of the train lines and the stations.

This isn't going to be free but the Ad revenue will go on to subsidize otherwise expensive tickets. It is a clever move by the Dubai transit authorities this isn't guaranteed to work for two reasons:

1. When you base your profit on sponsorship revenues even though your service adds value to your customers you destroying this value add. Your customers will end up valuing your service lower than they would have otherwise. 
2. If there are any changes in your Ad revenue you will need to compensate with increase in fees paid by travelers. As studies showed, moving from fee to free and increasing fees for an Ad subsidized service  causes customer dissatisfaction. The recent example is the failed attempt by The New York Times to charge for their Op-Ed pieces through Times Select.

In the end it still makes sense to determine your costs correctly and price it based on what your customers will value it. 

Willingness To Pay

Imagine a store, not just any store, one that sells just Aquafina brand of standard size bottled water.
Suppose there are no price lists, no price postings anywhere in the store.  You walk in to the store and pickup a bottle and walk to the cashier, who instead of scanning the barcode on the bottle scans your forehead. A LCD display flashes the price, $1.09. You pay that amount and enjoy the bottle of water.

It is you again and the same store, but a different day. You have just run 10K, practicing for Bolder Boulder race. As you walk to the cashier with the bottle, the LCD now reads $2.25.  You pay as indicated.

This scenario is  described as the Monopolist Dream, the Holy Grail of First Order Price Discrimination.  The price that flashes on the LCD display is your Willingness To Pay. The price is not only different for different customers, but is different to you as well based on your need.

Willingness to Pay is exactly that, how much you value the product. Priced exactly at your WTP, you are indifferent to keeping the money vs paying for it. Priced even a penny above you will not buy, and anything less you get a price rent or more commonly defined as "Consumer Surplus".

For the business owner, both situations are sub-optimal, they either let you walk out with too much surplus or lose out on sales. Every business would love to get the exact WTP of every customer who walks into their store.  But that is not possible, hence we need the multiple pricing models, customer segmentation and all the research that goes with it

Next time you walk into Chipotle, think why the Vegetarian Burrito is priced at $5.29? How much surplus are you getting at that price?

Source: My class notes from Microeconomics by Professor Steven Tadelis.

NYTimes Reports Increase in Online Shopping

Greg Manikw, the author of my favorite Macroeconomics book, writes in his blog a series on Cross-Price Elasticity of Demand.

The New York Times reports that shoppers are doing more online shopping than driving to the stores. While the demand for the products has not shifted to their substitutions, the channels through which people buy has.

Online shopping is gaining at a time when simply filling up a gas tank to head to the mall can seem like a spending spree.

A number of retailers — including Gap, Victoria’s Secret and J. C. Penney — are experiencing double-digit sales growth at their shopping Web sites, creating a surprising bright spot during an otherwise gloomy time for sales in brick-and-mortar stores.

Down the line this means drop in incentives to the employees who work in the shops and it is bound to cause shift in their consuming patterns.

If I can make predictions about other economic and consumer behavior changes we should expect in the future, these are in my short list:

1. People brown-bagging lunch
2. Product unbundling in restaurants. No more free bread, chips-salsa or worse no more free napkins or water.
3. 4 day work week, with 10 hours a day
4. US Mail stopping Saturday delivery
5. Newspapers adding a higher delivery surcharge, causing a shift to their online version.

Dynamic Pricing Under Scarcity

I came across an online made to order T-Shirt shop, which is a very legitimate and decent site despite its name  200nipples.com. It is different from any other made to order shop, like Cafepress.com.

1. This is not a site for you and I to sell T-shirts
2. They make custom print on T-shirts, graphics done by designers they hire on 10% commission
3. They sell only 1 design at a time 
4. There are only 100 t-shirts to sell for each design and then they say they scrap the design
5. The T-shirts are numbered 1-100
6. The Price?  It is same as the number on the T-shirt. You pay $1 for #1 and #100 for $100

From the 200nipples blog:

What's with "200 Nipples?"

That's how many nipples we assume will be covered by any single run of our high-quality shirts. (We'll have the third-nippled buyer in there occasionally, but we didn't want to count on it when naming the company; this is serious business, after all.)

It is a new model of dynamic pricing under scarcity (however artificial) and betting on customers high willingness to pay based on exclusivity.

I think this is a great experiment, I like the entrepreneurs showing creativity  but ...

As a viable business model I doubt its viability and scalability. Limiting to one design at a time seems unnecessary. It is easy to change however, but may cannibalize the sales as those not willing to buy a T-shirt for $40 or more may choose one that is available for less. While the first few designs and some of them will sell out for a total revenue of $5050 from a design, it is questionable that this would hold for the majority. There isn't a large customer base that would want exclusivity or would want to pay $30-$100 for exclusivity. This is a T-shirt not limited edition collectors item. The macroeconomic conditions are also not conducive to such a pricing model that requires high discretionary income (or even abundance of bubble days).

I see the latest version that shows RIAA people going to heaven sold just  42 T-shirts. The number has not changes since Sunday night. True they have not done any marketing, but is not going to be an outlier.

