Rafi Mohammed - The Art of Pricing

THE ARTofPRICING

HOW TO FIND THE
HIDDEN PROFITS
TO GROW YOUR BUSINESS

RAFI MOHAMMED

Contents

To my family,
thank you for your care, support, and friendship
throughout the various phases of my life.

Preface

Every company Ive met has had hidden profits. By hidden profits, I mean that through better pricing, they could increase profits and generate growth. The notion of better pricing often makes people uncomfortable because they assume it means taking advantage of customers by charging high prices. As you are about to see, better pricing does not have to be so draco-nian and can actually create win-win situations for both consumers and businesses. My perspective on pricing for profits and growth is really about offering customers a variety of pricing options and allowing them to select the one that works best for them.

The goal of this book is to discuss pricing, a key business strategy that many companies struggle with, in an easy-to-understand manner. The clear and friendly writing style that Ive tried to create shouldnt be interpreted as Rafis only discussing the basics of pricing. On the contrary, the concepts in this book range from the fundamentals to state-of-the-art. These tools will allow you to identify and capture your products hidden profits.

As with any challenging project, I had good and bad days while writing this book. On more mornings than I care to admit, it was a struggle to face the prospect of spending another full day on research and writing. However, some afternoons were truly magical. It was thrilling to come up with a new insight or write a particularly clever passage. I find the deeper I dig into pricing, the more fascinated I become with it. In this spirit, Id love to hear your opinions on the ideas in this book as well as your own pricing experiences.

Rafi Mohammed
Cambridge, Massachusetts

CHAPTER 1

Hidden Profits

Pricing for Profits and Growth

My friend David Straus has always been interested in cooking, not just as an avocation but as a career. Hes followed the tried-and-true career path of other successful chefs: attending culinary school and cooking at a variety of restaurants. Dave combined all of these experiences into a unique style of cooking and shares a trait that distinguishes the great from merely good chefs: he cooks to please his customers. So it wasnt a surprise when he recently called to tell me that he was opening his own gourmet restaurant.

After catching up with each other, Dave shared a business problem that he was struggling with. Rafi, he said, I dont know what prices to set on my menu. With a hint of exasperation, he went on to wonder aloud, Should I price the prime strip steak with morel mushrooms at eighteen or thirty-one dollars? How will the thirteen-dollar difference affect the number of customers that patronize my restaurant? His pricing decision was further complicated by conflicted feelings of not wanting my restaurant filled with just a bunch of rich people; I want to serve a more diverse group of customers. But then again, I am in business to make a profit.

Whats interesting about Dave Strauss pricing dilemma is that it reflects a fundamental challenge faced by every business in the worldfrom small startups to Fortune 500 companies.

Ive had the good fortune to work on pricing issues in academia, government, and the private sector. As an academic, I wrote my Ph.D. dissertation, published new ideas in top research journals, and taught classes to budding managers on pricing. As an economist at the Federal Communications Commission, I worked on deregulating local and long-distance telephone rates as well as on public-policy issues that use price subsidies to make telecommunication services affordable to the poor. Today, I work with companies of all sizes in a wide range of industries on their pricing strategies. Throughout all these experiences, Ive found that the root of pricing problems at most organizations is the same: they dont think about pricing in the right way.

For most people, pricing is an unsettling exercise involving a mixture of compromise, fly-by-the-seat-of-the-pants analysis, guessing, marking up costs, following competitors, and doing things as theyve always been done. What usually results is a price that just works. Eighteen- or thirty-one-dollar decisions compromise at $24.50. Whats the difference between using a price that just works and one derived from my pricing for profits and growth philosophy? A lot of hidden profits. The potential benefits of pricing extend far beyond making simple, black-and-white, $18 or $31 decisions.

Continuing my conversation with Dave, I pointed out that his desire to expand his clientele beyond rich diners actually touches on my central idea about pricing: some customers will value your product more than others will. For example, budget-minded young couples with a mortgage and kids who want to celebrate their anniversary with a fancy dinner cant afford to pay as much as the well-to-do who delight in dining at the best restaurant in town. This simple realizationthat customers place different values on the same productsempowers companies to price for profits and growth. The right way to think about pricing is as a series of strategies that serve (and capture different profit margins from) customers with different product valuations.

After an hour of discussing Daves business, goals, and potential customers, we designed a set of pricing strategies for the restaurant. They included early-bird specials; senior citizens discounts; regular menu prices; $200 annual charter memberships that provide a 25% discount on all meals for a year; discounted three-course meal bundles; a lower-priced bar menu; and premium-margined chefs-table seating. Of course, the restaurant will make lower profits from those ordering early-bird specials compared to the margins gained from high rollers willing to pay for the privilege of sitting at the chefs table and hobnobbing with the creative genius behind the meal. But this is exactly what pricing for profits and growth strives to accomplish. The right set of pricing strategies enables companies to serve (and profit from) as many customers as possible.

When I visited Dave six months later, he was beaming with pride at how well his restaurant was doing. He took particular delight in serving, through his early-bird pricing specials, those diners who normally could not afford to enjoy gourmet meals. As I looked around the packed dining room, I was happy for my friend. Dave had done a great job of pricing for profits and growth. Profits were being enhanced by options like chefs-table seating, and the early-bird specials were growing his customer base. Think about all the hidden profits Dave would have missed out on had he viewed pricing as an $18 or $31 decision!

This book presents a pricing for profits and growth philosophy thats relevant for any service or product, as well as for any type of businessdomestic or global, large or small. The reason for its universal applicability is the simple fact that for every product in the world, there are at least two people who are willing to pay different prices. Think about your own customers. Arent there some chefs-table customers who you know would continue to purchase if prices were raised? Similarly, arent there some early-bird shoppers who could be converted to customers if they were offered a lower price? If your company thinks about pricing primarily as an either/or, $18 or $31 type of decision, you are leaving a lot of money on the table. From this point on, pricing is not about setting numerical prices, its about creating a set of strategies to maximize your companys profits. Just as important, these strategies are easy to create and can be implemented on Monday morning.