When Uber rolled out surge pricing during the 2012 New Year holiday, the feedback from customers was terrible. A year later, they utilized the same pricing model with a much kinder reception. So why the difference? It turns out that if you properly communicate and prepare your customers for price changes, their response is significantly much more positive.
Uber—the service that allows customers to order high-end livery cabs through a smartphone application—has been using what the company calls “surge pricing” on the busiest of evenings (typically Halloween and New Year’s Eve) that significantly raises the price over the normal rate that customers will pay for that 2:00 a.m. ride home. Structured on the principles of dynamic pricing (where the price paid for services is not set, but rather a function of supply and demand and can change at a moment’s notice), Uber’s use of surge pricing during New Year’s Eve a year ago raised quite a few eyebrows from its client base. Here’s what the New York Times had to say about Uber’s spike in pricing during the early hours of 2012. 1
On New Year’s Eve, Dan Whaley, a tech entrepreneur in San Francisco, got into a black Town Car and was driven one mile to a holiday party. The ride cost him $27. At the end of the night out, Mr. Whaley took a Town Car home from the party. This time, the exact same ride cost $135.
Mr. Whaley was using Uber, a service that allows people to order livery cabs through a smartphone application. On New Year’s Eve, Uber, a start-up in the city, adopted a feature it called “surge pricing,” which increases the price of rides as more people request them.
Although New Year’s Eve was very profitable for Uber, customers were not happy. Many felt the pricing was exorbitant and they took to Twitter and the Web to complain. Some people said that at certain times in the evening, rides had spiked to as high as seven times the usual price, and they called it highway robbery. Uber’s goal is to make the experience as simple as possible, so customers are not shown their fare until the end of the ride, when it is automatically charged to their credit card. While the app does not show the total fare in dollars when customers book a ride, Uber did show a “surge pricing” multiple to customers booking rides for New Year’s Eve.
After the torrent of negative feedback from its customers (and the press), Uber co-founder and CEO Travis Kalanick went on the offensive to explain the company’s reasoning for utilizing surge pricing: 2
Phew! What a crazy 72 hours. As many of you might imagine, running a transportation technology company is no walk in the park on New Year’s Eve. It’s something else to see demand 20 times greater than any other time of the year across seven cities and four time zones. Uber’s surge pricing was quite an experience and I thought I’d share slices of it with our customers, fans and the Internet at large.
Without a surge pricing mechanism, there is no way to clear the market. Fixed or capped pricing, and you have the taxi problem on New Year’s Eve—no taxis available with people waiting hours to get a ride or left to stagger home through the streets on a long night out. By *raising* the price you *increase* the number of cars on the road and maximize the number of safe convenient rides.
The demand surge was nothing like we had ever seen. Up until midnight, things would be relatively smooth but like clockwork, when the ball drops in any city’s time zone, all bets are off. There were minutes where we saw more requests than we might see in a typical hour. It felt like there was no sensitivity to price, but what was really going on was a massive torrent of desperate demand.
To our dismay, the pricing multiplier kept going up. The math was doing its job—you could start to see the utilization figures getting some slack, but then another wave of demand would hit, and continue the price surge. At some point the East Coast cities started breaking 6x multipliers—we accepted defeat at that point—the unbending demand breaking our will. We would bring cities down to 3x, only to see conversion go up, supply go down, cars get saturated, and “zeroes” popping everywhere (zeroes is an internal term we use when an app opens and there are no available cars). The surge algorithms would bring the prices back up, and we would again take prices down again. The numbers bore out what we were trying to accomplish. Uber provided 60 percent more rides than our biggest day ever, with the average fare at 1.75x (75 percent greater) than normal.
So a year later, as Uber prepared to deal with similar surge pricing concerns this past New Year’s Eve, the company realized that the most important component of its strategy had to be proper communication to its client base as to what to expect. Again, Travis Kalanick and his Uber team went to great lengths in blog posts and emails to communicate the surge pricing effects to its customer base. 3
Hello Uber Faithful!
