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.

The Advent of the F-commerce Evolution

Don’t look now, but we are entering the world of F-commerce. What is that, those of you older than thirty will ask? F-commerce is selling through a Facebook page.

The trend is early yet, but likely to turn into a stampede. JC Penney and 1-800-Flowers.com both have established full E-commerce stores within their Facebook page. The stores include check-out and other features you typically find on an E-commerce web site. Facebook claims that twenty-five of the largest retail sites are already integrated with Facebook, as are seventeen of the twenty-five fastest growing retail sites.

Think of Facebook as a virtual mall. There are all kinds of people wandering around there, talking to one another. Facebook offers a nice opportunity for a company to interact with customers and allow them to bring their friends into the conversation to evaluate styles and colors and so forth. If a company integrates its storefront with the Facebook page, its Facebook “friends” will never have to leave the virtual mall in order to purchase. This is an important product innovation.

Product innovations reduce customers’ effective costs in one of three ways: add information about the product and how it is to be used, reduce the resources the customer must use with the product, or improve the customer’s experience with the product.

This innovation improves the customer’s experience with the product by increasing the customer’s sense of security in using the product. It allows the customer to get her friends’ opinions on what she is purchasing. Secondarily, the Facebook store reduces the customer’s resources used with the product by reducing the time the customer must spend in using the product. The innovation reduces the steps the customer must take to make a purchase and it places the company’s product closer to the customer’s location.

This is going to be a train to the destination of millions of customers. Every mainstream retailer has to get on board.

The iPhone Versus the iPhone

After nearly four years, AT&T has lost its exclusivity on Apple’s iPhone. It has been a great run. Now AT&T faces the formidable competition of Verizon, who started offering the iPhone in February of 2011. Market shares are about to shift. Let’s look at how they might change.

Market shares among established customers shift for one of two reasons. (See Audio Tip #40: The Components of Market Share Change" on StrategyStreet.com.) First, a competitor may “win” market share by offering a benefit that more than half of the market suppliers do not offer. On the other hand, market share may shift away from a competitor if it “fails” its customer relationship and opens that relationship to other competitors. A company “fails” a customer relationship when it refuses, or is unable, to offer something that half the other competitors in the market can or will offer.

AT&T garnered much of its share gain over the last four years with a “win.” That “win” was due to its exclusive offering of the Apple iPhone. While it won business with the iPhone, it developed a reputation for problems in the quality of its services. iPhone users tended to overwhelm the AT&T network and cause interruptions and dropped phone calls. AT&T’s customer service has been suspect as well. Still, its market share has grown with the iPhone, primarily at the expense of the smaller carriers. Its market share growth due to the exclusive on the iPhone offset its “failures” in its network and customer service.

Now Verizon enters with its own version of the iPhone. Today, any customer who wants an iPhone can choose either the largest competitor in the market, Verizon, or the second largest competitor, AT&T as his or her carrier. So, Verizon can “win” market share against the smaller competitors as well. These competitors, such as Sprint, Virgin Mobile and others like them, do not offer the iPhone and are unlikely to do so soon.

Verizon should also be able to gain share at the expense of AT&T. Here’s how. iPhone-using customers who are dissatisfied with their current service with AT&T now have a viable, high quality competitor offering an equivalent service with the same phone. Some of these customers will leave AT&T because they perceive that AT&T’s services are not up to the standard of the other competitors, especially Verizon’s, and migrate to Verizon. This is a phenomenon we call “flight to quality.” This “flight to quality” is also an example of a “weak win,” where a competitor gains share only after an incumbent supplier has “failed” the customer relationship.

This “flight to quality” is unlikely to be dramatic. A company can “win” share quickly with a unique Function. On the other hand, a “flight to quality” usually brings share gains in dribs and drabs. It produces share gains slowly, over time, because of inertia in the customer relationships. This inertia allows AT&T time to get its house in order before it suffers a great deal of customer immigration. (See Video #36: Probable Priorities for Innovation in Hostile Markets on StrategyStreet.com.)

A Very Rare Form of Pricing

Recently, Continental Airlines introduced a new service called “FareLock.” This new service gives travelers three days, or a week, to decide whether to buy a ticket and avoid a fare increase or the risk that the passenger’s flight will sell out. In return, Continental plans to charge a flat fee of $5 for a three day hold and $9 for a one week hold. Continental is offering its passengers a Call. For a fee, the passenger has the right to buy the ticket at today’s price for a few days into the future. This is a very rare form of pricing outside of the securities market.

Every price has at least three components. Most have four. (See “Audio Tip #113: Tools to Change Pricing” on StrategyStreet.com.) The first of these components is the benefit package that the price offers. The second is the basis of charge, that is, how the company quantifies in currency what it charges for a unit of the product. The units can be a package, an individual item, a unit of time, and so forth. The third component is the list price of the product. Virtually all products also have what we call optional components, the fourth component. These optional components may, but do not have to, be a part of the product price. Optional price components include various discounts, fees, coupons and other methods of conveying a change in effective price, either an increase or a decrease, to the customer. A Call is one of the optional components of price. It occurs only rarely.

