Posts Tagged ‘pricing’

You probably paid too much … especially if you’re bad at math.

August 14, 2012

Ac couple of weeks ago we reported a study that consumers almost invariably pick 33% more stuff than a 33% price discount.

Ouch.

Consumers are notoriously bad at spotting real values. Why?

According to the Atlantic ….

  • First: Consumers don’t know what the heck anything should cost, so we rely on parts of our brains that aren’t strictly quantitative.
  • Second: Although humans spend in numbered dollars, we make decisions based on clues and half-thinking that amount to innumeracy.

More specifically, here are some more ways consumers end up paying too much …

  1. Anchoring Effect: People are heavily influenced by the first price we see … it’s called “anchoring” …  that’s why the appliance salesman shows you the most-featured, highest-priced appliance first … it makes every other appliance seem like deal.
  2. Aversion to Extremes: People are  terrified of extremes … they don’t like buying the cheapest item … or the most costly …  they shy away from prices that appear too high or too low.For example, in one famous study, people were offered 2 kinds of beer: premium beer for $2.50 and bargain beer for $1.80.

    Around 80% chose the more expensive beer.

    When a third beer was introduced, a super bargain beer for $1.60, 80% bought the $1.80 beer and the rest $2.50 beer. Nobody bought the cheapest option.

    Then researchers removed the $1.60 beer and replaced with a super premium $3.40 beer.

    Most people chose the $2.50 beer, a small number $1.80 beer and around 10% opted for the most expensive $3.40 beer.

  3. Shining Light Effect: Savvy restaurants, for example, design their menus to draw our eyes to the most profitable items by things as simple as pictures and boxes.Good rule of thumb: If you see a course on the menu that’s highlighted, boxed, illustrated, or paired with a really expensive item, it’s probably a high-margin product that the restaurant hopes you’ll see and consider.
  4. Dulled senses: Alcohol narrows the range of complicating factors people can hold in their heads at once.  People are easily made dumber by alcohol, time, decisions.When we’re drunk, stressed, tired, and otherwise inattentive, we’re more likely to ask and answer simple questions about buying things.

    Cheap candy bars and gum are situated near the check-out at grocery stores because that’s where exhausted shoppers are most likely to indulge cravings without paying attention to price.

  5. Concealed habits: To save some $$$, cancel recurring payments like gym memberships and subscriptions to papers and services you don’t use.Cancelling is a hassle, right?

    So what?

    Cancel that subscription.

  6. Peace of mind… allows some companies to make more money on extended warranties and service contracts than they do on their productsExcept for PCs (high prices, risk of crashes), extended warranties don’t pay-off … otherwise, why would retailers push them so aggressively?

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Profitable pricing is literally “shrouded” in mystery…

July 20, 2012

A couple of years ago, behavioral economists Xavier Gabaix and  David Laibson wrote a seminal paper on the concept of “price shrouding,” and “information suppression”.

Here’s a summary excepted from The Red Tape Chronicles

The principle is simple, and shows why cheating is rampant in our markets and why honesty is rarely the best policy.

First, a definition of shrouding:

In days gone by, price tags were simple.

An apple cost 10 cents.  A cup of coffee cost $1.

But today, the consumer marketplace is far more complicated, giving sellers the opportunity to create confusion.

Many items have follow-up costs that make the original price tag meaningless.

Computer printers are the classic example.

You might get a great deal on a printer, but if the ink is expensive, you lose in the end.

In fact, Gabaix argues that it’s impossible for consumers to intelligently shop for printers.

No consumer knows how much ink costs — the cartridges don’t come in standard sizes, the amount of ink used to print varies and ink costs are unpredictable.

That makes the true price  “shrouded” — not quite hidden, but not quite clear, either

So, it’s easy for printer companies to lowball printer price tags and overcharge for ink, enabling them to print money.

Shrouded price tags are everywhere.

The hotel website might say “$99 a night” but you know the bill will be more like $120 or $130.

Pay TV companies promise $30-a-month service, which ends up costing more like $50.

At its best, the maddening mixture of coupons, rebates, sales and fine print fees can feel like a game.

At worst, it’s being cheated.

You’d think shoppers would love a chance to buy from a store that doesn’t play these games, the way car buyers (allegedly) like shopping at no-haggle auto dealerships.

They don’t.

Shoppers hunt for the tricks that let them save money.

Stores hide booby traps that let them take money.

If a firm tries to educate consumers on tricks and traps, and tries to offer an honest product, a funny thing happens: Consumers say, “Thank you for the tips,” and go back to the tricky companies, where they exploit the new knowledge to get cheaper prices, leaving the “honest” firm in the dust.

Once you educate consumers on the right way to shop, they will seek out the lowest cost store, and that will be the one with the shrouded prices.”