New Year’s Eve is upon us, and we’re getting a ton of questions about how to plan Uber into your evening. It’s going to be a crazy night and Ubers are going to be pricey, so here are a few pointers to keep in mind:
Surge pricing is in effect for New Year’s Eve. The price will increase in order to maximize the number of cars on the road during peak times—and automatically decrease when there are enough cars on the road. We do this to make sure Uber is always a reliable ride, even during New Year’s!
So that there are no surprises, we’ve worked hard to provide clear price notifications when surge pricing is in effect.
● You will be able to estimate the fare prior to requesting a ride (iPhone only).
● All riders will need to accept the fare multiplier before finalizing a booking.
● When multiples get really high, we have our own sobriety test.
To the surprise of most skeptics, Uber’s communication strategy seemed to work. Customers were much better prepared for Uber’s surge pricing during the evening hours; complaints were way down from 2012, and the negative press that overwhelmed the company a year earlier was almost non-existent. Uber’s proactive (and informative) approach was really about the only option the company had if it wanted to continue its surge-pricing model.
Having said that, Uber still faces major challenges in improving its pricing model. Unlike other services where the price is known (and agreed upon) before utilizing the service, Uber’s ride prices are not finalized until the customer has reached his or her destination—similar, of course, to most other taxi pricing models. Unfortunately, this quite different from, say, how airlines and hotels price during high-demand periods. Can you imagine the angst of booking a Thanksgiving week airline flight (where you know that the price will be significantly higher than normal), but not receiving the actual bill until you arrive at your destination? Or staying for a week at a five-star hotel during peak tourist season and not knowing the actual room charge until checkout? This is the challenge Uber faces—even without surge pricing, but multiplied almost exponentially when the uncertainly of surge pricing is applied.
1. Bilton, Nick. "Disruptions: Taxi Supply and Demand, Priced by the Mile" New York Times. (January 8, 2012). http://bits.blogs.nytimes.com/2012/01/08/disruptions-taxi-supply-and-demand-priced-by-the-mile/?scp=1&sq=uber&st=cse 2. "Surge Pricing Followup". (January 3, 2012). http://blog.uber.com/2012/01/03/surge-pricing-followup/ 3. "NYE 2012 Surge"(December 30, 2012). http://blog.uber.com/2012/12/30/nye-2012-surge/
One year and over 6,700 downloads later, “Five Rules for Pricing Excellence: Getting the Most for Your Services” has become one of the most popular ChangeThis manifestos to date. To all who have downloaded and viewed our eBook over the past twelve months, thank you! I hope that you’ve come to appreciate these five rules for pricing excellence. For those who haven’t, what’s taking you so long?
Pricing is critical, and short-changing your pricing strategy is the fastest way to leave cash on the table—money that will be lost forever and never recovered.
So after that initial spark of innovation and the completion of the design, development and marketing phases that follow, don’t screw up the process by treating price as an afterthought. Have you spent as much time and resources on price as you have on your latest social media campaign? (Probably not.) The most successful organizations know that pricing is strategic and it can affect top-line growth and bottom-line profitability faster and more directly than anything else.
Pricing is also a key element of your brand. It sends a message to the market and creates expectations about value. It’s often the first impression you make, either attracting buyers or repelling them. And it can create the last, and lasting, impression, depending on perceived value for price paid. Think about it: Is your price sending the message you intended?
Master these five rules and you’ll be well on your way to achieving pricing excellence, along with putting more coin in your pocket.
Rule One: Anchors aren’t just for ships.
Rule Two: Never underestimate the power of Free.
Rule Three: Innovate with price.
Rule Four: Let price drive value.
Rule Five: Price wars are a fool’s game.
How well do your salespeople know their customers? No, I’m not talking about knowing basic customer information or buying habits. Rather, I’m talking about knowing how each customer will react to price changes for each product or service he or she currently consumes. It’s about listening and constantly probing to find the answer to one very important pricing question.
If prices were raised today, how would your customers react?
