Tuesday, May 12, 2009

13 Pricing Mistakes...or How to Make Profits and Not Alienate Your Customers

10 pricing mistakes from our MIT Sloan's brilliant Catherine Tucker.  

1) Cost plus pricing ensure a profit - This is only true if you are spot on estimating quantity and costs, which is very rare.  

2) Customer always prefer low prices - This is not true in goods that are given as gifts or luxury items where price signals quality.  

3) If customers don't know prices, it is not necessary to have a pricing strategy - In this case, it's important to have one that educates them on the value of the product.

4) Simpler is better for pricing structure - Sometimes a more complex model is better for extracting value.  Telco is a good example of that.  Sometimes a new player can try to simplify the model to take business, and that could hurt industry profits.

5) If we are profitable, we don't need to price discriminate - More than likely, anyone who says this is leaving money on the table.

6) Razor blade pricing works because customers are stupid - It actually works because it allows you to price discriminate to extract more value from power users.

7) Our product has network effects, so we need to price low - Often, the products either do not have network effects, or the low price results in the company running out of cash before they acheive any scale. 

8) Adjust price until capacity is full - Full capacity does not mean profits.  With our family's restaurant business, I'd rather charge twice as much and be half as full - it's less work to do.

9) Industries must avoid price wars - Actually, they really do need to avoid price wars.  

10) Our competitors understand our strategy - Being able to communicate your pricing strategy to competitors to avoid price wars is worth its weight in gold.  Any time you are cutting prices, it is important to be careful not to set off a profit destroying price war.

And three more pricing lessons from Industrial Economics:

11) Consider using a judo entry strategy - Price aggressively, but commit to staying small enough so that it is not worth it for larger players to cut prices to put you out of business.

12) For entry pricing, use long term marginal costs - Your costs will fall in the future if you produce large quantities, so project into the future and maximize profits using that cost basis.

13) Don't beat up your competition too much - You might be able to look your competitors look stupid with a brilliant pricing strategy a few times, but especially if you are undercutting them, it will eventually catch up with you.


Shreenath Regunathan said...

Great Read Ted - I'm going to add this one to my list of classes to take at Sloan if all goes well!

Ted Chan said...

Shreenath: I highly recommend Catherine Tucker, I thought she was great. And if you need a project, contact me, I have a bunch of iPhone apps pricing data if you're interested!