Learning from industry
Pricing across the lifetime of a product
Add-ons and after care – double the profit
Unexpected extra costs and penalties
Price matching promises to (accidentally) stop competition
Power by the hour – changing the supply dynamic
In this chapter I’m going to look at the wide variety of pricing strategies and tactics of very disparate businesses. They might be consumer facing, transport, technology or industrial and I want to see if there are lessons that we can learn from the approaches that they have developed in order to survive and prosper.
Some of the most interesting lessons are about how you might deliberately vary the price of a service across its lifetime (rather than just having one price); using price to match your capacity in the way that airlines do; using add-ons and maintenance contracts to dramatically increase the profit per transaction; using key client programmes to drive and reward loyalty; and how to use price matching to prevent a price war.
PRICING ACROSS THE LIFETIME OF A PRODUCT
Sometimes called ‘skim pricing’ because of its skill at taking extra money off early adopters, there are some valuable lessons to be learnt from a proactive approach to product cycle pricing. This is in contrast to the much more common, passive approach which occurs by way of default, where service firms drop their prices late in the service cycle when clients refuse to pay them. Let’s look at this in practice.
In the technology sector it is very common to bring out the latest gadgets at a very high initial price (aimed at the segment of customers who have to have the latest technology), and then after a relatively short period (six months being typical) there is a reduction to attract the next segment of customers before finally being discounted at the same time as the next innovation is launched, and the cycle starts again.
The pricing over time would look something like Figure 9.1.
In this example, a company introduces a 40-inch television at an initial price of £700, in the knowledge that this is currently the largest size available and also that it has a 55-inch television with 3D capability in development. After the early adopters have paid £700 it drops the price of the 40-inch model to £450 at the same time as launching a 55-inch model (but holding back on the 3D) at a price of £800. Again it waits for the early adopters to pay £800 before dropping the price of the 40-inch model to £300, the 55-inch to £600 and launches a 55-inch plus 3D model for £900, and so on ad infinitum. Life-cycle pricing requires constant innovation so that new, higher specified models are continually coming along the track.
Figure 9.2 Skim pricing
For an individual product or service, skim pricing looks like Figure 9.2.
This works well in the electronics industry, which needs to keep innovating and to keep persuading us that we need to buy their latest product. The initial production run might not be huge because there could be a relatively small number of early adopters, and as scale production begins the price can be dropped against higher production runs. Notice also that this approach is very different from the more typical ‘cost-plus’ approach to pricing used in services. The cost-plus model tends to allocate the same price to the service throughout its life cycle. This means ignoring the realities of the marketplace, which could mean undercharging at the start when a service is cutting edge (and a premium is justified in market terms), but then overcharging in maturity when clients are seeking lower prices for a service that has become more commonly available. The end result is that there is a failure to realise available profits at the start and clients force the price down (switching suppliers, or threatening to) as it becomes more widely available. Cost-plus would be the equivalent of pricing at the level of the ‘Second price’ in the graph in Figure 9.2.
It is common for there to be a life cycle in service offerings, but it is rare for the firms involved to prepare for price drops as the market matures. That would mean planning to deliver cutting-edge services based on using Rocket Scientists to solve new problems (or to produce new answers to old problems), but in the knowledge that this workstream needs to be passed across to Relationship Advisers at some point who can then deliver well-established solutions at lower prices using teams with higher leverage. Rather, service providers tend to complain about the commoditisation of their services as their Rocket Scientists find increasing price resistance from clients. The same applies to Relationship Advice which (over time) moves to Routine Work (as some, but not all, will).
Service firms can be at a definite advantage to competitors if they introduce this change of work methodology, and therefore change pricing, over the lifetime of a service. They will end up driving the process while continuing to develop new services at the top end. What are you doing in your business to manage price across each service’s lifetime to achieve that?
Try this exercise: imagine that a brand new competitor is coming into your market. They don’t carry the baggage of the past. They are starting with a blank sheet of paper. What specific area of your business should they target if they are going to be most successful? Given that they are starting afresh, how should they best organise themselves in terms of location, team structures, technology and so on?