The simple answer is that it all depends on how price sensitive (or insensitive) your customers are for specific products or services. For customers who are relatively price insensitive, then the answer is that volumes would remain pretty much unchanged whether you raise or lower prices. This is important information for any pricing team to consider when analyzing the effects of a potential price increase or decrease. Do you know which products or services represent the most price-insensitive offerings, and do you have that information at your fingertips? If not, then you should.
It gets a little sticky for those customers who are relatively price sensitive. For a price hike, the real question to ask here is not whether you will see a volume decrease (as predicted by a normal downward-sloping price demand curve), but whether the price hike will force the customer to change suppliers (because of the cross elasticity of demand). 1 If a supplier change occurs, you’re out—and one of your competitors is in!
The difference between these two scenarios (sales volume dropping somewhat as opposed to sales volume dropping all the way to zero) is huge! Does your sales force know its customer base well enough to be able to gauge their reaction? It should because again, this is one of the most valuable pieces of information that needs to be brought into any serious price strategy discussion—a discussion you should be having with your sales force right now.
The challenge with answering this question is that it requires time—time for your sales force to not just get to know the buying habits of each customer, but the extra time needed to probe. It’s all about asking questions about how customers might react to price changes that are initiated by both you and direct competitors. Remember that these questions will allow you to either directly or indirectly ascertain the overall price sensitivity of each customer, along with the price sensitivities to each offered product or service. It is also crucial to gather enough information to predict within reasonable certainly which customers would change suppliers. Only when these issues are faced head-on and addressed can you ensure that you will not be blindsided by an exodus of customers in the face of a supply shakeup or other unforeseen (or seen but unaddressed) calamity.
Again, the process takes time and can’t be rushed. So if you’re thinking about adjusting prices later this year, you need to look down the line and ensure your sales force is well on its way to gathering this information today.
1. Cross-elasticity of demand is the proportionate change in the demand for one item in response to a change in the price of another item. It is 'positive' where the two items are mutual substitutes, and any increase in the price of one will increase the demand for the other. It is 'negative' when the items are complementary and any increase in the price of one will decrease the demand for the other.
The concept of pay-what-you-want pricing is quite simple. Rather than setting a fixed price, sellers instead ask each buyer to pay whatever price they feel is appropriate for the object or service. In some cases, a minimum price (“floor”) or suggested price may be set, but in most cases buyers are allowed to pay what they want—even nothing.
Some restaurants have been experimenting with this strategy for years, with mixed results. Software developers have also used freeware and shareware as another form of this type of pricing model. In doing this, they rely on donations from buyers to continue further development and support of these products.
But the most well-known use of this pricing model was when British alternative-rock band Radiohead released its In Rainbows album in 2007 as a digital download using a pay-what-you-want model on the group’s website. Fans of the band were freely allowed to download the album and pay whatever price they wanted, including paying nothing if desired. While 60 percent of the million-odd downloads that first month were, in fact, for free, the other 40 percent paid an average of $6 per copy—netting the band nearly $3 million.
And while Radiohead’s relative success with In Rainbows (which proved to be a critical success) has led others to try this unique pricing model—both in the digital and brick-and-mortar world—the results have been mixed (at best).
Non-profits—especially museums and other brick-and-mortar attractions—that rely on suggested donations (as opposed to setting a fixed ticket price) for entry have also begun to experiment with pay-what-you-want pricing—again, with mixed results. Relying on patrons to determine the value of their experience (and thus the amount that they willing to pay for entrance) may sound good in theory, but it also can leave patrons confused regarding the appropriate amount to pay. Nobody wants to pay too much, but then again nobody wants to be perceived as cheap. Unfortunately, the way that most humans deal with this conflict is to just avoid it altogether. The easiest way to do so is to go somewhere else (besides the museum) where the pricing decision has already been made.
So where does the pay-want-you-want pricing model go from here? Is there a way to tweak the model so that it shows real, meaningful results? One such way is to combine the model with an added layer of corporate charity.