“Shrouding is the more profitable strategy.”

Like it or not, hidden fees – and secret discounts – are here to stay.

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Quick, pick one: a 33% discount or 33% more for free …

July 17, 2012

According to a study at the University of Minnesota’s Carlson School of Management, report in The Economist

When offered two deals on loose coffee beans: 33% extra free or 33% off the price, most shoppers considered them equivalent though he discount is by far the better proposition … it would take a 50% increase in quantity to be equivalent.

More generally, the researchers found, that shoppers prefer getting something extra for free to getting something cheaper.

For example, the researchers sold 73% more hand lotion when it was offered in a bonus pack than when it carried an equivalent discount (even after all other effects, such as a desire to stockpile, were controlled for).

The main reason is  “consumer innumeracy” … e.g. people can’t do fractions or simple math in their head.

* * * * *
How can retailers compensate for (or exploit) consumers’ math blind spots?

One way is to befuddle them with double discounting.

People are more likely to think that a product that has been reduced by 20%, and then by an additional 25%, is a better deal than one which has been subject to an equivalent, one-off, 40% reduction.

Similarly, when evaluating a car’s fuel efficiency, consumers understand the number of extra miles per gallon it gets, more so than the equivalent percentage fall in fuel consumption.

We’re not talking calculus, we’re talking fractions … ouch.

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Ever since Wilbur and Orville’s first flight …

June 19, 2012

The airlines industry — in aggregate — hasn’t made money.

Think about that for a second.

There have been some brief periods of prosperity, but longer stretches of losses … some  pretty deep.

image

Makes sense when you think about the number of airlines that that have consolidated, gone through bankruptcy or fallen off the radar screen (think, Pan Am, Eastern, TWA)

The irony is that we feel gouged by airlines … especially when they start charging us for bags and peanuts.

Side note: “ancillary revenue” supplements the flight by another $18 per person on a 100-passenger flight.

That includes fees for checked baggage, seat assignments, ticket penalties and revenue from cargo.

According to the Bureau of Labor Statistics, baggage fees for the U.S. airline industry last year totaled a hefty $3.4 billion, or roughly $5 for every passenger boarded.

Cancellation and change fees totaled $2.4 billion, or more than $3 for every passenger.

Source: WSJ

What’s the problem?

First, there are pricing pressures.

In the past 15 years, fares haven’t come close to matching inflation.

In other words, “real” prices in the industry have stayed flat or declined.

image

That makes sense …

In the airlines, there’s a huge amount of capacity … something close to a commodity product … with high fixed costs and virtually no marginal costs.

Since one more  passenger.doesn’t cost you anything except, maybe a cup of coffee, there’s great  temptation to sell seats at rock bottom prices — just to fill them.

Further, there’s the Southwest factor.  Legacy airlines (think United or American) have big infrastructures, huge hub-and-spoke networks, old fuel – inefficient planes, and high cost, unionized employees.  Southwest’s cost-effective operations — point-to-point network, fuel-efficient 737s,  happy employees — changed the pricing game.

Then, think about fuel costs — generally high, and subject to wide, unpredictable swings.

According to the WSJ, “fuel now is by far the biggest cost for airlines. , the tickets and fees of 29% of passengers pay just for the fuel to make the trip.

Airline gas mileage has improved over the years, the result of filling more seats on each flight, replacing multiple trips on small planes with fewer trips on larger aircraft and replacing older planes with newer, more fuel-efficient jets.

In 2000, U.S. airlines burned 28.6 gallons of jet fuel per passenger. Last year, that improved to 22.5 gallons per passenger. “

Add on maintenance that keeps the planes safe and government fees and taxes (think TSA) and the bottom line is that there is very little wiggle room on the plane for profit.

Put it all together, and airlines — the well run ones — are only able to convert  less than 1% of revenues into profits.

Decoding a Flight
Source: WSJ

Probably not what Wilbur & Orville had in mind …

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For Sale: Best-seller books … Price: $8 per kilo, hardcovers extra.

April 9, 2012

In one of my classes we study how books are priced.

Last fall, a team suggested that page count was a relevant criteria … that books with more pages should be priced higher than shorter books.

I summarily rejected the idea and joked at the team’s expense.

Well, the page has turned.

The team just returned from China and sent me me this picture.

image

 Lo and behold, in China, they encountered book stores that sold books based on their weight.

A counterfeit version of the Steve Jobs biography (above) weighed in at 360 grams, and was priced by weight at 18 RMB ($2.85). Roughly 50 RMB ($8) per kilo.

The team tells me that all paperback books in that particular shop (located on Nanjing road, main street Shanghai) are sold at this rate; hardcovers are also priced  by the kilo but at a higher rate.

