One of the classic lines from Sun Tzu in the Art of War goes something like this:
“All warfare is based on deception. Hence, when able to attack, we must seem unable; when using our forces, we must seem inactive; when we are near, we must make the enemy believe we are far away; when far away, we must make him believe we are near. Hold out baits to entice the enemy. Feign disorder, and crush him.”
One of the classic examples of this type of success in real warfare is the story of how confederate General Nathan Bedford Forrest was able to feign his way into prompting the surrender of a much larger Union force. The story comes from author Chet Richards in his book Certain to Win:
In May 1863, Confederate cavalryman Nathan Bedford Forrest was chasing a regiment of Union cavalry across a wide swath of northern Alabama, finally cornering them a few miles west of the Georgia border near the town of Cedar Bluff. Forrest demanded surrender, and the Union commander, a colonel named Abel D. Streight, refused. At that point, one of Forrest’s men rode up and asked for orders for his regiment, which was coming from the north, followed shortly by another requesting orders for a regiment approaching from the south. Streight, who could also hear sounds of large amounts of equipment moving in the distance, figured the game was over and honorably surrendered his 1700 men to what turned out (to his horror) to be Forrest’s 350, less than one-quarter of one fully manned regiment. He was still demanding his guns back when Forrest put his arm around him and uttered those immortal words or strategy, “Ah Colonel, all is fair in love and war, you know.”
Here’s the takeaway: The best strategy in warfare (as in business) is to sometimes mystify, mislead and surprise. In the end, it’s all based on deception.
Peter Drucker tells a great story about how the leading American consumer electronics manufacturers fumbled away their technological advantage during the early days of the transistors.
“In 1947, Bell Laboratories invented the transistor. It was at once realized that the transistor was going to replace the vacuum tube, especially in consumer electronics such as radio and the brand-new television set. Everyone knew this; but nobody did anything about it. The leading manufacturers--at the time they were all American--began to study the transistor and to make plans for conversion to the transistor “sometime around 1970.” Till then, they proclaimed, the transistor “would not be ready.” Sony was practically unknown outside of Japan and was not even in consumer electronics at the time. But Akio Morita, Sony’s president. read about the transistor in the newspapers. As a result, he went to the United States and bought a license for the new transistor for a ridiculous sum, all of twenty-five thousand dollars. Two years later, Sony brought out the first transistor radio, which weighed less than one-fifth of comparable vacuum tube radios on the market, and cost less than one-third of what they cost. Three years later Sony had the market for cheap radios in the United States; and two years after that, the Japanese had captured the radio market all over the world.”
So why did American manufacturers reject the transistor when it was clear that it was going to replace the vacuum tube? Drucker thinks the manufacturers rejected the transistor because of a “not invented here” mindset in that it was not invented by one of the electrical and electronic leaders at the time--RCA and General Electric. He felt that it was a typical example of pride in doing things the hard way. The American manufacturers were so proud of the way their products were built that they viewed the new transistors as “low-grade, if not indeed beneath their dignity.”
My take is different. I think that the American manufacturers were scared of introducing the transistor too early because it would make their existing product obsolete. The problem, of course, with this strategy is that if you don’t continue to innovate and make your own products obsolete, then somebody else will. In this case, their fear of cannibalizing themselves allowed Sony to step-in and devour their high-margin radio business.
Here’s the takeaway: if you don’t continue to innovate and make your own products obsolete, then somebody else will.
There’s an interesting article in the Marketplace Section of today’s Wall Street Journal written by Dana Mattioli that talks about CEOs paying more attention to pricing strategies as they struggle between rising costs and price-sensitive shoppers. The article is titled Executives Zero In on Pricing and it can be assessed here (registration may be required).
The article lays out many of the strategies that companies are implementing in their quest to raise revenues through price increases including balancing out price increases on some items with decreases on others, rolling back discounts, and targeting price increases for certain places and not for others. Nothing remarkable in that, but I was struck by a statement made by one of the CEOs who was interviewed for the article.
Larry Zimpleman is CEO of Principal Financial Group; an insurer and asset management company based in Des Moines, Iowa. He indicated that while the company hasn’t slashed its fees for insurance, 401(k)s and mutual funds, it also hasn’t raised them and doesn’t plan to in the foreseeable future. He also stated that “our working assumption is that we have no ability to raise prices.”
