High Quality vs Low-Cost Bargain: The Current Dichotomy! (XIX). Contemporary Pricing Adjustments.
Wishing you a fantastic week. Any price that you set is subject to adjustments. Usually any of us, naturally, sell under different circumstances, in different geographical contexts, where the demand and the market segments are different. We adjust our prices when the existing competition rises, or because our product is seasonal, or because of external issues as the Covid19 or inflation or war, or because of changes in government policies. This also happens in the financial world with the trading in stock markets and another financing trading in between financial entities.
Normally, as human beings, we tend to change, and so our living conditions change. The same happens with prices. Of course, there are theoretically two ways to adjust net margins, through pricing, either by cost reduction or by price increases. Nevertheless, price and demand are interconnected. Any price adjustment will influence the volume of our sales on a minor or major scale.
With the introduction of the Internet and Social Media (which is nothing else than the global use of instant messaging for communicating, sharing content, and making transactions) information flows at the speed of the light. Pricing adjustments are triggered, not just because of the competitors in the same industry decisions, but because of the electronic commerce websites, or e-retailers or resellers in the huge Internet marketplaces as Amazon.com or Alibaba.com, or Ebay.com. Moreover, social media platforms are all emigrating to become B2C (business to consumers) or C2C (customers to consumers) huge marketplaces that are going to be used more and more to buy and sell. For example, Instagram is connecting individuals, businesses, and corporations to sell and buy whatever they produce. When Facebook, Twitter, Instagram, Snap-chat, YouTube social platforms did not have a massive amount of clients, things were quite controlled and it was nice to search for information there. But today, after the COVID19 pandemic, all these platforms are overwhelming us, because these have also become a place for trading. These platforms for communication are also evolving to become marketplaces that will inevitably compete with amazon.com or the rest of similar web marketplaces that are shown through Google Chrome, or Mozilla or Firefox. In this context of internet marketplaces competition, price adjustments will be required to be ubiquitous. If our pricing continues being based on the method of cost-based pricing, all these adjustments will tend to the reduction (giving discounts, low-price wars, cash rebates, and net price analysis in comparison to competitors) which will end killing the economic long-run sustainability of the industries too.
Reduction of prices through promotions is often a zero-sum game. If the reduction of prices can’t keep clients for the long run, bargain prices are a waste of money that instead could have been invested into building up product quality and service or strengthening value differentials.
The ubiquity of information triggers price wars if following cost-based pricing. I have observed that a global internet marketplace, grounded on cost-based pricing, and without regulation of any kind, is also triggering mediocrity and unlawfully practice monopoly/cartel prices at the big players (usually Multinational Corporations) or between the top manufacturers of the same industry. Once the biggest players establish the reference price, they affect the rest of the artisans, micro-small, or medium producers. If the biggest from any industry, sets the prices down, there is nothing that a little artisan producer can do to try to sell its products, because people are now looking for cheapskates. Anything constructed without regulation promotes the slaughtering of the transparency, the quality standards, and the innovation of value differentials required in free markets to operate correctly. The same applies to things that become ubiquitous competing only under the cost-plus formula. For example, 10 years ago, if we wanted to know how to prepare oatmeal chocolate chip cookies, we looked for the cuisine books of our mothers, aunties, or grandmas. We also web-searched for the traditional chefs of recognized prestige, those grouped under the Food-network brand, or we at least tried to follow the recipes of those high recognized cooks who won local, regional, or international Awards, or at least they were best TV Food Program, instructors. Nowadays, if you type oatmeal chocolate chip in YouTube, you find 164,000 channels that provide a recipe via an instructional video. On top of it, if you search in Google, there are around 7 million results in between blogs, Pinterest photos, Instagram posts, websites, and so on.
Which oatmeal choco-chip recipe to choose? Since everyone can post whatever they wish to post (because there are no standards, neither regulation of any kind requesting at least a diploma or a certification to share your recipe), the excessive amount of sellers who share their knowledge makes it difficult to discern which recipe is the correct one, or the best one, unless you try it and by test and error, you can pick the one.
The cost doesn’t determine the selling price. During this trimester I have been keen to express that the cost-based pricing is not correct. Moreover, cost-plus formula pricing is fallacious because when we establish our pricing foundation on costs, we are not thinking about the client value, but only about making revenues no matter what. I have mentioned to you an example about paintings. We saw the mistake of the artist when writing her proposal for an AES Call for Artists. If you wish to reminisce it, please read the past written article here: https://eleonoraescalantestrategy.wordpress.com/2021/02/12/high-quality-vs-low-cost-bargain-the-current-dichotomy-viii-formulating-the-concept-of-pricing/.