In the research paper, “Shared Social Responsibility: A Field Experiment in Pay-What-You-Want Pricing and Charitable Giving,” 1 researchers from both the University of California, Berkeley and University of California, San Diego, along with Disney Research, conducted an extensive field experiment where photographs taken of riders on a roller coaster and then offered for sale were priced using the typical fixed-price model, and then priced using a couple of variations of the pay-what-you-want model. The results were surprising.2
The researchers observed customer behavior under four conditions: 1) when photos were offered at the regular price of $12.95; 2) when photos were offered at $12.95 with the added information that half would go to charity; 3) when photos were offered for whatever price the customer wanted to pay (including nothing); and 4) when photos were offered at pay-what-you-want pricing with the added information that half their money would go to a popular patient-support organization.
Of 28,224 riders who saw the photo priced at the regular $12.95, only a tiny half a percent of them purchased the item, yielding a small profit of about 6 cents per visitor. Slightly more people paid that price when they learned that half of it would go to the charity, yielding a profit of about 7 cents per visitor. So the charitable component increased demand, but only slightly.
Under pay-what-you-want pricing, many more people bought the photo—8.4 percent, but they paid only about 92 cents each, slightly less than the cost of production. This resulted in a slight loss.
The results get interesting when pay-what-you-want pricing was combined with information that half the customers’ money would go to the charitable partner. About 4.5 percent of riders chose to purchase a photo, a figure that was lower than without the charitable partner, but substantially higher than for either of the fixed price conditions. The crucial change was in the price they chose to pay: Whereas riders under strict pay-what-you-want pricing had paid only 92 cents, when it was combined with charity, they paid an average of $5.33. Overall, this produced a profit of nearly 20 cents per visitor compared to the 6 cents observed at the standard price. For a ride that attracts more than 15,000 people a day, that difference is enormous.
Once again, letting customers pay what they want when they know a significant portion of their money is going to a good cause not only generates the most profit for the company—it also generates the most donations for a charity.
Setting aside obvious concerns that companies could misuse the pay-what-you-want plus corporate donation model to trick buyers, this research is quite interesting. The most obvious example would be for museums and other like-minded organizations that currently use a pay-what-you-want/suggested donation model to add a charitable component to the mix. It’s also too bad this research was conducted after the Radiohead pricing experiment in 2007; it would have been interesting to see the Radiohead results had they added a charity component to their pay-what-you-want pricing model for their digital release of In Rainbows. Incorporating a charitable aspect into the model certainly seems to be one avenue of potential success.
As the pay-what-you-want pricing model continues to gain popularity, its ultimate success (and potential acceptance as a mainstream pricing model) will hinge on how the model is framed and presented. Still, given human nature and the state of the economy, this process may be slow—no matter how expertly and optimistically the appeal to consumers’ higher angels is sold.
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1. Ayelet Gneezy, Uri Gneezy, Leif D. Nelson and Amber Brown. "Shared Social Responsibility: A Field Experiment in Pay-What-You-Want Pricing and Charitable Giving" Science Magazine. July 6, 2010.
2. Frank Flynn. "Pay-What-You-Want Pricing and Charitable Giving". Stanford Graduate School of Business: Center for Social Innovation. Winter 2011 http://csi.gsb.stanford.edu/pay-what-you-want-pricing-and-charitable-giving
According to a recent TechCrunch story, Google is set to go after Amazon’s Prime Service that for $79 annually, gives Amazon customers unlimited movie and TV streaming, (free) access to the Kindle Owners' Lending Library, and free two-day shipping on most everything bought on Amazon. While the unlimited movie and TV streaming along with access to the Kindle library are ‘nice to haves’, it’s the free two-day shipping (with no minimum purchase) that clearly drives customers' willingness to fork out the $79 annual fee.
Here’s the story:
Google is stealthily preparing to launch an Amazon Prime competitor called “Google Shopping Express.” According to one source the service will be $10 or $15 cheaper than Amazon Prime, so $69 or $64 a year and offer same-day delivery from brick-and-mortar stores like Target, Walmart, Walgreens and Safeway (though no specifics were mentioned by our sources).
When and if it launches, the product will be a competitor to Amazon Prime, eBay Now, Postmates’ “Get It Now” and even smaller startups like Instacart.