If you look at that last statement closely, it really implies a Principal Financial Group assumption that the pricing points for all their products are perfect. That’s quite an assumption that one would hope is backed up by strong quantitative data. Just because prices happen to be where they are today, doesn’t mean for a minute that they should be there. How much rigorous testing has the company done with regards to its pricing model? Does the company understand the price elasticity curves that its customers implicitly use when purchasing its products? And is the company constantly testing its pricing model assumptions against real world data? There are just a few of the questions I would ask Mr. Zimpleman and his senior executive team.
Contrast Principal Financial Group’s relative simplistic view of pricing with that of another firm mentioned in the article. Royal Caribbean Cruises actively collects data from booking inquiries on phone calls and its website. It then analyses the data to adjusts hundreds of its prices through the course of a day--day in and day out--to maximize ticket revenue. The result has been a 7.1% rise in revenue from the year-ago quarter.
Here’s the takeaway: Developing an effective pricing strategy requires more than just going with seat-of-your-pants assumptions. It’s easy to assume your current strategy is best, but doing so usually results in leaving money on the table - money that will be lost forever and never be recovered.
As we've said before in previous posts here and here, value-based pricing is the ultimate objective for most organizations. It’s what enables successful firms to charge above-average industry margins for their products that ultimately drive superior bottom-line results.
The final key to success is remember that the first sale is always to your sales force.
Nothing can sink value-based pricing faster than having a sales force that has not bought into the strategy. This means that the sales force has to believe deep down that prices reflect the value that is created for their customers. If they don’t, they will be easy prey to discounting pressures once buyers recognize this lack of confidence. Because of this, the first sale always has to be to your sales force.
So why is this buy-in so challenging? One reason is that the data behind value-based pricing is significantly harder to wrap your hands around. Most of it is based off of conversations with the different members of the buyer community (users, buyers, decision makers, etc.) about value—which results in data that is much more subjective. Contrast this with the experience of most cost and cost-plus strategies where pricing is based off of much more objective data—such as internal production costs—and desired margins. Information that is much easier to understand results in prices that are much easier to defend.
Instilling the necessary confidence in your sales force to successfully execute value-based pricing is hard work. It takes time and, sometimes, specialized training. And it’s not going to happen just in a two-hour pricing strategy meeting that typically occurs at the end of the annual sales launch.
The key is to ensure that the sales force understands the value provided to their customers. This value, again, comes from a detailed analysis of the product, the competitive environment and the particular needs of the customer. Your sales force has to be absolutely confident both in the underlying pricing and that the value proposition they use will resonate with their customers.
One of the worst outcomes for a value-based pricing strategy happens when sales professionals are not ready for it. When this occurs, high-value features and services are given away and discounting soon follows. This typically results in an undesired—and impossible to stop—movement back to lower-margin cost-based pricing.
Here's the takeaway
: Firms that utilize value-based pricing need to create a credible value proposition that communicates to the customer the value of the offering. This value proposition must be based on credible and untainted information that comes from various outside sources: buyers, competitors and alternate products in use today. Once a strategy is developed, the first and most important sale is always to the sales force.
Repeating what was said yesterday, value-based pricing is the ultimate objective for most organizations. It’s what enables successful firms to charge above-average industry margins for their products that ultimately drive superior bottom-line results. But to be successful, value-based pricing requires having clearly defined benefits that differentiate you from the competition.
The second key to success for value-based pricing is: Don't taint the decision-making process.
Determining the value of your product 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.
Value-based pricing is the ultimate objective for most organizations. It’s what enables successful firms to charge above-average industry margins for their products that ultimately drive superior bottom-line results. But to be successful, value-based pricing requires having clearly defined benefits that differentiate you from the competition.
Successful implementation of this strategy requires a combination of hard work, patience, confidence and a little bit of luck. As you move down the road of success for value-based pricing, the first key to success to reach that final destination is to do the required heavy lifting.
Unlike cost-based (or cost-plus) pricing, which only requires a percent markup over costs, value-based pricing requires that you compile a full inventory of the benefits offered to your customers during the price discovery process.
This is the “heavy lifting” that requires you to leave the office and meet with key prospects. Talk not only to the economic buyers, but also survey the end users, the influencers and the key recommenders. They all have a stake in the buying process and they all have their own opinions as to the actual value of your product or offering. And don’t forget to ask about your competitors—talking to your potential buyers is sometimes the best way to glean information about the competition.
