Tuesday, April 26, 2011

A Squeeze at the Top

The very highest end of Parisian hotels includes such names as the Crillon, the Plaza Athenee and Le Bristol. There are four of these highest prestige hotels in Paris. Their prices start at Euro 750 a night. Average room prices run around Euro 1000 a night. These are among the highest prices for hotel rooms in the world. Still, occupancy rates run around 80%. Even in the doldrums of 2008 and 2009, they fell only to 70%.

Something new is happening, though. The high end of the market is about to see a doubling in capacity as four new luxury hotels open over a three year period. Two are already open and two more will open over the next two years. There is a prospect for even more coming beyond this next two year window, as other competitors mull a market entry.

Many experts believe that prices will hold steady despite the massive influx of new capacity. They cite an increase in demand to support their beliefs. This demand is to come from Chinese tourists upgrading from luxury boutique hotels and from the growth of major conference events.

Really, though, it isn’t the price that is at issue with this new capacity. It is margins. This new capacity, despite being at the very high end of the market, is coming faster than demand is growing. As a result, margins, if not prices, will fall. This margin squeeze has already started. The existing high-end hotels are spending money to upgrade their current offerings with celebrity-chef restaurants, branded spas and upgraded hotel rooms. Even if prices stay the same as they are today, margins will fall until demand fully catches up to this new capacity.

While it is always margins that suffer when the growth of capacity outstrips the growth of demand, I would not want to bet on prices holding as steady as these analysts expect. My guess is that industrial conferences who can afford to place their attendees at the highest end hotels will also be able to negotiate room price discounts over the next couple of years.

Wednesday, April 20, 2011

Another Creative Pricing Scheme

It is not often that you see companies using really unusual pricing to build future business. Here is one that I like.

Every price has three and, usually four, components: the Benefit Package, the Basis of Charge, the List price and usually some Optional Components of price. The Benefit Package includes all of the Function, Reliability and Convenience benefits associated with the main product. The Basis of Charge is the way the company quantifies the unit of sale that it prices with the List Price, which is the stated price per unit of product sold. The Optional Components of price enable the company to leave the List Price unchanged, but to alter the value the company offers the customer by changing Functions, Reliability or Convenience benefits beyond those of the main product. The most creative pricing schemes usually involve the Optional Components of price.

Recently, we described one of these Optional Components of price, a Call, offered by Continental Airlines. In this blog, we will describe a “Put” offered by Best Buy. A Put is an Optional Component of price that enables the customer to sell back a product to the seller at a stated price in the future.

Best Buy recently introduced the Buy-Back program for various electronic gadgets it sells. This program adds a fee to the original List price of the product. In return for that fee, the customer gets the right to bring the product back for up to two years for a return value of a stated percentage of the original List price of the product. These percentages run from 20% to 50%, depending on the time of the return. The value of the return itself comes in the form of a Best Buy gift card. Best Buy hopes the customer will use this gift card to purchase an upgrade on the product that the consumer returns.

This Put may be attractive to consumers concerned about the speed of technological innovation in electronic gadgets. The Put effectively reduces the future price of purchasing a new electronic gadget. It leaves the current List prices and future List prices unchanged. It also increases the odds that Best Buy will be the retailer who delivers the new technologically-advanced product.

Wednesday, April 6, 2011

The NYSE Stumble Offers a Lesson for All Leaders

Recently, the New York Stock Exchange agreed to sell itself to the German exchange, Deutsche Boerse. For generations, the NYSE was the place to trade equities of the finest companies in the U.S. Its sale to a German exchange is a sign of how desperate its market situation has become. The NYSE’s fall offers some important lessons for a market leader in any industry.

The NYSE’s market share has fallen out of bed. Six years ago, 75% of the traded shares of companies listed on the New York Stock Exchange traded on that exchange. Today, only 35% of those shares trade on the NYSE. This precipitous fall came because the NYSE fell behind in both service and price. The market changed and new competitors emerged.

First, the market changed. High frequency traders, using computerized trading algorithms, do two-thirds of share trades today. These market-dominating customers demand the highest speeds in their transactions and the industry’s lowest prices. The New York Stock Exchange struggled to meet these requirements.

Second, new competition emerged. There are roughly fifty trading venues which will provide these high-frequency traders with fast services and low prices. The majority of these venues did not even exist ten years ago. They sprang up using relatively inexpensive computers in low-cost outlying and suburban locations. These new trading venues offer newer, faster technology and lower prices than the NYSE.

The NYSE held a price umbrella over these emerging firms. The new firms grew and became ever more capable. Today, they can compete and win in competition for even small trades.

The New York Stock Exchange was a dominant market leader. Its precipitous fall holds lessons for all market leaders in any market. Among these lessons are these:

1. Always protect your relationships with the industry’s heart-of-the-market customers. These are the key, primary and secondary relationships with the industry’s large customers, those purchasing 80% of the industry’s unit volume. These key relationships usually hold 65% or so of the total industry sales.

2. Avoid consistent failure with these heart-of-the-market relationships, especially failures in function and price. Customers generally will not leave an established relationship until their supplier fails them. Any failure, especially consistent failure over time, opens the customer relationship to other competitors.

3. Parry fast-growing competitors at any price point. The fast growth of these competitors tells us that customers like what they offer. Their growth in share will not stop until the market leader itself puts an end to it. The NYSE has allowed many new competitors into its marketplace. It would have been much easier to stop them when they were much smaller or, indeed, even before they entered the market. This market will consolidate again into far fewer competitors. But now it is going to be a bloody fight.

4. Fix the products that are losing share in the heart-of-the-market. Customer retention is important in any market, but it is critical in markets where prices are falling. The first demand of product innovation is to fix problems that cause the company to lose customer relationships.

5. Cover any price point your heart-of-the-market customer purchases. Companies often have price point biases, either against a low price point because it pulls down margins, or against a high price point because it makes operations less efficient. If the heart-of-the-market customers are buying the price point, you have to cover it.

6. In a falling price environment, develop pricing that discourages competition. This pricing can, and should, involve more than simple reductions in list prices. There are several components of a price. The NYSE can use these components to beat back many of these competitors. In a low, or falling, price environment, the only real function that price serves is to discourage competitors from competing for your customers. Ultimately, low prices push competitors out of the marketplace. This takes a long period of time when there are as many competitors as the NYSE faces today.

7. Develop and exploit economies of scale to support the falling prices the company faces and to maintain the best returns in the industry. The NYSE is still the largest competitor in the market. It no longer enjoys dominant share, but it is still large enough to create a more productive cost structure, especially by matching benefits and overhead costs to customer segments and eliminating benefits that customers do not need.