Spend some time thinking about what this competitor would look like if they got it absolutely right – targeting exactly the right segment of your market and set-up to do so efficiently and so as to maximise their profit? You could find that the design you create is very different from your existing set-up. That’s interesting in itself, isn’t it? Now, the good news is that this competitor doesn’t exist today – but why don’t you create this competing service? In fact, with your existing experience you would make a better job of it than they would. Don’t wait for a new competitor to get it just right. Do it yourself!
This type of thinking is increasingly important. It will ensure that you do not complain that your (premium) services are being commoditised, but that you take the lead in seeing where you can create efficiencies due to your experience in carrying out the work. As a team handles more and more work of a similar type they will benefit from the experience curve effect: that over time the cost (time) of carrying out a task drops. This is an opportunity to revisit the team needed to carry out the work and it enables you to create different services at lower costs. That doesn’t automatically mean that you need to reduce the price to clients – at least in the early stages you can simply achieve higher profitability.
Given the benefits of life-cycle pricing and using innovation to develop better services, it is a surprise that more service firms are not embedding this at their core. Innovation can create newly differentiated services justifying higher prices or it can be used to lower production costs when prices are falling. The key elements in success will include the following:
- Creating the right internal culture for innovation. That means having very visible support, from the top, and devoting people, time and money to innovation while recognising that these new projects carry a higher risk of failure than existing products.
- Aligning your reward systems. Most service firms offer greater rewards to people who do not innovate! Firms look for volume returns, and that may reward those who reliably deliver the equivalent of 40 televisions rather than taking time out to develop new services (some of which may fail).
- Involving your clients. The real dangers in internal teams being ‘creative’ is that they are very unlikely to produce solutions that meet current clients’ expectations and needs. This is not a question of handing the project over to clients (as Henry Ford remarked: if he had done that his customers would have demanded faster horses, rather than cars), but it does mean trying out your ideas on them and asking them to help you build final services which are of maximum value to them.
- Using external facilitators. Teams that are wholly internal may fail to ask obvious questions because they have become institutionalised. They may accept ‘the way things are done around here’. An outsider may be much more challenging.
If you do start producing new solutions and services, then reread Chapter 2 to remember the rules for pricing new service launches.
PENETRATION PRICING
The exact opposite of skim pricing, penetration pricing, is about entering a market (or creating a new one) at deliberately low prices in order to establish a foothold in a competitive market. An often-quoted example is the Lexus car, introduced by Toyota into the United States in 1989 as an entirely separate marque designed to compete with the likes of BMW and Mercedes Benz. At its launch the Lexus would have been something of an unknown quantity. It had no established track record and despite the obvious build quality, customers would have been nervous of being one of the first buyers. The Lexus strategy was to create substantial value in its product but also to price it about 40% below its intended competition. That enabled it to gain a foothold, build up its sales and then, year-on-year, increase its prices to their intended level.
Partners love penetration pricing even though they don’t call it that. Typically a partner meets a potential new client and wants to be certain of winning the first job. So they deliberately go in very low on price, but as previously discussed, this tactic is more likely to position you as a low-price provider in the mind of the client and make it very difficult for you to charge realistic prices later on. However, there is one area where I believe penetration pricing can be very successful, and that is in the realm of cross-selling additional services to an existing client. In this case you have already built up a reputation and a position. You want to persuade the client to try you out in another area of work and here you could position an offer as follows:
I know you have not tried out our services in [new work type/new location] but I would like you to do so. To encourage you to try us out, I would like to offer you a 50% discount on the first piece of work. In that way you will have the opportunity to see what we can do and in the process will make a substantial saving.
Positioning the cross-selling offer in this way makes it very clear to the client that subsequent pieces of work will not also be at half price, while showing them a real benefit for giving you a trial.
A second way of using reduced prices is in relation to referrals. What is it worth for you to gain another client in the same industry as an existing client? How much would you be prepared to spend in terms of marketing, hosting events and creating brochures in order to gain such clients? What is the best, most successful way of gaining a new client (and I will give you a hint, it’s not the brochure)? One of the strongest reasons for a new client coming to you is because they receive a recommendation by someone in their industry.
Putting this together means that you can actually reward your existing clients for giving referrals. If you did this directly to the introducer client, then this might look quite improper and indeed may have influenced their introduction – but there is a way of giving rewards that works for both of the clients. I first saw this approach used by an accountant. In return for the introduction he emailed both the clients, thanked the introducer for his actions and said that as a reward he would give the new client 10% off their first three months’ fees. That makes the introducer client feel great as their actions have directly benefited the new client. It also gives the new client an extra incentive to test you out. Rewarding referrals through pricing is an effective and safe way of building new business.