Here are some other examples:

* Some colleges have used the Call in the form of a fixed tuition price for any student returning for the four years of the student’s education. This pricing mechanism increases the college’s retention rates. (See “Audio Tip #142: Defensive Pricing Guidelines” on StrategyStreet.com.)

* There are also contingent Calls. Waterford Development Corporation was dealing with a difficult real estate market. It offered to have homes re-appraised two years after the date the transaction closed. If, after two years, the price of the home dropped, the company promised to write the buyer a check for up to 15% of the original sales price. With this Call, the customer gained the right to live in the house and yet pay a lower effective price for the house if the market should decline in the next two years. (See “Audio Tip #151: Changing Performance and Price Together” on StrategyStreet.com.)

* A discount broker, in an effort to attract more high-volume traders, offered a Call. This broker charged the customer only a single commission for multiple trades of the same stock on the same side of the market on the same day.

Google at Risk

Google continues to dominate the search market. It commands about two-thirds of all the searches done on the internet. Its next closest rival is Microsoft’s Bing which, at 28% market share, includes its integration with Yahoo’s site. (See “Audio Tip #9: Introduction to Step 3 of the Basic Strategy Guide” on StrategyStreet.com.) Google’s dominance in this market has brought with it a disproportionate share of the spending on paid advertising. Google may be putting that premium position at risk.

Google has been investing heavily in developing its local search capability. It hopes to gain even more advertising dollars by making this investment. Now the problem. Some companies, who also specialize in local marketing have begun complaining that Google discriminates against their sites in favor of Google’s own local search results. This is a very dangerous development for Google. It risks its Reliability reputation.

Google’s competitors have had a difficult time gaining market share against Google. As competitors develop new Functions, Google simply copies them. Internet searchers have had little reason to shift from Google to other competitors, including Bing. In our terms, Google’s competitors are not able to take market share away from Google by “winning.” (See “Audio Tip #32: Introduction to Step 7 of the Basic Strategy Guide”) They have not been able to do anything unique that causes a substantial portion of customers to shift their searches to Google. Rather, most of the market share that shifts in this market today comes as the result of a “failure.” Google must fail to meet its searcher’s expectations in order for Bing and the other competitors to have a significant opportunity to gain market share.

Google may be creating this opportunity by risking a failure in Reliability. A searcher has to know that Google will provide the most relevant results. If Google offers up its own less relevant results ahead of other web sites’ more relevant results, Google will lose market share. (See “Audio Tip #72: Reliability Failures Among Outstanding Companies” on StrategyStreet.com.) Google’s actions in promoting its own results over more relevant results are equivalent to a retailer offering a customer a lower quality product over a higher quality product simply because the retailer makes more money with the lower quality product. After a while, customers catch on and defect to other retailers. A failure in Reliability is particularly troublesome because trust is so hard to rebuild.

Strangling the Goose

Some time ago, we wrote a blog (see HERE) on the declining value of airline miles programs. At the time, we noted that most of those miles awarded were worth less than a cent. In fact, the airlines themselves believe that these miles are worth far less than a cent. That means the miles that you gain return less than 1% of your spending to your account.

Here is an example. United Airlines offers a one year membership in its Red Carpet Club for 70,000 miles. If you are a normal flyer, without particular value to United as a Premier or Premier Executive and so forth, you can buy a one year membership for $425. United Airlines is telling us that its miles are worth 6/10th of 1 cent.

But let’s say you are a highly valued flyer with United Airlines. Let’s assume you are a 1K flyer, one of their top categories. If you are in that fortunate (or unfortunate as you will have it) position, you may purchase a one year membership in the Red Carpet Club for $325. As an alternative, you can purchase the membership with 40,000 of your frequent flyer miles. This is a much better deal. Here your miles are worth 8/10th of a cent.

These airline-sponsored deals strike me as dangerous. (See the Symptom & Implication, “Customers are more price sensitive” on StrategyStreet.com.) They telegraph clearly that airline miles are worth less than 1%. This is dangerous because there are a number of credit cards available to you which will return 1% of your spending every month, in cash. That is a considerably better deal than the United Airline miles offer you. (See the Symptom & Implication, “New competition is entering a settled market” on StrategyStreet.com.) These airline miles keep losing their allure.

A Price Leader Market and Competitor

In StrategyStreet terms, a competitor or product that offers below industry standard performance for a very low price is a Price Leader. Price Leaders contrast with the typical industry leaders who set standards for the industry, called Standard Leaders in our terms. The competitors or products at the higher end of the market are called Performance Leaders.

The Price Leader’s product has fewer benefits than Standard Leader products. Because the Price Leaders are able to save costs, their product prices average 25% to 50% below the Standard Leader’s price. Because their products do offer less than the Standard Leader product, Price Leaders, as a group, have relatively small market shares, usually less than 15% of industry sales. (See the Perspective, “Why Do Leaders Lead?” on StrategyStreet.com.)