When pricing her oeuvre of art, she calculated the supplies/materials and the number of hours that was going to take her to paint her 60 inches W x 40 inches H watercolor, and her offer was US$7,500.00; but AES was prepared to pay to the winner a maximum customer value of US$12,500.00. The artist left US$6,000 dollars on the table, that she would have profit if she knew that the approach to pricing is not “cost-plus formula basis” but value-based pricing. In consequence, today, I will honor all the pricing adjustments that we can do to differentiate ourselves to raise our prices, and not the price discounts or allowances or promotional pricing.
Adjusting prices based on EVC. From the point of view of those who develop a pricing structure, there are several price adaptation tactics used to aggregate value differentials:
- Geographical Pricing
- Financing Installments Pricing
- Price Discrimination
- Psychology Preaching of the EVC concept
- Contracts and Terms
- Exit Barriers
Geographical Pricing. This is nothing else than to offer, the same product priced differently at different locations and countries. Should the company charge higher prices to distant customers to cover the higher shipping costs? Alternatively, should the company lower the prices if the location is near the manufacturing/packaging scene? How should it account for exchange rates and the strength of different currencies? Counter-trade pops up when companies want to do business abroad. Counter-trade takes several forms: barter, compensation deal, buyback arrangement, and offset.
Financing Installments pricing. Many companies can raise their prices by offering interest financing. This is particularly treasured by clients that cannot pay in one-installment cash. Please remember there is no free lunch. Even if companies tell you that there is zero or no-interest financing, that is not true. The price adjustment is prepared and included in the price, and it charges at least commercial banking market interest rates or more. These retailers offer contracts that allow customers to split their purchases into several smaller payments. Sellers use banks or well-funded technology companies to offer an ample range of payments duration and use longer payment terms to make clients believe that they can pay little sums of money. Especially auto dealers, mobile phones, home domestic appliances, furniture, department stores, and other retailers use this. Nowadays, retailers bundle the financing with other non-regulated financial entities under the figure of Point of Sales Lenders using a RISC: Retail Installments Sales Contract. Usually a RISC has diverse forms, but one example could be AfterPay and Quadpay, which allow customers to pay for purchases in four biweekly installments through a linked debit or credit card.
Another example of financial intermediaries called Point of Sale lenders or RISC providers (other than VISA or MasterCard) are companies such as Affirm or Klarna that offer traditional credit arrangements through partnerships with regulated entities, and these programs have more variable payment schedules and terms with interest rates between up to 30% or more per year.
The key success factor for RISC providers bundled with the retailers is that they have been able to inculcate the buyers, to worry less about the cash price or the interest rate or the duration scheme of the payments, but focus on the idea “if clients can afford the monthly payment”.
Price Discrimination. Companies adjust their basic price to accommodate differences in customers. The recognition that customers differ enormously is the foundation of price segmentation. For some customers, price is the dominant criterion: but for others, the quality, the service, the warranty, the image, the time, or the type of usage are much more significant. Do you remember the price of the jeans that we discussed in our last post? Well, the same happens in cosmetics companies that have designed a multi-branding strategy as a response to different customers/segments. Let’s see the following price discrimination cases.
- Intensity of demand: The seller charges a separate price to each client depending on the intensity of his or her demand.
- Volume of demand: The seller charges less to buyers of larger volumes or with higher levels of usage of the product.
- Customer segment differentiation: Different customer groups pay different prices for the same product or service. This happens in live concerts or sport stadium events, theaters, cinema, museums, etc. For example, museums often charge a lower admission fee to students and senior citizens. Frequently, concert or music spectators are charged differently if they want to be near the musicians or artists, in comparison to those who are far away. A theater varies its seat prices according to the audience preferences.
- Size of the product: Different versions of the product are priced differently regardless the costs content. For example, the price of an Evian bottle of water (1.5 lt) is US2.28 dollars in Walmart, meanwhile the 5 ounces of the same water in a moisturizer spray is US$ 13.54 dollars.
- Image: Companies price the same product at two different levels based on image differences. A perfume manufacturer can put the perfume in one bottle, give it a name and an image, and price it at US4$15 dollars per fluid ounce. The same perfume, can be packed in another bottle with a different name and image, and the price can sell for US45.00 dollars.
- Channel: Any soda or liquid beverage as coffee or tea carries a different price depending if you buy it in a fine restaurant, a cafeteria, a fast-food eatery, a gas station, at a stadium concurrence location, supermarkets or a vending machine. I am sure you have bought a soda for 35 cents in a convenient store, but you pay $1.00 at a vending machine, and up to $5.00 at a fine restaurant. And it is the same product.