OK guys, you get the last laugh.

Thanks to Ash Kaluarachchi & Greg Berguig for feeding the lead

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Wasn’t it cheaper to park here yesterday?

March 21, 2012

Punch line: Airlines have priced dynamically for years — raising or lowering prices depending on how fast a flight’s seats are selling.

Some sports teams have started charging different prices depending on the  day-of-week and and drawing power of the opposing team.

Coke was busted in some locales for electronically jacking up prices when dispensing machines were running low on inventory.

Now, some cities are using high tech meters to dynamically change parking prices.

* * * * *
Excerpted from NYT: A Meter So Expensive, It Creates Parking Spots

As much as a third of the traffic in some areas has been attributed to drivers circling as they hunt for spaces … causing  lost time, polluted air and illegal parking.

In his 2005 book, “The High Cost of Free Parking”, Donald Shoup, a professor of urban planning at UCLA advocated dynamic pricing of metered parking spots — finding the lowest price a city can charge and still have one or two vacant spaces available on every block.

San Francisco is putting the theory to test.

San Fran is using new technology and the law of supply and demand, raising the price of parking on the city’s most crowded blocks and lowering it on its emptiest blocks.

San Francisco installed high tech parking sensors and new meters at roughly a quarter of its 26,800 metered spots to track when and where cars are parked.

And beginning last summer, the city began tweaking its prices up and down and shortening (or lengthening) time limits — trying to to leave each block with at least one available spot all the time.

Eventually, the metes may charge different prices at different times of the day.

“We only need a few people to see there is a price difference and choose to park in a different location to open up just a few spaces here and there.”

But raising prices is rarely popular … and the program was “complicated on the social equity level” since high parking prices can shut out poorer parkers. 

Thanks to JF for feeding the lead.

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Remember when Southwest was the ‘no frills’ airline?

March 16, 2012

Just back from vacation … nice trip if you ignore the travel to and from Punta Cana.

Friends know that I’ve been a SWA loyalist for years.  I liked their cut-rate prices, was willing to forego some frills, and perversely enjoyed the fight to get a pass to board in the prized “Group A” and rush to get a prime seat.

My vacation flights were on United.  Ouch.

Base ticket price was ok … but, then the add-ons.

$25 for the 1st bag … $35 for the 2nd … 50 pound limit — strictly enforced.  C’mon, man.

Good news: United and Continental were converting to their new combined computer systems the morning I was flying … the agents weren’t able to collect the baggage fee because of a systems glitch.  Bank error, my favor

Then, the seat pricing scam.

Of course, I booked at the lowest available fare … with seats in the back.

Going — no problem. Got 2 pre-assigned seats close to the lavs in the back.

Got a couple of emails inviting me to shell out $59.99 each for seats closer to the pilot.  No thanks.

Returning — not so easy.

Initially told: no seats available at this time.  See agent when checking in for the return flight.  Huh?

Kept checking for seat availability.  Kept getting told: None, except for the $59.99 upgrades.  Hmmm.

During online check-in, a miracle.  UAL found 2 seats for us and took the liberty of pre-assigning them.

You guessed it … a couple of $59.99 special upgrades.

May we have you credit card number?  NO !!!

OK, Mr. Cheapskate … here are 2 seats back by the lavs.  Enjoy your trip.

Reminded me of an old restaurant tactic.  Servers were getting spiffed for wine sales.  So, they’d ask “would you like wine with your meal?”.  If the answer was “no”, they’d come back in a few minutes and query: “Excuse me, did you say red or white wine?”.  If the answer was “none”, they’d bring a glass of wine anyway to see if the customer had the nads to send it back.  Folklore had it that wine sales soared.

Hoped my bag would fly free again, but no luck. Got charged $29 (note- not $25) and had to carry on stuff to stay under the weight limit.  Bummer.

In flight, noticed there weren’t many takers for the relatively high priced (and presumed low quality) airplane food.

But, did see a dude walk-in with an extra large pizza.  Not the mini Papa John’s you get at the Verizon Center …. a full 16 inchers.  Thought the guy was going to get mugged.

What an experience.

As a friend observed: Southwest is suddenly the frills airline …

Go figure.

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Ditched by NPR … for the record, here’s what I said.

December 23, 2011

A couple of weeks ago I was invited to do a radio interview with NPR for its MarketPlace business segment.

The topic was retailer’s pricing practices.

Right down my power alley, so I was amped.

I took the interview seriously – even did some research.

Went to the studios for the interview … which was recorded.

After the allotted 30 minutes, the reporter asked me if I could continue for another 3o minutes.

Sure.

I expected she’d pull a couple of 15 second sound bites out of the 60 minutes.