We have analyzed several hundred Price Leaders and found that we could group them into two types, Predators and Strippers. Predators offer the user of the product Functions similar to those of the Standard Leader products but less Reliability because they sell brand names that are unknown. They offer the user equivalent benefits but the purchaser fewer benefits. Strippers offer fewer benefits to both the user and the purchaser of the product. The printer ink industry offers good examples of our Price Leader findings. The total printer ink industry has sales of nearly $22 billion a year. Something just below $3 billion of this is owned by Price Leader competitors, who refill or remanufacture ink cartridges. These Price Leaders, as a group, have 13.5% of the total market.

Most of these Price Leader competitors are Strippers. (See the Perspective, “Attention K-Mart Copiers” on StrategyStreet.com.) Customers who buy their products are often dissatisfied. In fact, only about half of the customers who try the Price Leader product are satisfied with it.

One of these Price Leader competitors, Cartridge World, is in the Predator category of Price Leader competitors. Cartridge World is a leader in the cartridge refill and remanufacturing industry. As a general rule, the company prices its laser cartridges at 25% off of the cost of a new brand named cartridge. Its ink jet cartridges come with discounts of 30% compared to a new brand named cartridge. Its Function benefits are the same as the Standard Leader products. It offers less Reliability due to its unknown brand name. But, Cartridge World puts a 100% guarantee on its products and offers relatively high levels of customer service. As a result, the company is experiencing growth rates of 20% per annum, while its competitors grow at a much slower pace.

The Holiday Season: The Most Creative Pricing Season We Have

Watch the deals that retailers offer during the Christmas season. They find ever more creative ways to get us into their stores and shopping. I want to note a couple of these creative ways.

But first a bit of context. A price has four typical components: the package of benefits the product or service offers the list price, the basis of charge for the product (i.e. the unit in the dollars per unit in the list price) and, usually, some optional components of price. The optional components of price are helpful to companies who want to change the effective pricing for a customer. The retailers in this note are making creative use of some optional components of price.

The first example is the use of price to get people into stores by offering them a particular deal. Sometimes these are simply Loss Leader products, for example, offering very inexpensive bread and milk sold at the back of a grocery store in order to get a shopper in to buy other products at the store. So, one optional component of price is a Loss Leader product. Here is a creative twist. Offer the Loss Leader product in a “flash sale” with a very limited time frame. For example:

* Penney’s ran flash sales called “7 Hour Steals” offering towels for $3.69 that normally sell for $7.99 and 70% off gold and sterling silver jewelry.

* Banana Republic stores offered 40% off full-priced sweaters from 11 a.m. to 2 p.m.

Other optional components of price encourage multiple purchases. One way to do this is to offer discounts on all sales above a given purchase price. For example, a company might offer 20% off for all purchases above $50. A more creative, and aggressive, approach is to offer discounts that increase with the money spent. For example, a company might offer 20% off on a $50 purchase, an additional 20% off all purchases from $50 to $75 and a final 20% off on all purchases over $75. According to consumer research, many consumers would assume that they get a total of 60% off on all purchases over $75 with this offer. In fact, they get about 49% off on their total purchases. Still, a compelling deal.

In our study of several thousand pricing initiatives, we have found many of these optional components of price. They enable a company to improve its market share and margins in any price environment. These are available at StrategyStreet/Improve/Pricing/Innovation Ideas.

Sometimes Smaller is Better

Retailers suffered through the last two years with low or declining sales as typical consumers struggled with an economy in the doldrums. Some of these retailers experimented with cost cutting and discovered an innovation for customers.

As retail demand fell, some retailers decided to reduce the size of their stores and cut their inventories to fit the smaller market they were facing. One company, Anchor Blue, put in temporary walls and cut its selling space in half. This certainly saved them money. It also provided a big surprise. Anchor Blue found that its foot traffic rose by 7% and sales increased by 23% after the remodel.

As other stores had the same experience, bigger chains began their own small-is-beautiful experiments. Bloomingdales and Nike are both trying smaller stores. Retailers are reducing their inventories by removing the slower moving items. These changes enable their customers to find, choose and pay for their products faster. In other words, the smaller stores are a Convenience innovation that customers seem to like.

We seem to be reaching a limit in the retail world. For the last generation, retailers grew by increasing Functions in ever-larger stores. (See the Perspective, “When to Compete on Features” on StrategyStreet.com.) They added categories and assortments to increase customer choices. These Function innovations demanded more space. More choices and space added to the time customers had to spend at a store. The Convenience innovation of the smaller stores suggests that customers have reached saturation points with the larger stores offering more choices. Sometimes smaller is better. (See the Perspective, “Is Bigger Really Better?” on StrategyStreet.com.)