See which value propositions resonate best with your audience. Find out what existing products are out there and how much perceived value they add. Gather data on how they are priced. As you collect this data from your audience, you will begin to have a better feel for the perceived value of your product.
In new markets, sometimes the value is determined by the cost of alternative solutions available to the customer. These alternative solutions can be anything from internal development within the buyer’s organization to, in some cases, many different products that are currently being purchased by the buyer that can be replaced by a single product or offering.
Another area to examine is the non-product features that prospects might highly value. Depending on the offering, unique services can add significantly to the value of your product. Additionally, other non-product features, such as offering easy availability and fast delivery through distribution channels, should not be forgotten. You might be surprised at the value that some buyers place in these non-product features. But you will never know unless you go out and ask.
In the end, this will be an iterative process that may seem to be as much art as science. And remember, you are not selling the product here; rather, you are going out and having discussions about perceived value among key members of the buyer community.
Here’s the takeaway: Firms that utilize value-based pricing must do the "heavy lifting" to create a credible value proposition that communicates to the customer the value of the offering.
Peter Drucker tells a story of contrasts between Honda Motor Company founder Soichiro Honda and Ford Motor Company founder Henry Ford.
When Soichiro Honda decided to open his small business in the toughest of business environments after Japan’s defeat in World War II, he did not start his company until he found the right man to be his partner and run the non-engineering parts of the company; administration, finance, distribution, marketing, sales and personnel. Honda was smart enough to know that his talents belonged only in engineering and production. That key delegation decision made the Honda Motor Company what it is today.
Contrast that outcome with an earlier example; that of Henry Ford. According to Drucker, when Ford decided to go into business for himself, he first did exactly what Soichiro did forty years later. Before starting the Ford Motor Company, he found his man--James Couzens--to run administration, finance, distribution, marketing, sales and personnel. Like Honda, Henry Ford knew that he belonged in engineering and manufacturing. For fourteen years, James Couzens worked along side Henry Ford to build up the company. It was Couzens, not Ford who implemented some of the best-known policies and practices; the famous five-dollar-a-day wage of 1913 along with Ford’s pioneering distribution and services policies. And it was Couzens who pushed these policies through despite the resistance of Henry Ford. These policies became so effective that, in the end, Henry Ford became increasingly jealous of Couzens. Fourteen years after Couzens partnered Henry Ford to build one of the great manufacturing companies of all-time, he was forced out of the company. The last straw, according to Drucker, was Couzens’ insistence that the Model T was obsolescent and his proposal to use some of the huge profits of the company to start work on a successor.
“The Ford Motor Company grew and prospered to the very day of Couzens’ resignation. Within a few short months thereafter, as soon as Henry Ford had taken every single top management function into his own hands, forgetting what he had known earlier where he belonged, The Ford Motor Company began its long decline. Henry Ford clung to the Model T for a full ten years, until it had become literally unsalable. And the company’s decline was not reversed until thirty years after Couzens’ dismissal when, with his grandfather dying, a very young Henry Ford II took over the practically bankrupt business.”
Here’s the takeaway: The question of ‘where do I belong?” needs to be answered well before the first signs of success occur for any start-up. If you’re smart, you’ll follow the path of Soichiro Honda and not that of Henry Ford.
Coupons are one of the many ways that retailers differentiate pricing. But to do so successfully, they must erect barriers (or hurdles) to prevent all customers from taking advantage of the coupon. That’s the reason why coupons must be clipped and presented in order to get the differentiated price. It’s a laborious process and it’s meant to be so. If not, then everyone--both budget-minded customers and those who are prepared to pay full price--would be able to take advantage of the offer. Sounds good in theory, but sometimes the real-life experience can be quite different.
Recently, I was shopping in one of the large New York City department stores. I picked the store because (a) I desperately needed to buy some summer shorts and shirts, and (b) it was on located on Fifth Avenue right on the way as I walked to Penn Station to catch a train home for the day. After finding the items I needed (and some that I probably didn’t), I proceeded to the cash register to pay for the items. After the cashier had rung everything up and just as I was giving her my American Express Card for payment, she applied a 25% discount to the price by applying a coupon that was in effect for that day only. I certainly appreciated the thought; I was unaware of the coupon and it saved me over $30 on my purchase. And I’m pretty sure that the cashier felt good that she had personally saved one of her customers $30 dollars because she was beaming from ear to ear. But did her employer; the store owner feel good? Probably not.