- Time: Prices can vary by season, month, day or hour. Public utilities (water, electricity) vary energy rates to users by time of day and weekend versus weekday. Transportation systems charge less to clients that use the metro at non-peak hours.
According to Professor Kotler, for price discrimination to work, certain conditions must exist. (1) The market must be segmented and the segments must show different intensities of demand. (2) Members in the lower/price segment must not be able to resell the product to the higher-price segment. (3) Competitors must not be able to undersell the firm in the higher-price segment. (4) The cost of segmenting and policing the market must not exceed the extra revenue derived from price discrimination. (5) The practice must not breed customer resentment and ill will. (6) The particular form of price discrimination must not be illegal.
Preaching the Psychology of the EVC Concept. When people focus on selling their product on the cost-plus formula, they fail to take advantage of many opportunities to differentiate their company. When differentiation is weak, price competition becomes paramount. That is what happens when huge massive marketplaces push industries to compete on cost-based pricing and not value-based pricing. The EVC is probably a concept that is not known by a whole generation by now because globalization privileged the cost-plus formula pricing. In consequence, it is important for sellers to learn how to show economic value to the customer (EVC) rather than price. The seller has to demonstrate the EVC based on the perception process that can captivate the client on the whole spectrum of value differentials (including life cycle) that we have already covered in this saga.
Contract and terms. Each long-term contract or agreement implies a significant period between order and delivery. In addition, if the contract includes a financing term for payments, there are conditions in which the client can perceive value differentials. For example, Two years ago my parents bought to me as a Christmas gift, an HP Notebook 15-da0006LA. They bought it from CLARO, our Internet Service Provider.
This laptop had the option of buying it in 12, 24, or 36 installments. My parents chose to pay under the longer duration scheme, to reduce the monthly fees of the article. Each 18 dollars computer installment is attached to the internet/phone service invoice. The guarantee from HP lasted only one year. Last week the hard drive of my computer failed. We have not even finished paying for the laptop yet, and we are out of the possibility to get a repair/maintenance from HP neither from CLARO. Given the nature of this article, I am sure my parents wouldn’t have cared to pay an extra fee of US$1.50 or $2.00 dollars at the moment of initiating the contract, for an extended guarantee over the lifetime of the payment duration. At least, now we would have taken an extended safeguard to fix the computer. Contracts and agreements can provide extended arrangements where there could be an increment of the price that can favorably protect the customer’s needs.
Exit Barriers. Skillful companies create exit barriers, which make it difficult for the customer to switch to lower/price competition. Such barriers include outstanding levels of service, loyalty schemes, provision of trade-in allowances (like turning in an old item when buying a new one). Another exit barrier is the promotional allowances, or rewards to clients for participating in advertising, sales, focus groups, surveys, and sales support programs. Another type of exit barrier is to take into account different segments of clients for research and development initiatives, in exchange for free upgrading of equipment or coupon rebates. In general, exit barriers act to fuse the customer to the seller, making it unattractive to throw away the investment embodied in the relationship.
Innovation. In the long run, innovations, which offer superior value to the clients, are the only way to achieve better prices. New product development is the most obvious source of innovation, but given the circular economy premises of recycling, companies will be forced or will have to innovate in a way that products can be re-usable, or be able to be adapted/modified to new features, instead of continuing with the “buy a new, dismiss the old and throw it away” culture. The same applies to pharmaceutical companies. After the COVID19, I am sure that the pharma industry will have to be ready to change its conceptual framework. Instead of waiting for sicknesses to appear to be cured, this industry will have to start by analyzing the cure. Moreover, they will have to take each plant and mineral on earth, or search for natural sources of medicine with all its benefits and properties (biotechnological at the service of organs recovery). This will be a different conceptual framework to prevent pandemic catastrophes, by knowing in advance the properties for organ recovery with natural medicine ready to use for future virus/bacteria epidemics.
I will leave this article here. The next post will be to provide a summary of the strategic reflections that come into my mind when finding the meaning of high-quality and low-cost bargains. Please remember that we are going to finish this saga exactly before the beginning of Easter. And we will begin a new one as of April 20th.
Have a happy week. Wishing you a lovely beginning of Spring. Thank you for reading to me.
Source of theory reference for this article
Disclaimer: Illustrations in Watercolor are painted by Eleonora Escalante. Other types of illustrations or videos (which are not mine) are used for educational purposes ONLY. Nevertheless, the majority of the pictures, images, or videos shown on this blog are not mine. I do not own any of the lovely photos or images posted unless otherwise stated.
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