I think those entrepreneurs are not after making it big with this T-shirt shop, they are probably looking for marketing credentials or more, just like more bloggers who spend hours of their unpaid time writing blogs that never get read.

Good luck Wade and Shandra.

Gas Station owners are not raking in the dollars

Sometime back I wrote about the gas prices and the gas station owners. From a simple math I did, I computed a margin of less than 5 cents a gallon that cost $3.50. If the customer paid in cash, the gas station earned additional 7 cents per gallon.

The Marketplace reports that the situation just got worse for gas station owners with gas now selling for $4.50-$5.00 a gallon.   The credit card charges are set at a fixed percentage of 2% on the transaction but the gas station owners do not mark up gas at a fixed percentage. The retail price is marked up by a fixed dollar amount, 10-12 cents. With gas price at $4.50, the credit card charges come to 9 cents, for a meagre profit of 2 cents per gallon.

It is a tough business to be in.

Trying To Stand Out Among The Airlines

Jay Leno, in his monologue, scoffed at Airline unbundled pricing.

At the rate they are going, in an emergency they will ask us to swipe a credit card before the oxygen mask drops out. Oh listen to this, a SouthWest airline plane landed in Phoenix with one its wheels on fire. If they are going to bill us for every little thing under the sun, may be they should give us some discount, like when the plane is on fire.

Unfortunately for SouthWest, it is the only one not charging extras but it got the bad PR. In fact
SouthWest is aggressively going after the price unbundling by other airlines. All their messaging is now focused on "No fees". But when every airline but SouthWest is charging extras, does it help to be the one who does not? There is a pubic tendency to look at the Airlines as a collective, so it is not a good strategy for SouthWest.

Pricing Your Air Travel

The Dallas Morning News gives us the run down of the different charges Airlines make these due to their increasing costs:

FEE SPREE

Airlines are adding fees and charges aggressively as they grapple with rising fuel costs.

AMERICAN AIRLINES

$5 to redeem a frequent-flier award online, up from $0

$6 for a sandwich or liquor,

up from $5

$15 to check the first bag (each way), up from $0

DELTA AIR LINES

$25 for booking a trip over the phone, up from $20

$100 for an unaccompanied minor on nonstop flights, up from $50

$100 for transporting a pet in the cabin, up from $75

UNITED AIRLINES

$25 to check a second bag (each way), up from $0

$150 to change a nonrefundable ticket, up from $100

OTHER AIRLINES

US Airways: $5 and up for a window or aisle seat in the first rows of coach, up from $0

Northwest: $50 for each bag weighing over 50 pounds, up from $25

Frontier: $100 to transport antlers, up from $75

SOURCES: The airlines; Dallas Morning News research

Will the Oil Shock Lead to Unbundled Services?

When I was visiting Sweden I found it shocking that they charged me 4 Kroner for a 8oz glass of tap water. As I traveled a bit more in Europe I found this common practice of restaurants charging extra for things that in US we take for granted. Sitting at a table has a surcharge, bread has a surcharge, water too. I compare this to a sign that I saw outside a Hot Dog stand near UC Berkeley, "All toppings always free", this captures the characteristic of US restaurants.

These are not really free, restaurants here use bundled pricing. The problem with this bundling is some of the added items are valued below cost by the customers and hence the restaurants do not reap the advantages of bundling.

Now in US, as the food and fuel prices keep increasing, restaurants are finding it hard to keep their margins. All these free toppings and additions that are "always free" add to the cost with no relief through higher pricing. Until now they have not passed on much of the supplies cost increases to their customers in the form of higher prices. It is not that it is difficult to keep changing prices (economists call this the menu costs).

Restaurant owners are wary of customer reaction and competitor moves. There may also be lingering doubts on whether we are experiencing a temporary price shock or the higher prices are here to stay. If the businesses and the public are convinced that is is the latter, then the cost increases will flow into prices.

However, an acceptance of increased prices does not mean the demand will stay the same. There are substitutes, eating at home and packing lunch from home. So restaurants may still be reluctant to increase prices. That leads us to unbundled pricing. Should the US restaurants do costing right (do not price items below their cost)? Should they price the food items at its current levels and start charging for service, water, bread, toppings, paper napkins, plastic ware etc?

It is not clear to me.

Customers may not value some of the items included in the bundle but will consider these essential to support the main product they are buying. If customers do not value something by itself, they also will not be willing to pay it. So charging a quarter for toppings may find fewer takers. While the costs will go down, I am not certain if the demand for the main product will remain steady.

It is definitely worth experimenting at a smaller scale before unbundling the whole burrito.

Branding and Pricing effects on Consumer Behavior

I regret not doing the Consumer Behavior course this semester. I see a whole bunch of experiments being conducted by my classmates for their final projects. I served as a willing subject for many such experiments, from tasting organic vs. non-organic vegetables and wines to deciding whether or not I will bet on an outcome with same expected payout but different entry costs. There was one study that promised a gift card raffle for participants deciding on Tulley's pricing market entry strategy, now I wonder if the study was really about consumer behavior with respect to raffles.

The New York Times talks about recession diets, people cutting down on brand name goods for cheaper alternatives.