We’re hearing that the project is being run by Tom Fallows, an e-commerce product manager at Google, and is an effort to focus Google’s e-commerce initiatives. Google Wallet and Google Shopping need a focal point, and serving as a “store shelf” to big-name retailers could be that in. Google has been scrambling for a way to capitalize on its advantages in the space — the fact that it’s arguably one of the first places people visit when they want to find a product — for a while.
If the Google Shopping Express service debuts publicly, and we have no reason to think that it won’t, this would mean that the company could capitalize on its recent acquisitions of both BufferBox and Channel Intelligence to dominate the online-to-offline retail market. Google could possibly use its BufferBox delivery lockers to facilitate the ease of shipment — like what Amazon has been testing in Seattle, New York and the UK. It could use Channel Intelligence’s data-management platform to coordinate sales and delivery.
We believe Google employees may already be dogfooding the service, but we have little information as to how partnerships are handled and how subscribing works.
So if Google Shopping Express does enter the space, the question is how will Amazon react? I’m not sure they will do anything. Shopping Express is positioned as a similar service with a lower price point, but I don’t think Amazon will view it as such. For Amazon, their Prime service is much more than just providing free two-day shipping (and other extras) for an annual $79 fee.
The reality is that Amazon Prime is more like a hyper-growth customer loyalty program. By some estimates, members typically increase their purchases 150% after joining the program. And these same Prime members account for only 4% of Amazon’s users, but account for almost 20% of overall sales…all the while paying $79 each year to belong. Now that’s customer loyalty!
So my view is that until Amazon views Google’s Shopping Express as more than just a ‘free shipping’ offer, don’t expect a reaction from Jeff Bezos and crew..
My thoughts on Groupon and the recent firing of CEO Andrew Mason were published Friday in Jason Hahn’s DM Confidential article titled, What Groupon’s Firing of Andrew Mason Means for the Company and the Daily-Deals Industry.
On Thursday, Groupon booted Andrew Mason from his seat as the daily-deals company’s CEO, less than a day after it announced disappointing fourth-quarter results and a tepid forecast for the first quarter of 2013.
While less than surprising, Mason’s firing marks the end of an era filled with offbeat humor, bad accounting and controversial Super Bowl commercials.
That said, Mason and his tenure at Groupon did have laudable highlights, including an IPO that was the second biggest for a U.S. Internet company. Groupon also blazed a trail and carved out an industry that countless copycats and innovators benefited from.
Now that Mason has exited the biggest stage in the business (with a severance package totaling $378.36), what does the future hold for Groupon and the deals industry as a whole? We spoke with eight experts to find out.
Here’s what I had to say:
Patrick Lefler, founder, The Spruance Group
"The departure of Andrew Mason may eliminate some of the short-term distractions that were clearly affecting Groupon, but it will not be a catalyst for change in the fortunes of the company. That will only occur when its business model changes. Until then, the company will continue to languish. Having said that, the coupon business is huge and remains ripe for innovation. Just because the Groupon business model isn’t working doesn’t mean the space can’t be conquered. It will just take a different company with a better business model. You can be sure that there are tens — if not hundreds — of startups today that are applying the lessons learned from Groupon’s mistakes to exploit their ‘second-mover’ advantage."
I do believe that the coupon space is ripe for innovation. Groupon didn’t invent the space, they just tried to innovate it. Poor customer service and a business model that didn’t properly align the interests of its buyers and sellers clearly hurt the company. Can Groupon rebound with new leadership? I don’t think so. As I said in the interview, it will take more than new leadership to change the course. It will be interesting to watch the space over the coming year as more and more newcomers will enter in their attempt to find the right business model.
And for those who want to read a really great resignation letter, Andrew Mason penned perhaps the gold standard of departure letters. Funny, sad, self-deprecating, yet optimistic.