Vanguard vs. Fidelity

We are going to use this blog, and the next one, to speak more about pricing. Over the years, we have learned some surprising things about pricing. For example, in the average market, price moves much less share than most people assume. (See the Perspective, “The Price Segment” on StrategyStreet.com.) In most markets, the true price-driven market share volatility is 15% or less of the current volatile, changing, market share. You might ask how that can be. But the explanation is relatively easy. Most of us buy most of the things we purchase on the basis of a unique Function, better Reliability, or more Convenience, before we even get to Price. Did you buy your last car on the basis of Price? How about those snow skis? Were they the cheapest on the market? Do you stay in the cheapest hotels or drink the cheapest beer? True Price buyers are in the minority. And before these buyers get to Price in the decision sequence, they have satisfied themselves that there is no important difference among competitors on Function, Reliability or Convenience.

Even more surprising to most people is that in a hostile market, one with severe overcapacity and intense price competition, price moves even less share. We have worked in many hostile markets. In all of them, the true price-based volatile market share was less than 5% of the available volatile share. The reason for this phenomenon is that in a true hostile marketplace, virtually all competitors have learned to copy lower prices, or face an immediate loss in market share. (See the Perspective, “Why Price Cuts Don’t Build Share” on StrategyStreet.com.) For an example, look at the airline industry. When one airline offers a price discount, all the other peers of that airline offer the same discount on the same flight to the same locations.

Now I am going to offer what seems to be an exception to these “guidelines” I have just set down. The exception appears to be Vanguard in its competition with Fidelity Investments and the other money managers. This year, Vanguard Group replaced Fidelity as the largest U.S. mutual fund company. Fidelity had held that number one ranking since 1988, when it passed Merrill Lynch. At one time, the Fidelity Magellan fund, while it was run by Peter Lynch, was the world’s largest mutual fund. In 2000, it reached $110 billion under management. Lynch had a phenomenal record, but his successors did not. Today, the Fidelity Magellan fund has less than $30 billion under management. The biggest mutual fund today is the Vanguard 500 Index Fund at $87 billion under management.

The big difference between a managed fund and an index fund should be performance. A managed fund is supposed to earn more than an index fund. Some do, most don’t. So many investors have been migrating to the lower-priced index funds. Stock index funds charge an average of 29 cents per hundred dollars invested. Actively managed funds charge more like 95 cents.

Vanguard has unseated Fidelity by offering low-cost funds. Fidelity offers mostly managed funds. Vanguard is the ensign bearer for index funds. Investors seem to pay more attention to management costs when returns are already low. Over the last ten years, Vanguard has taken in more than $4 in new money to manage for every $1 Fidelity has gained. Almost 80% of the new money coming to Vanguard this year went to index funds. Exchange traded funds, ETFs, are even cheaper than many index funds. Vanguard has over $100 billion in ETF funds. Fidelity has side-stepped that business.

So Vanguard appears to be winning in the market due to pricing. How does that jibe with the guidelines we talked about? The key rule is that a customer does not buy on Price until after the customer has satisfied herself, that there is no important difference to the customer on Function, Reliability or Convenience, so the customer decides on Price. Vanguard has proven to many investors that it is the Functional equivalent of Fidelity, that its returns are Reliable and that it is equally Convenient to purchase, so many customers buy on Price. The price markets here are the index funds and the exchange traded funds. Fidelity needs to offer exchange traded funds to stay in the game. What really is happening is that Fidelity is “failing” on Price while Vanguard beats the other competitors on the basis of Reliability and Convenience.

Microsoft Phone 7 - A Long Row to Hoe

Recently, Microsoft introduced Windows Phone 7 Mobile software. This is all new software that Microsoft hopes will stop its slide in market share. It is going to have tough sledding.

Until this introduction, Microsoft’s market share in the mobile software business was dropping off a cliff. The company was one of the early entrants into the market. In 2004, it owned 22% of the market. By 2009, its share was down to 9%. Today it is about 5%. Microsoft was quickly fading away. But maybe the new software can help.

For a bit of perspective, we have to explain that there are five separate players involved in this marketplace: the operating system developers, the phone manufacturers, the wireless carriers, the software application developers and the ultimate users. Each of these entities are in separate businesses and represent separate competition. Microsoft plays in the market exclusively as an operating system developer. That’s what Windows Phone 7 is. The Google Android system is another stand-alone mobile operating software platform. So has been Hewlett Packard’s Palm mobile operating software. Three other competitors offer their operating software only in combination with their handset hardware. These include Nokia, with the Symbian operating system, Research In Motion’s Blackberry products and Apple’s iPhones.

The market share ranking today among those competitors in total operating software starts with Nokia’s Symbian, followed by Android, then Blackberry and Apple. Each of these has a market share that are multiples of Microsoft’s current share. Microsoft is fifth, followed by Palm and others.

The new Windows Phone 7 software is a wholly new product. It is completely different than the previous Microsoft mobile software. So different, in fact, that none of the thousands of applications written for the previous Microsoft software will work with Windows Phone 7. The company must start from scratch with applications.

Consumers love applications and make many of their buying decisions on the basis of these applications. (See the Perspective, “When to Compete on Features” on StrategyStreet.com.) Today, Apple has about 250,000 applications, followed by Android with about 70,000. The differences between the two are probably much less than these numbers would indicate because most of the popular applications are available on both platforms. You can see this in the marginal purchases. Android garners more of the current new purchases than does Apple. So, for all practical purposes, Apple no longer owns a significant application lead on Android.