Holly Levitsky, a 56-year-old supermarket cashier in Cleveland, buys a brand of steak sauce called Briargate for 85 cents and surreptitiously pours it into an A1 steak sauce bottle she keeps at home.

“My husband can’t even tell the difference,” she said.

The packaging and the marketing has obviously trained her husband to associate the taste and the experience to the brand name A1 even if there is no clear link (as Ms. Levitsky's experiment demonstrates).

On a more scientific level, Business Week reports a study done by Stanford and CalTech researchers on the same consumer behavior on wine pricing.

"The marketing industry has done a good job convincing people about their free will and that they are making logical, well-thought-out decisions about the things that they buy," Linn said. "Studies like this suggest that, in fact, there are lots of things that influence our responses to marketing and our choices of products that are completely irrational that we might not be aware of."

It's a Text Book case of Market forces

Text books are expensive. I paid about $120 on the average for my new text books and did not have good experience buying used books online. The New York Times wrote an editorial on the high price of college textbooks calling it "outrageous pricing". I do appreciate the Congressional bill that will allow unbundled pricing. But more than this I do not see a need for any actions for setting prices.

Greg Mankiw, the author of my favorite Macroeconomics book that not only helped me do extremely well last semester but also gave me tools to analyze McCain's gas tax vacation, says in his blog that the Times should consider entering the market instead of editorializing sine there are no barriers to entry, t has a strong brand and it already knows how to hire writers. He concludes that Times, "would not view starting a new textbook publisher as an exceptionally profitable business opportunity"

I looked at the Market Research 2007 data on Text book publishing.
Size of new text book business: $3.4 billion, growing ~3%, slower than used book segment
Market share of top 8 players: 95%
Operating margin of top 4 players: 25.6%, 20.2%, 15.7%, 13.0% (a nice margin)
Demographic characteristic: Students buying fewer books as they share or buy more used books.

I think with such strong concentration at the top and high fragmentation at the remaining 5% it is not easy to enter the market. While the students buy the books, marketing is done to the professors who recommend the books. I wonder whether the professors rely on the established brand name publisher than the author of the books. This creates barriers for new entrants despite the latter's established brand name in other areas.

I also think margins like 15% to 25% are extremely attractive and also tells us that the publishers are not doing this just as a service to education. The continued increase in prices despite the technology, marketing strength, outsourcing and experience curve benefits is surprising. It does leads one to wonder if there is tacit price collusion. More analysis is needed to look at specific segments each of the top players specialize in and whether they split the market among themselves to avoid competing with one another.

I would like to see no more recommended textbooks and unbundling at chapter level. Professors should pick and choose separate chapters from a variety of authors (dealing directly with them instead of publishers) and suggest a proposed electronically published course pack. This sure would solve the high price of textbooks by changing the game instead of through legislations.

Death by million posts

How difficult is it to produce that one more blog post?

Could the last post you and I wrote be the last one we would ever write?

Is there a pricing model from Miroeconomics we can apply to blogging?

Is your blog meant for transactional readers or relationship readers?

The New York Times talks about the difficulties in driving users and hence generating revenue from blog posts. With no barriers to entry, infinite supply, zero switching costs and customer loyalty, and limited number of reader-hours blogging is taking its toll on those who blog for money.

The very fact that reader volume is unpredictable and determined by when the post hits the blogosphere relative to other posts points to world of "transactional readers" and not "relationship readers". The latter is also known as subscribers to the RSS feed. Blogging for the transactional readers is unproductive, the marginal cost of producing one more post is way more than the marginal traffic (revenue) from that post. Since the probability that any single post can generate positive revenue is zero, the marginal revenue is zero as well.

If it is anything Microeconomics teaches us worthwhile, it is the concept of marginal costs and revenue. It is unpardonable to produce at marginal cost higher than marginal revenue.

On the other hand, going after relationship readers is a different game. The marginal revenue from one additional post is not the additional traffic and Ad clicks it generates but how much it adds to your credibility as an expert which gives a justification to your current subscribers for subscribing to your feed and for the transactional readers to become your subscribers. Note however that in relationship model, the marginal revenue is sill zero. But you are not producing and selling one post at a time. You are selling your expertise as a whole and it is irrelevant whether or not a single post brings in readers.

Once you realize this, there is no more pressure to produce in volume or beat others to break a news. There is no need for "toiling under great physical and emotional stress created by the around-the-clock Internet economy that demands a constant stream of news and comment" (NYTimes).

The other way to look at relationship blogging is to see it as an output of the work you did to gain and improve your expertise. This means that blogging is all fixed cost and zero marginal costs. Since the marginal cost and the marginal revenue are equal (of course, they are both zero) this is the right profit maximizing point to be.

But how do you recover your fixed cost when marginal revenue is zero? The pricing scheme that models the relationship blogging is Two-Part-Tariff. When the readers subscribe to your blog they pay the one time entry cost. You earned your revenue by gaining a share of their mind, time and space in the RSS reader. By charging this fixed price and a unit price of zero you have captured all you can from any single reader.

It is not difficult to see which model is better to pursue.