People of Groupon,
After four and a half intense and wonderful years as CEO of Groupon, I've decided that I'd like to spend more time with my family. Just kidding -- I was fired today. If you're wondering why ... you haven't been paying attention. From controversial metrics in our S1 to our material weakness to two quarters of missing our own expectations and a stock price that's hovering around one quarter of our listing price, the events of the last year and a half speak for themselves. As CEO, I am accountable.
You are doing amazing things at Groupon, and you deserve the outside world to give you a second chance. I'm getting in the way of that. A fresh CEO earns you that chance. The board is aligned behind the strategy we've shared over the last few months, and I've never seen you working together more effectively as a global company -- it's time to give Groupon a relief valve from the public noise.
For those who are concerned about me, please don't be -- I love Groupon, and I'm terribly proud of what we've created. I'm OK with having failed at this part of the journey. If Groupon was Battletoads, it would be like I made it all the way to the Terra Tubes without dying on my first ever play through. I am so lucky to have had the opportunity to take the company this far with all of you. I'll now take some time to decompress (FYI I'm looking for a good fat camp to lose my Groupon 40, if anyone has a suggestion), and then maybe I'll figure out how to channel this experience into something productive.
If there's one piece of wisdom that this simple pilgrim would like to impart upon you: have the courage to start with the customer. My biggest regrets are the moments that I let a lack of data override my intuition on what's best for our customers. This leadership change gives you some breathing room to break bad habits and deliver sustainable customer happiness -- don't waste the opportunity!
I will miss you terribly.
Love,
Andrew
Finally, someone with the guts to admit they were fired as opposed to other CEOs who have trotted out the standard “I need to spend more time with my family” line after their own involuntary departures. The joke here (as Marc Andreessen points out) is that most executives are not liked by their families, who would prefer that they not spend more time at home and try to get them into a new job as quickly as possible.
Well done Andrew!
This is interesting…
MarketPrice is a service that crawls eBay auctions for products priced over $100 and then displays both past and current prices for the searched item.
Here’s how it works. If you’re looking for say, a new Patagonia Ultralight Jacket--there are 80 currently for sale on eBay with pricing that ranges from around $100 to $260—MarketPrice displays both past transacted prices along with current ‘ending soon’ prices.
You can view the graphical analysis above and raw data set below of both recently ended and 'ending soon' transactions.
The funny thing is about the site is that it gives you no MarketPrice company information. All that is displayed is information about the eBay item you’re searching from – that’s it. No advertising, no ‘contact us’ information; nothing! Take a look.
I’m curious to see where this goes…
After its highly publicized launch a year ago, the Fiat-designed Dodge Dart has been a sales flop. With all the fanfare highlighting of its Fiat roots, Chrysler was looking for the car to give it a foothold in the competitive, but highly desirable compact-car segment. But for all of 2012, Dart sales in the U.S. totaled only 25,303; a far cry from some of the optimistic estimates at its launch that it could top 100,000 sales in its first year. And compared to the leader of the pack--the Honda Civic with over 317,000 sales—the Dart has a steep mountain to climb if it wants to even be relevant in the compact-car segment.
The reasons for its dismal sales performance vary, but one that doesn’t get nearly enough attention is how Chrysler completely misunderstood the paradox of choice. We first highlighted it here last summer just prior to Chrysler’s big advertising campaign for the Dart:
This is the week that Chrysler is set to begin an all-out advertising blitz for its newly developed subcompact – the Dodge Dart. Hoping to complete against the likes of Toyota, Honda and Hyundai, they have positioned the car to appeal to younger drivers by including artists Jay-Z and Kanye West in their advertising. Chrysler is also making a big bet that consumers will flock to the car because of the number of features and choices that are offered; what the Wall Street Journal calls, “a menu offering as many as 100,000 possible combinations of colors and optional features."
Chrysler Group LLC’s newest compact car will be available in five different basic styles, 12 different exterior colors and up to 14 different interior color schemes, including black and ruby red, and “diesel gray and citrus.” Buyers will pick from up to seven different wheel choices and can get a dashboard they can personalize to show either digital performance data, or virtual analog gauges.
The array of choices is designed to appeal to drivers in their 20s and 30s, says Richard Cox, director of the Dodge brand. Chrysler, which has long been weak in compact cars, concluded that offering more customization and technology was a way to stand out.