Windows Phone 7 faces a real hurdle with applications. In some ways, it offers a few benefits over the Android and Apple operating systems. For example, it works off of “tiles” that enable a user to get information somewhat faster than in the Android and Apple software. It works easily with Microsoft Office software and it enables gamers to connect to online games easily. These are modest innovations at best, and likely to be followed by others quickly. For example, Motorola already produces software for its phones that pretty much duplicates Microsoft’s “tiles.” Apps are the big problem.

If you are an applications developer, Microsoft would likely be far down your list of the companies for whom you would write new application software for a smart phone. Android and Apple would lead the pack. Nokia, Research In Motion and others offer more current customers than Microsoft but pose difficulties for developers. Microsoft would fall below all these firms. Microsoft has to solve this problem quickly.

Application developers are also likely to be leery of Microsoft and its continued presence in the market. Not only has the company lost share, but it introduced a software platform called Kin in the spring of 2010 aimed at young people, between 12 and 20. This product did not stay in the market even two months. So developers are likely to hold fire on their application development for the Windows Phone 7 platform until they are relatively sure that the product will succeed.

Microsoft is backing its Windows Phone 7 introduction with a $100 million advertising program emphasizing the ease with which a user can get to the information most important to the customer. This seems to me to miss the mark. This advertising investment is a Convenience innovation that advises the customer why the Microsoft system is faster and, therefore, better. (See “Video 15: Definition of Convenience” on StrategyStreet.com.) But it seems that most of the smart phone purchases today are the result of other current users’ recommendations and demonstrations. This is a Reliability innovation. These current users are apt to emphasize the Function benefits of their phones rather than the speed of access to information.

Microsoft might have spent this money differently. It is already paying some developers to create applications for its platform. My guess is that their $100 million might have been much better spent paying for applications, where Microsoft is likely to fail on the basis of lack of Functions rather than paying for the Convenience innovation of advertising.

Market Share Volatility in a Fast Growing Market

The smart phone market continues to grow quickly. The market for the operating systems on smart phones illustrates one of the patterns you will see in a fast growing market.

In order to see these patterns, we will use the Customer Buying Hierarchy. We will evaluate the reasons for market share volatility using the Customer Buying Hierarchy. Market share volatility is market share that moves from one supplier to another. (See “Audio Tip #26: Introduction to Step 6 of the Basic Strategy Guide” on StrategyStreet.com.) This market share movement may happen because new customers enter the market, where all competitors may compete for the customer, or because customers simply change their suppliers. The Customer Buying Hierarchy (CBH) holds that customers buy: Function, Reliability, Convenience and Price, in that order. (See “Audio Tip #95: The Customer Buying Hierarchy” on StrategyStreet.com.) New Functions or lower Prices dominate the causes of market share volatility in fast growing markets.

The emergence of the Apple iPhone, with the Apple operating system, illustrates the impact of new Functions. The Apple operating system virtually exploded on the market and probably created the consumer interest in smart phones. Apple was able to gain a quarter of the smart phone market very quickly on the basis of its many unique Functions, the result of the thousands of apps written for the operating system.

More recently, the growth of the Android operating system illustrates the second major driver of market share volatility in high growth markets, low Prices. The Android operating system is growing very quickly now, taking share from the Research in Motion, Apple and Microsoft operating systems. What is its advantage? It’s free. The handset manufacturers and the cell phone service providers like an inexpensive operating system. So, it turns out, do many customers. The Android operating system is now grabbing market share by the handfuls. There is no let-up in sight.

A Pricing Scheme Guaranteed to Fail

There is a new gift card brokerage product coming to the online market. It’s called CardWoo.com. This company buys your unwanted gift cards at a discount. You mail in your card and they will send you a check for it. The amount of the check, as a percentage of the card value, is not stated in their online information. You, then, have fourteen days to decide whether to accept the check or send it back and get your gift card back.

The problem comes on the other side of the deal. CardWoo then takes the cards it buys and resells them online. The problem is their discount. Most of these cards have face values of $10 to $75. The majority seem to fall in the $25 to $50 range. The discounts CardWoo offers the purchaser of the card range anywhere from 0% (why would anyone do that?) to 5%. 5% of $50, the higher end of most of the cards, comes to all of $2.50. This discount is far too small to really attract many customers. (See “Audio Tip #143: Offensive Pricing Guidelines” on StrategyStreet.com.)

We have looked at more than 800 examples of discounted products. The median discount offered in a marketplace is 25%. 75% of discounts are 10% or more. CardWoo’s discounts are far too low to attract a mass audience. (See “Audio Tip #137: Price Shavers and Their Pricng” on StrategyStreet.com.)

Apple's Future in Smart Phones - Part II

Apple is the clear leader in today’s consumer smart phone market. Research in Motion leads the commercial market. I am going to make the case that a few years from now, they will have a single digit market share. They will turn into a Performance Leader, a small high-priced competitor in the market. (See “Video #24: Price Point Specialists in Hostility” on StrategyStreet.com.) This position will be similar to the one Apple holds today in the personal computer market. In Part I of this blog, we described the evolution of Apple in the personal computer market. Apple today produces a marvelous personal computer. It appears that Apple is following the same map in the smart phone market as it followed in personal computers.

