To Be or Not To Be, That is the Question…

A hard question to answer in a business school professor’s teaching life.  Am I just teaching common sense? Is This Material Too Simple?  Existential questions.  And then comes evidence that actually rather basic knowledge is quite helpful.  Witness the startling article “Real-Life Lessons in the Delicate Art of Setting Prices” in the NYT.

Lesson 1: Inelastic Demand

‘About three years ago a computer error caused all of the prices on Headsets.com to be displayed at cost rather than retail. With the lower prices on display for a weekend, Mike Faith, the chief executive, expected sales to soar. Instead, the increase was marginal. “It was a big lesson for us,” Mr. Faith said’

Lesson 2: Vertical Differentiation and Market Power

(1) Math tutor Kronenberg:

‘I learned it’s a misconception that if you raise prices too much, you’ll have no business,” Mr. Kronenberg said. “There are many customers who shop based on quality, not lowest price.’

(2) Headsets.com:

‘[Mike Faith] realized that sales for his company, which is based in San Francisco, were far less dependent on price than on what he now says differentiates his business: customer service. “Every call we get is answered by a human being within four rings,” he said, “and our reps are well trained and know a lot about the headsets.”

Since the incident, Mr. Faith has raised prices once, by 8 percent and without much fanfare, although regular customers were told in advance. The result? Revenue rose about 8 percent as well.’

(3)  Artisan wheat flour producer:

`Naomi Poe, founder of Better Batter Gluten Free Flour near Altoona, Pa., learned that it is important to try to understand how your customers value your product.

In the food industry, Ms. Poe said, customers generally look for the cheapest price, but because her flour and baking mixes contain no gluten, they cost more to manufacture. She initially tried to compete with products that contain gluten on price but lost money on every sale. To raise prices, she had to convince customers her products offered added value. “In blind taste tests on regular people — not just those who are gluten-free — we heard consistently that our cakes were superior,” she said. “We also offer an unconditional guarantee as well as education and counseling.”

 Her first year in business, 2008, she raised prices 20 percent, increasing her gross profit margin — the profit on each item she sells — about 11 percent and increasing sales revenue 25 percent, she said.
“This helped us cover our expansion costs in 2008,” Ms. Poe said. After that, the business grew about 250 percent year to year.’

(3) Lesson 3: Price Discrimination

‘Last year [Footsyrolls, a company producing roll-up flat shoes] changed their offerings, going to two tiers of products and pricing. The Everyday Collection sells for $20 a pair and a higher-end category, Lux, for $30 a pair. “We actually have had the most interest in our higher-priced shoes,” Ms. Caplan said.

Because they brought one line down $5 and another up $5, the average price per unit remained about the same, but the impact was immediate. “We introduced the Lux line in summer 2010 and had a 100 percent increase in revenue,” she said. “We actually ran out of stock.”’

Lesson 4: These people need more lessons.

(1) Mike Faith: ‘The truth about pricing is it’s an art with a little bit of science, rather than a science with a little bit of art.’

No, Mike!  It’s the other way round.

(2) Naomi Poe: ‘In January she raised prices an additional 10 percent, this time to cover broker and distributor fees as well as the rising cost of fuel and ingredients. Far from losing customers, she saw her revenue double and her gross margins leap to about 36 percent from 20 percent.’

Revenue is not the same as sales.  Sales can go down when you raise price and revenue go up.  If this happens, your price is in “negative marginal revenue” territory so your pricing strategy is horribly wrong.  Perhaps a short exec ed course at the Kellogg School of Management taught by me for a large but well worth it fee will help you learn what marginal revenue means and make you hundreds of thousands in profits.

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