The problem with choice (and specifically, too many choices) is that it can lead to something called decision paralysis – where as the choices available (even if they’re all good options) increase, so too does the likelihood that indecision follows. It’s a well-established psychological bias that limits our decision making process. In The Paradox of Choice, author Barry Schwartz highlighted one of the most obvious cases from a recent study.
Researchers at an upscale gourmet food store set up two tables where shoppers could taste different varieties of jam; one table had six different flavors while the other contained twenty-four. The table with twenty-four different types of jam attracted more people to taste (than the table of six) – makes sense so far, (more choices, more interest) right? But when it came to buying, thirty percent of the people exposed to the smaller choices of jam actually bought a jar – ten times as many compared to the people exposed to the table with more choices.
The conflict of all these choices—benefits that Chrysler felt would actually help the car stand out and increase sales—induces buyers to avoid decisions. Can’t decide between any of the 100,00 combinations? Then the easy way out is to walk out the door. And that’s what potential Dodge Dart customers did…they walked out of the showroom unsettled by the all the choices (probably headed across the street to the local Honda dealership) without making a purchase.
Perhaps one of the most annoying aspects of traveling by air. With thousands of different prices for a single flight—most of which don’t seem to make any basic economic sense—it almost requires a Ph.D. in quantitative statistics to fully understand the basic concept.
But 30 years ago, the use of dynamic pricing for airlines was still in its infancy. Airlines had just begun to mine the data that was being produced by their proprietary reservations systems—systems that linked the tens of thousands of domestic travel agents to each of the major airlines’ ticketing systems. While the primary purpose of these systems was to automate the ticketing process from agent to airline and keep track of seat availability, most airlines soon found that the data that resulted from the process (passenger names, frequency of flight, destinations, load factors, ticket price, etc.) became just as valuable as the process itself.
American Airlines’ SABRE computer reservation scheme was just such a system. In use since the early 1960s, it was considered the most technologically advanced among the other proprietary systems in use. By the early 1980s, the data produced by SABRE had become a gold mine for American’s marketing department. The airline could now accurately predict the number of empty seats for each flight and thus sell those seats at discount. Additionally, American began to implement “fences” (Saturday night stay requirements) necessary to prevent full-fare passengers (e.g., business fliers) from taking advantage of much lower discount fares. It was the first version of dynamic pricing. But as more and more of American’s major rivals came to similarly utilize data produced by their own reservations systems, American spent the vast majority of its resources defending its current route and pricing structure from major competitors, including United, Eastern and Delta.
At about the same time American was battling its major rivals, the advent of low-cost upstart airlines came on the scene. Unencumbered by the high cost of union labor, these newcomers competed solely on the basis of price. One such upstart was People Express. Founded in 1981, the new airline operated out of an abandoned terminal at Newark Airport and pretty much stayed off the radar of the more established airlines by initially offering low-price flights to Buffalo, Norfolk and Columbus. It later added flights to Florida, and by 1983 it was offering low-cost flights throughout the continental United States and to London. Unlike its initial foray to destinations where the majors lacked routes, People Express was now competing head-on with the major carriers in both its domestic and international routes.
But while the major carriers had established reservations systems spewing out mountains of valuable price and load factor data for each flight, People Express had no such technology. If People Express offered a flight from Newark to Los Angeles for $99, every seat on that flight was sold for the same price. It didn’t matter that some of its passengers may have been willing to pay two to three times that amount—People Express had no way of knowing which ones they were and how many seats to reserve on those flights for full-fare passengers.
It didn’t take long for the majors—American Airlines in particular—to realize that its most potent weapon against upstarts like People Express was its technology-driven dynamic pricing strategy. In early 1985, American made the first move. It essentially declared war on People Express by matching the competitor’s low fares but used its dynamic pricing analysis to only offer a fraction of the number of total seats on each flight at that low fare.