Here’ s why. I was fully prepared full price for my purchase had the cashier not applied the discount. And the department store in question was also counting on customers like me (who either weren’t aware of the coupon or didn’t take the time to clip and present the coupon) paying full price. That’s why they erected the barrier of having to find, clip and present the coupon in the first place. The coupon was only targeted at those customers (who on the margin) wouldn’t have made a purchase that day without taking advantage of the discount. What they didn’t count on was their employees lowering those barriers and undermining their differentiated pricing strategy by trying to be generous to customers. I’m pretty sure the cashier wasn’t being malicious and wasn’t trying to undermine the store’s pricing strategy, but it happened just the same.
The solution is pretty easy. Ensure that all employees who touch pricing (especially cashiers and customer service representatives who deal with returns and refunds) are made aware of the pricing goals. Make sure that they understand the basic concept of differentiated pricing and how many of their actions--while seemingly innocent at the time--undermine the profitability of the store. You can still empower them to serve the customer, but they need to know the best way to do so.
Here’s the takeaway: Differentiated pricing is only as good as the weakest link in your pricing process. And many times, that weak link is with your cashiers and customer service representatives who (unknowingly) lower the barriers necessary for differentiated pricing success.
Full Court Press: A John Wooden lesson for today’s CEO
In 1964, coach John Wooden’s UCLA basketball team won their first NCAA title; the first of ten championships over the next twelve years until his retirement. What’s most surprising about Wooden’s career was that before his 1964 team, Wooden had enjoyed limited success at UCLA for sixteen previous seasons. So what was the ‘tipping point’ for this sudden reversal of fortune? Better players? Better coaching? No, it turns that Wooden's success was the result of one of the great mid-course management corrections of all time. It's a lesson that CEOs and other senior executives need to learn. Read more...
Anchors, prices and value
What's the best way to sell a $600 pair of shoes? Better marketing? Better packaging? Maybe...but perhaps the best way to sell that $600 pair of shoes is to place them next to pair priced at $1,200. Anchor pricing has been used by luxury retailers for years, but can you apply similar techniques to the sale of high tech products and professional services? Read more...
Improvement is not innovation
It’s easy to confuse improvement for innovation. The two terms have become interchangeable in today’s marketplace. But only innovation creates such superior outcomes that your competitors will be either unable or unwilling to come close in matching. Read more...
Thanks for reading. We appreciate your interest and welcome your feedback.
Earlier today, Oracle Corp. named Mark Hurd co-president and appointed him to its board of directors, heightening the rivalry between the software company and Hewlett-Packard Co., the technology giant Mr. Hurd ran as chief executive until departing amid a scandal last month.
Larry Ellison and Mark Hurd are close friends. While Oracle and H.P. have been partners in the past, Oracle’s recent acquisition of Sun Microsystems will force the two firms to become rivals. Ellison probably views the hire as a win-win. First he gets a trusted and extremely competent senior executive who knows H.P. better than anyone; and second, he gets to stick a finger in the eye of the H.P. board - the first skirmish of many to follow. Hurd knows that Elison is God at Oracle. I’m sure he’s not going to challenge Ellison for that role; rather, Hurd will be quite content to be Ellison’s field general in their war with H.P.
If I were an Oracle employee, I’d be thrilled to get such a valuable defection. It shows that Oracle and Larry Ellison are committed to battling H.P. in the computer hardware business.
Just days after Hurd’s departure, Ellison sent a very public e-mail message to The New York Times chiding H.P.’s board. Pure “Ellison” in its content:
“The H.P. board just made the worst personnel decision since the idiots on the Apple board fired Steve Jobs many years ago. That decision nearly destroyed Apple and would have if Steve hadn’t come back and saved them.”
Strap on your seat-belts, it’s going to be a wild ride for the next few years as the Oracle / H.P. war heats up.
Two weeks ago, the folks at Innovation Tools republished my article on innovation titled Improvement in not innovation which allowed the article to gain a bit of traction within the innovation community. There were those who agreed and those who disagreed with my premise which was that far too often, we confuse improvement for innovation.
Here’s a brief summary of what I had to say about improvement not being the same as innovation.
First, an improvement that only meets the market standard or reacts to innovation that your competitors have already introduced into the market is NOT innovation. It’s playing catch-up.
Second, introducing an improvement that does not significantly differentiate you from your competitors is NOT innovation. It’s simply just an improvement - evolutionary not revolutionary.