To my dismay, all 60 minutes of my “filet”  hit the edit room floor.  Ouch.

Below, I’ll give my hypothesis for what happened … here (based on my notes) is what I said … some pretty good stuff – if I must say so myself.

Studies consistently show that consumers’ have very imprecise knowledge of prices.

Very few consumers are even able to recall — within 5 or 10% the price they paid … even for recently bought or frequently bought items.

The exceptions are so-called “signpost items” — such as a gallon of milk or a 12-pack of Coke. Consumers often use those items as “sample precincts” used to implicitly judge other prices in a store.

“If they’re priced right on milk, they must be priced right on other products”

* * * * *

People look for “cues” when evaluating a product’s price.

The words “free”. “new” and “sale” are probably the most impactful in a marketer’s vocabulary.

“Sale” takes on a particularly strong meaning when it’s supported by a comparative price claim  … versus competitors’ prices  … or versus a self-proclaimed “regular price”.

Since people tend to have imprecise knowledge of prices, they often  anchor their price perceptions on stated regular prices and react — or over-react – to the implied discounts.

Shoppers conclude – sometimes erroneously: The bigger the discount, the better the deal.

* * * * *

Legally speaking, a “regular price” is defined as a price that was offered for a meaningful length of time and at which a substantial amount of sales were made.

Of course, the terms “meaningful length of time” and “substantial sales” are subject to interpretation and often tough to pin down in practice.

It boils down to whether a good faith effort was made to sell the product at its “regular price”.

* * * * *

While the FTC has legal jurisdiction over unfair marketing practices – including “fictitious price claims” –  it hasn’t brought any cases in the past 30 years.

The FTC has largely delegated enforcement to the states and localities … which have a crazy-quilt of statutes that are selectively enforced, typically when there is a veritable groundswell of consumer complaints.

Even then, cases are hard to prove and any penalties are relatively light slaps-on-hands.

* * * * *

Some retailers make heavy use of what’s called “high-low” or “was/is” pricing tactics.

That is, they run frequent sales that emphasize the discount from so-called regular prices.

Kohl’s is famous for using the “was/is” tactic; so is the men’s clothing chain Jos A Banks – which routinely run sales touting “buy 1 suit at regular price and get 2 for free”.

If anybody buys anything at those stores at “regular” prices, they should look over their shoulders to make sure that Darwin isn’t chasing them”

* * * * * *

These high-low tactics are a relatively benign form of marketing hype.

Savvy buyers ignore everything but the bottom line price that they’ll be paying.

They ask themselves do I want to buy this product at this price?

Sure, they might want to shop around to see if they can find a lower price someplace else, but …

What somebody else may or may not have paid for the product at another point in time is largely irrelevant … except for bargain hunter’s bragging rights.

The real question is whether you want to buy that shirt for $19,99 or not.

* * * * *

Further, strict enforcement of the statutes may actually have a harmful effect on consumers.

Think about it … why force a retailer to sell more stuff at a high price to satisfy a statute?

That would result in consumers – on average – to pay more for products

* * * * *

I get more concerned with hidden charges that aren’t reflected in the prices that customers think they’re paying.

For example, shipping & handling charges that far exceed the cost to ship or handle …

Or, stripped down products that don’t include all the necessary components … like computer peripherals that don’t include the connecting cables … or printers that come with toner cartridges that print a minimal number of copies.

Often times, buyers don’t know what hit them until after-the-fact

Basically, the piece that aired was dumbed down to “lots of stuff is on sale … really, LOTS of stuff”   A surprisingly light piece.

My hypothesis: the reporter went into the story expecting to nail retailers (like Kohl’s) for deceptive practices.  My view was that the “was-is” pricing tactic is pretty benign and that shoppers should just focus on the current price.  That didn’t support the story line.

And, I doubt the reporter could find anybody who got very excited about whether retailers’ “regular” prices really were regular prices.

So the storyline fell apart and “lots of stuff on sale” became the emphasis.

Woulda thought the Darwin line would make the cut. 

Oh well … it made the Homa Files !

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Buffett says: “The airline business is unusually treacherous” … no bleep, Warren.

December 1, 2011

With American Airlines filing for bankruptcy, seem like a good time to dust off a slide I use in my class re: airlines revenue management practices.

My students hear often that I think airlines are pricing masters.

Which begs a question: why is their profitability so low?

Warren Buffett’s answer:

“A great management in that business will not necessarily get a great result …

In the airlines, you have a huge amount of capacity … something close to a commodity product with high fixed costs and no marginal costs

Since that extra seat doesn’t cost you anything, the temptation to sell it at a terrible price is overwhelming.”

As a result, inflation-adjusted air fares have been essentially flat for decades.

image

Even extra baggage fees can’t save the day …

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