According to Thomas Petzinger, author of the book Hard Landing: The Epic Contest for Power and Profits That Plunged the Airlines into Chaos, People Express and its CEO Donald Burr knew immediately that a war with American was underway.1
"This is it!” [Burr] cried, slamming the newspaper down on the desk of one of his marketing executives. “This is the shot across our bow! If we don’t invent a way to deal with this, we’re history! We’re going to be dead meat.”
In his panic, Burr wanted to know how many seats American was offering at these prices. Two seats on any plane, or 20, or 200 on a DC-10? There was no way of telling from American’s ads or public comments. Burr began rounding up people to dial the phones like mad, posing as American customers and keeping track of which flights had sold out of discount seats and which still had low-fare seats available, but the answers kept changing. The advertising agency working for People Express was pressed into action; hundreds more calls went out. But the more they called, the less they knew. As days progressed, calls went out by the thousands, eventually to United as well, once it matched American. The answers kept changing there too! Burr was beside himself. How could he compete with something that he couldn’t see? How could he fight the devil?
But there was no way for People Express to compete. The pricing strategy derived from data as the result of millions of historic SABRE transactions could not be overcome. Losses quickly mounted and the airline became soon became desperate. In the following months, People Express looked first to build (from scratch) a reservation system to compete against American and its SABRE system. Upon determining that the build-from-scratch process would take years, not months, People Express looked to acquire a system. But about the only way to acquire an existing reservation system was to also acquire the airline that owned the system.
Enter Denver-based Frontier Airlines. Burdened with a high cost structure along with high debt, but with a reasonably good reservation system to its credit, People Express acquired the airline with the hope that Frontier could somehow be the white knight needed to keep its company alive. The merger was a disaster from the start. The much-needed reservation system was antiquated and unable provide any type of dynamic pricing strategy. By 1986, People Express was on the verge of bankruptcy—saved only when the airline was sold for pennies on the dollar to Texas Air Corporation. The airline ceased to exist in early 1987 when its operations were merged into the operations of Texas Air subsidiary Continental Airlines.
While most experts attribute the demise of People Express to its ill-fated merger attempt with Frontier Airlines, its ultimate underlying cause was the fledgling airline’s inability to compete with American Airlines’ technology-driven pricing strategy. Once American discovered that it could compete by selling at an advertised price and not feel required to sell every seat at a discount, People Express had no response. This early dynamic pricing skirmish and the swift results that followed underscore the strategic power of dynamic pricing. While few people may recall People Express, its lessons resonate across all industries and everywhere business pricing strategies are formulated.
1 Thomas Petzinger Jr., Hard Landing: The Epic Contest for Power and Profits That Plunged the Airlines into Chaos. (New York: Random House Digital, Inc.), Kindle edition.
Determining the value of your involves both collecting hard data and mixing it in with a number of different intangibles. It’s an internal discussion that takes place among the various stakeholders immediately after the data has been collected.
The one piece of data that should never be part of this early discussion is the cost of building the product. One of the biggest mistakes you can make during the pricing process is to taint your decision-making process by introducing cost information into the discussion.
William Davidow, author of the classic marketing book Marketing High Technology, says this about the conflicts inherent in introducing cost data into a value-based pricing discussion:
“When a marketing department is given cost information about a product, it will tend to rely heavily on that information in determining the value of the product to a customer. I’ve long believed that the first pass at pricing a product should be made without foreknowledge of what the product will cost to manufacture. When a marketing department knows the cost and market acceptable to the company, it will use that data to determine a price acceptable to the company rather than one to the market. If you are interested in finding out if your company is guilty of pricing by computation, try this experiment. Deprive your marketing department of cost information during a pricing exercise and see how much agony it produces in the group. The experiment will quickly bring that problem to the surface.”
Resist the temptation to take shortcuts in your pricing analysis discussions. While including internal production costs into the later stages of the discussion is necessary, introducing the cost information too soon into the pricing analysis will taint the outcome and eventually result in money being left on the table.
Here’s the takeaway: Introducing cost information too early into the pricing discussion generally results in money being left on the table. No matter what the pressure might be to do so, resist the temptation.