Apple owns both the hardware and the software in its smart phones. And it keeps both exclusive to Apple. It had early mover advantage so it garnered virtually all of the apps that people cared to develop for its smart phone platform. But a new competitor has emerged in the Android operating system. Android fills the same role as Microsoft did in the personal computer industry. Microsoft was cheap and available for many hardware platforms. The PC attracted the most app developers. Android is cheap and attractive to app developers. On the other hand, Apple has made life difficult for app developers by forcing them to jump through hoops in order to gain approval to offer apps on the Apple iPhone platform. Today, Apple has something north of 200,000 apps. Android has 70,000 apps. But, as one analyst noted, every app that a number of people are likely to want to use today is already available for both the Android and the iTouch. Apple may have more apps, but most of the apps exclusive to Apple appeal to narrow niches.

Now let’s play forward the next few years. (See “Audio Tip #32: Introduction to Step 7 of the Basic Strategy Guide” on StrategyStreet.com.) Motorola, HTC, LG and Samsung are among the many companies producing Android-based phones. The Android market is growing quickly. It will grow even more quickly as the prices of the Android handsets fall under the pressure of competition in the smart phone hardware market among some big, capable companies. Within a year, the app developers will write new apps, first for the Android platform and second for the Apple iPhone or other smart phone platform. Several years from now, the intense competition in the hardware market will reduce the cost of an Android smart phone low enough to remove a good deal of the profit that Apple now enjoys with the iPhone. (See “Audio Tip #102: When is Price Likely to Go Down?” on StrategyStreet.com.) As the Android smart phone producers continually add the features and capability to make their phones unique for consumers, the Android phones will be nearly as capable as, if not the equal of, the Apple iPhone. And, the Android phones will be much cheaper. Apple will be pushed into a Performance Leader position, where it offers high-priced feature-rich phones and garners a share of the market likely to be in single digits. This will not happen overnight. The smart phone market is still in its infancy. But check back in three to four years.

It will be interesting to see whether this competitive pattern holds in the tablet computer market as well.

Apple's Future in Smart Phones - Part I

Apple is the clear leader in today’s consumer smart phone market. Research in Motion leads the commercial market. I am going to make the case that a few years from now, they will have a single digit market share. They will turn into a Performance Leader, a small high-priced competitor in the market. This position will be similar to the one Apple holds today in the personal computer market. It appears that Apple is following the same pathway it followed in the personal computer market. Perhaps a bit of history is helpful here.

The business model of Apple differed from that of the PC. Apple was not the first personal computer, but it was, by far, the best. And, it got paid for being the best. Apple really created the mass market for personal computers. It had a huge percentage of the marketplace by the time 1981 rolled around and IBM introduced the PC. Apple controlled both the hardware and the software for its personal computer products. On the PC side, Microsoft’s Windows controlled the software, while a large number of companies became hardware producers for the Windows operating system. In the early years of the personal computer, the hardware was far more expensive than the software.

The PC market had a great deal more competition…and cost/price reductions. Apple prevented any other hardware producer from copying its products. There was at least one company who tried, Franklin Computer. But Apple killed them off in the mid-1980s. From that point on, there were no clone producers of Apple machines. The picture was very different on the IBM/Microsoft side. IBM found itself facing many competitors. Most of those competitors we called “clones.” Dell was one of those clones. This large number of hardware competitors reduced the cost of hardware drastically during the late 80s and through the 90s. (See “Audio Tip #196: Why Economies of Scales Exist” on StrategyStreet.com.) The source of much of the cost of the hardware for a personal computer shifted to the Intel or AMD chips embedded in the hardware. Still, AMD constantly challenged Intel, so Intel had to reduce its prices in order to maintain its very high market shares in chips. All of this intense competition reduced the cost of hardware until today the software costs as much as the hardware. Competition forced hardware components and prices down to such an extent that the PC platform had significant price advantages over the Macintosh/Apple platform. Apple was pushed into a high-cost/high-priced hardware position.

The competition in software was much less pronounced. It has only been in the last few years that Microsoft has had to respond to lower cost competition from Linux and Google. These lower cost competitors have had an impact on Microsoft’s prices, but nothing like the impact that the hardware competition had in reducing the price of hardware. The mass market followed the lower priced PC market. Apple today produces a marvelous machine. It has rabid and loyal fans. It also has high prices and a single digit share of the personal computer market. Were it not for the genius of Steve Jobs and his cohorts at Apple inventing new products with higher margins, Apple would be struggling today, much as it was before Steve Jobs returned to the company. It wouldn’t make a lot of money in the personal computer industry because the industry Standard Leaders, the PC producers, are so cost effective, and so much lower in price, than is Apple.

In Part II, we will see how this same pattern is playing out in the smart phone market.