And finally, introducing improvement that may give you a competitive advantage but can be easily emulated by your competitors is NOT innovation. It’s just a temporary advantage.
I also used the example of both Southwest Airlines and Sony with their successful innovation efforts to illustrate my point. As I mentioned earlier, the article elicited a fair amount of discussion within the innovation community and I’d like to mention one conversation in particular that occurred with James Todhunter who writes a very well written (and well read) blog titled Innovating to Win. While James acknowledged that he and I were pretty much in agreement on the overall premise, he did share his views that there were important aspects of improvement (or what is often referred to as “incremental innovation”) that I was ignoring in the fervor to make my point.
Here’s what he had to say:
“Breakthrough innovation, incremental innovation, minor improvement—these are all points on a continuum of value creating solution generation. Incremental innovation is very beneficial to an organization trying to develop the core competence needed to support a high-performance innovation system. Specifically, incremental innovation delivers both short and long term benefits. In the short term, immediate business benefits can be realized—extended revenue life of a product, increased market share, better contribution to margin, etc. In the long term, incremental innovation provides a low risk platform to hone the basic innovation skills needed for successful, repeatable breakthrough innovation practice.”
In what turned out to be a healthy discussion between James and myself via his comments section, the topic turned from the slight disagreement we had on using the terms improvement and innovation interchangeably, to one where James made some valid points on the best ways to hone innovation skills within the organization. He used a rather nice analogy of Larry Bird using his work ethic and diligence in maintaining his skills--the same type of work ethic is needed by those in our organizations today if we want innovation to flourish.
“[The] honing basic innovation skills, is too often overlooked. Most organizations lack these basic skills and the knowledge of innovation best practices. These skills must be developed and practiced constantly. Even seasoned innovation workers should take a page from Basketball legend Larry Bird’s play book. Larry was well known for his work ethic and diligence in maintaining his skills. He would arrive for a game hours before anyone else and warm up by taking hundreds of practice shots.”
All in all, a worthwhile discussion where I most appreciated James’ opinion on finding ways to hone innovation skills within the organization. It's a topic that seems to be forgotten during most innovation discussions, but one that is extremely important with regards to the success or failure of any innovation effort. Thanks again James for initiating the discussion and I hope that our paths cross again sooner rather than later.
Borders Group announced that they are cutting prices on two of their e-readers in hopes of gaining increased market share in the fiercely competitive e-book space. The price cuts will bring the price of its lowest priced e-reader, the Aluratek Libre down to $99.99, and it’s Kobo readers will now be priced at $129.99--a $20 price drop for each product.
Borders president Mike Edwards stated that Borders' goal of achieving an e-book market share of 17% within the year was “entirely contingent on selling devices” and that the retailer wanted to make sure it had an e-reader offering priced below $100 to attract customers.
No matter what their stated market share may be, Borders is in a real fix in the growing e-book market. First, they are already light years behind the two established (and highly capitalized) frontrunners ; Apple and Amazon. Amazon raced to the early lead with its early mover advantage, and Apple, is becoming the textbook example of a ‘fast second’, by taking the new market niches developed by others and scaling them into a mass market.
Borders is also caught in the middle of a price war for the e-readers--a war that seems to favor their better capitalized and lower-cost competitors. About the only way to exit this price war successfully is to either (a) not compete on pricing which seems to be Apple’s strategy; or (b) raise the stakes with your other price war participants by giving the e-readers away for free. If maximizing e-reader distribution is the stated goal, then give the readers away now--for free. If you look at the trend over the next six months to a year, that seems to be where the price is heading anyway. If you wait with the rest of the market for the price to get there, your market share will remain relatively unchanged. If you make the bold move today, you might get the desired market share at the expense of Barnes & Noble and possibly Amazon.
The larger problem for Borders (and their primary rival Barnes & Noble) is whether the e-book market is more than just a two-horse race. My feeling is that once the dust has settled, Amazon and Apple will control between 75%-80% of the market. The continuing battle between Borders and Barnes & Noble may not matter a in a year or two, if all they’re battling for is the bottom 20% on the market. I don’t see the e-reader market shaking out anyway other than that.
Here’s the takeaway: Don’t be caught in a price war unless you are either the the lowest cost or highest capitalized competitor. The graveyard of failed companies is littered with the carcasses of those who don’t heed this advice.