3 Distinct Paths in Pricing Strategy
Pricing is one of the most, if not the most, important levers in our businesses. When utilized correctly, it creates immense value. Conversely, when it’s misused, it can not only impact your revenues and profits directly, but can also send a confusing signal to your customers. I would like to highlight three companies that have taken distinctly different paths in pricing, yet have been consistent in using pricing as a way to advance/strengthen their business strategy.
Costco, two-tiered pricing
I’m sure you have heard of the retail giant, Costco. With three growing boys (and a dog), we make our pilgrimage to Costco every week to get “stuff.” Since I am a pricing professional, I’m always intrigued by Costco’s ability to price their goods so low and still make huge profits. When I researched further, I was also surprised to see their stated reluctance to increase margins on items even though they could. Their pricing strategy seemed somewhat old school: cost plus margin model. Costco’s markup on any item never exceeds 15%, whereas other retailers’ markups are typically 25 to 50%. As I dug a little deeper, I found that the lion share of Costco’s profits come from annual membership fees, not from merchandising. They practice a form of two-tiered pricing – annual club membership fees plus the markup on goods. Since the majority of Costco’s profit comes from membership fees, the strategy of adding/retaining memberships by using low prices also enables them to capture higher volume. This sets them apart from other retailers whose only lever is low prices.
Apple, price skimming
Now let us look at Apple. Even though it lost some of its sheen in the last couple of years, Apple keeps churning out great products and, yes, huge profits. Their pricing strategy is also unique. Most companies provide some form of discount to their most loyal customers. Not Apple. In our household of five, we have more than fifteen (yes, fifteen!) Apple devices and yet, I don’t remember getting an iPad or iPhone at a discount – ever. In fact, Apple is known to practice a pricing strategy known as price skimming. In price skimming, you start at a high price point and capture as many sales as you can and then lower price over time. Thus the most loyal Applephiles pay the highest price. Apple is also good at using pricing strategy to complement product strategy. When a new generation of the iPad comes out, you can be guaranteed that only a low-end configuration of the old device is available (for the pricing scientists among us, Conjoint Analysis is an excellent technique to identify price points for competing products in your portfolio). This is to make sure that only price sensitive customers go for the older version. Apple wants its customers to be in a constant upgrade cycle as the company releases new versions (arguably, sometimes only with marginal improvements), and then uses pricing intelligently to support their product strategy.
Uber, surge pricing
Finally, a more recent observation is Uber. I am a huge fan of their disruptive technology and their surge pricing model. Surge pricing is very similar to dynamic pricing that many companies employ but with one key difference. In most businesses, supply (inventory) is limited to what is at hand and increasing it when faced with higher demand requires significant lead time. Uber uses pricing as a way to stimulate supply and hence ride volume and revenue on their platform. Given their revenue model is share of the fare, they strive to maximize the total dollar volume of rides (not just number of rides) and use price as the lever to achieve that optimal supply and demand mix.
I hope you agree with me that pricing is a very integral part of strategy and also understand that I am not suggesting pricing is the whole strategy. These three companies excel in other areas as well in order to execute their overall business strategy – Costco with their relentless focus on operational efficiencies, Apple on innovation and Uber on customer experience.
Whether explicit or not, we all have pricing strategies we follow. Are you following the one you designed to help execute your enterprise strategy or the one defined by your customers or worse, your competitors?