Pricing in the Dog Days of August

It seems that not many people wanted to spend the weekend in Philadelphia during August. Hotels that might be full during the week were sparsely populated on the weekends. But, Marriott was not taking this situation lying down.

The Philadelphia Marriott came up with an innovative pricing strategy. Any guest who booked a two-night stay starting any Friday during August into mid-September had to pay only the price of the highest outside temperature for the Saturday night rate. So, the guest paid regular prices on Friday night and the heavily discounted rate, based on the day’s high temperature, for Saturday night. A clever approach to discounting.

This is one of several approaches companies have used to get through periodic, or seasonal slow demand times. Companies have used the components of a price in order to bring customers to its products during slow times. For example:

* A construction company changed its list price much as did the Philadelphia Marriott. It priced its services very aggressively for the months of January and February so its customers would move work forward that would normally be done in the spring or summer.

* Other companies change the definition of their product to reach a new, lower, price point. Companies who sell fractional ownerships of private jets offer discounts up to 25% for flying on off-peak days.

* Other companies make direct payments to customers. We can see this approach with the current Orbitz program called Price Assurance. Orbitz refunds customers the differences in fare if a customer purchases an airline ticket and then sees the price of the ticket fall before he leaves on his trip.

* Some sellers throw in a free, or heavily discounted, product from a third party. For example, as the housing market became more difficult, some sellers offered to outfit a media room or pay closing costs for their buyers.

We believe that a company facing a tough pricing environment can gain a lot by studying what other companies have done when facing the same circumstances. We have many of these examples on our web site. (See Improve/Pricing on StrategyStreet.com.)

Reliability in the Purchase Decision

In our StrategyStreet analytical framework, a customer subjects a potential supplier to two levels of elimination: invitation and evaluation. With “invitation”, the customer decides who he will spend any time considering in the purchase decision. In “evaluation”, the customer eliminates potential suppliers on its most important purchasing criteria. Then, the customer analyzes the remaining potential suppliers in detail in order to make his final choice. At both levels, the customer is looking to eliminate suppliers, not to choose one. (See the Perspective, “The Tallest Dwarf” on StrategyStreet.com.) In the final analysis, most buying decisions are the result of the elimination of all other competitors, rather than the positive choice of one of them.

McKinsey & Company used a construct similar to our approach of “invitation” and “evaluation” when looking on consumer decisions in the mobile phone market. It considered three stages of the customer buying decision: initial consideration, active evaluation, and moment of purchase. McKinsey, then, looked at how consumers made their choices at each stage in mature markets and in developing markets. What we see in the McKinsey statistics is the paramount importance of Reliability in getting to serious consideration, even in a relatively fast-growing market like mobile phones. (See “Audio Tip #95: The Customer Buying Hierarchy” on StrategyStreet.com.) The three most important criteria in the initial consideration in a mature market were advertising, previous usage and word-of-mouth. Previous usage and word-of-mouth are indications of Reliability concerns. Advertising can be either Reliability or Convenience. It is Reliability when the consumer looks to advertising as a sign that someone is a serious, reliable competitor. It is Convenience when the purpose of the advertising is to let the consumer know that the company can provide the product. In a developing market, the top three criteria are the same in a somewhat different order. (See “Audio Tip #70: Several Rounds in Evaluation Failures” on StrategyStreet.com.)

The mobile phone market is fast-growing. Differences in Function are important differentiators among competitors in this market, more so than in very difficult, hostile markets. But if the company can not convince a customer that it is a reliable supplier, it will never get the chance to demonstrate its superior Functions.

Reliability is important in every market, even in one with very fast growth.

Reliability in High-End Cars

Several years ago, BMW ran into a problem with its technologically advanced automobiles. It found that some customers were reluctant to buy their cars because the customers were concerned about the cost of maintaining products with such high technology. But BMW believed in its product and felt that the customer should believe equally. So, for more than the last ten years, BMW has offered free maintenance with its new cars. For four years, or 50,000 miles, a BMW customer will not pay for maintenance except for gas and tires. BMW continues to gain share and profitability in the North American market. (See “Audio Tip #160: How Do We Segment Customers by Emotional Needs?” on StrategyStreet.com.) Competitors have noticed.

Now, competition is beginning to offer free maintenance of its own. As always, the devil is in the details of “free maintenance.” The “Gold Standard” BMW covers everything but gas and tires. Competition offers “free” maintenance, but their version of free maintenance does not match BMW’s. Volvo’s “Safe + Secure Coverage Plan” covers five years or 60,000 miles, and includes oil and filter changes and replacement of brake pads and rotors and windshield wipers. Cadillac’s “Premium Care Maintenance” doesn’t cover brakes and is limited to scheduled oil changes, tire rotations, replacement of engine and cabin air filters and a multi-point vehicle inspection.

Other competitors cover what BMW covers, but charges for it. Audi sells a maintenance plan separately with the list price of about $790. Mercedes Benz offers prepaid service packages.

All of these competitors to BMW fall short of the mark. If you were a customer deciding on an automobile to buy, and you cared about the Reliability of the vehicle during the time you owned it, who would you trust more? On the one hand, you have the company that promises true “free maintenance.” On the other hand, you have competitors who qualify, or charge for, their promise of “free maintenance.” If you want to compete with the standard, you have to be at least as good as the standard. BMW still leads the pack in Reliability when it comes to “free maintenance.” (See “Video #14: Definition of Reliability” on StrategyStreet.com.)

The Importance of Consistency in the Approach to Pricing

A company has to send a consistent pricing message if it wants its customers to get its message. An example is Asda. Asda is the U.K. arm of Wal-Mart stores. Asda has always advertised itself as the home of “every day low prices.” It strayed from this message during the recession.

As the recession took hold, Asda followed its major competitors in offering promotional pricing, such as temporary price deals and two-for-one specials. (See the Perspective, “The Grasshopper and the Ant” on StrategyStreet.com.)

This approach worked during the recession. The company gained market share. However, as the recession ended, the company lost all of the market share it had gained with its promotional pricing. It then found that its customers were confused about what its pricing tactic really was. The company has re-established its theme of “every day low pricing.” In order to emphasize that theme, it has launched a price guarantee program which guarantees the consumer that its prices will be the lowest among its competitors, whether there is a promotion or not. The program invites the customers to check receipts online, and to obtain a rebate if a competitor is offering a better deal. (See the Perspective, “How Price Kills Profits” on StrategyStreet.com.)

It will take a while for consumers to have confidence in this renewed emphasis on every day low prices.

Defending the Low Cost Position

The last couple of years have been very tough on the hotel industry. Now, some of the mainline hotel companies are starting to recover, but the high-end hotels continue their prolonged suffering. A typical example are the Four Seasons hotels. Last year the occupancy rate at the chain’s hotels was below 60% and revenue per available room, a key measure of sales, fell 26%. There are 82 Four Seasons hotels. At least 12 of them reputedly are near the breaking point.

The Four Seasons Company no longer owns any of its 82 branded hotels. It, like most of the hotel chains, sold off its hotels in the 80s to companies and investors who had more willingness and ability to carry high levels of leverage on the hotel properties. The Four Seasons, and most other hotel chains today, manage their brands but don’t own them.

The hotel brands tightly control the quality of their hotels through their management agreements. The management company receives a management fee of a percentage of the branded hotels’ revenues and also gets a percentage of the hotels’ profits. The hotel investor gets the use of the brand name and must conform to the rules as written in the management agreements. This arrangement allows for a disconnect between the interest of the hotel property owners and the hotel brand owners. The property owners may wish to find cost shortcuts that the brand owners abhor because the cost savings sully the brand name.

The founder of Four Seasons Hotels & Resorts watches carefully over the brand he created. Isadore Sharp is the founder and Chief Executive of Four Seasons Hotels & Resorts. He started with his first hotel in 1961. He built the company into the chain it is today by providing top notch service to its affluent guests. In the past, the company has weathered market downturns as relatively minor bumps in the road. This downturn has proven to be different. In this downturn, several property owners have petitioned the brand management company to reduce costs, sometimes at the guests’ expense. (See the Symptom & Implication, “The industry is reducing costs aggressively” on StrategyStreet.com.) Mr. Sharp will have little of it.

Mr. Sharp, who remains CEO of the company and 10% owner of Four Seasons Hotels & Resorts, agreed to some cost savings that have relatively little impact on the guest. Hotels may now outsource their laundry. They may simplify menus in the restaurants and even close a restaurant on slow nights on those hotels that have multiple restaurants. Some hotels may discontinue stocking fresh flowers in the lobbies as long as they replace those fresh flowers with sculptures or ornate vases. The property owners may also combine management positions and cross-train employees to work in multiple departments. Mr. Sharp believes that a guest will not see these kinds of cost savings in their visits to a Four Seasons Hotel.

But he refuses to go along with other cuts proposed by some property owners. The property owners may not combine the concierge desk with the check-in duties on the graveyard shift. Mr. Sharp insists that hotel employees continue to turn down guest bed covers each evening. He also refused a request to end room service during the middle of the night. All of these changes a guest would notice. (See “Video #46: The Place of Cost Management in Hostility” on StrategyStreet.com.)

These decisions by Mr. Sharp tell us a lot about why he has been so successful in his career. He keeps his attention focused on the quality of his guest experience, despite the short-term cost of continuing that form of Reliability. Profits may dip in the near-term, but he believes they will hold up in the long-term as customers return for the consistent quality of high level services they associate with the Four Seasons brand.

Mr. Sharp is protecting the ultimate low-cost position. We have found in our work and research in many industries that the low-cost position in a market is the ownership of a satisfied customer relationship. A company that owns a satisfied customer will not lose that customer to any other competitor unless that competitor can offer a similar product at a discount that begins at 15% and usually is more. We have not seen any market where peer competitors have cost structures that vary from one another by as much as 15%. Hence, the ownership of a satisfied customer relationship is the equivalent of having a 15% of revenue cost advantage on your peer competitors.