LEARNING FROM AIRLINES
Where to start? Airlines have developed such sophisticated pricing strategies to cover a combination of yield and price management that they are generally seen as at the forefront of pricing innovation. It is worth unpacking some of their approaches to see if we can use them more broadly.
Segmentation
Addressing different parts of the flying community with very different offers is clearly at the heart of much airline competitive strategy. From the budget airlines seeking to profitably serve the most cost-conscious travellers (but then developing clever tactics to derive the maximum yield from those passengers) up to flag carriers running business-only aircraft on the most lucrative routes, and everything in between, there is clearly a high level of sophistication here. One very interesting issue that arises (and has great implications for brand) is whether a premium service provider can also provide a very low-cost service. You might think that they already do, when you step onto a large aircraft and see a small first class section, a larger business class followed by premium economy and economy. However, the budget airlines showed that a very low-cost service is actually something very different and (at least initially) is built on the basis that a clean start allows the budget airline to create low-cost services using its cost base advantage. It is not saddled with legacy costs (particularly labour costs), can buy the latest, most fuel-efficient aircraft and create lean administration and overheads (EasyJet began in a tiny cabin at Luton Airport). It can offer seats at prices that, if matched, would mean a loss on every seat for the traditional flag carrier airline. Of course, as budget airlines grow and mature there is increasing evidence that their complexity starts to erode some of their cost base advantages, but there is no doubt that their fresh start approach offers us some lessons.
No matter what type of service you are currently offering in the Relationship Advice or Routine Work space, it is likely that a new competitor could use these techniques to start afresh and create a service that looks similar to yours but at a lower price; or to create a service that is unashamedly a cut-down version of yours, but at a much lower price. How do you react? The risk for you is this: clients who are price sensitive may ask you to match these lower prices so that they can save money, and even very loyal clients themselves may have come under pressure to cut costs and start passing on that pressure to you. If you are in the position of the flag carrier airline then it is easy to match the lower price, but only by sacrificing all profits, which is not a sustainable strategy. If your cost base is higher than your competitors’ it is not wise to start a price war.
There are three strategies that can work:
- The first strategy is to accept that a proportion of business will be lost to the lower cost competitor and to concentrate on making a good profit from the others. For example, let’s say that 25% of your customers will be lost to the ‘budget’ competitor. It may be better to carry on providing a better, more expensive service to the 75% than it is to fight over that 25% and have to lower prices and perhaps take your own brand downmarket in the process. In my observation of telecom companies, I have seen financial calculations that show them to be much more profitable by accepting the loss of a client segment rather than seeking to match a new competitor.
- The second strategy is to introduce ‘complex pricing’. Using this, you erect barriers to a client obtaining the lower price so that effectively the clients self-select who receives lower prices. This might include being able to order well in advance, having to accept minimum quantities, carrying out some of the work themselves (the equivalent of printing your own boarding pass) and so on. This can be really successful in beating off the lower priced challenger by showing clients that, provided they meet some (reasonably possible) criteria, then your price is pretty similar. In fact, budget airlines realise this in reverse, because if you try to book a flight at short notice for a short trip (so that you look like a business traveller) then you might be surprised to see that their price is very similar to a flag carrier airline. I have also seen complex pricing, which is just designed to be complex and deliberately so. In these cases – and they often appear across industries in response to initial price-driven competition – each company offers a complex plethora of options so that it is difficult to know in advance which company is going to give you the best deal. Think of utilities and telecoms providers. If they all offered exactly the same service then customers would be left only to compare on price. If I can buy my electricity from three possible suppliers which all charge a monthly fee of £10 plus 15p per kilowatt hour, then there is no competition. If one supplier drops to 10p a kilowatt hour then I (and everyone else) may move to them, which would force the other suppliers to match it. So their defence is to create multiple, complex tariffs, some offering fixed rates, some variable, some with standing charges and some without.
For generic goods (or services) simple price competition isn’t going to work because any supplier dropping prices will find that their competitors have to match them or lose the market to them. I’m not sure that any electricity supplier could convince me that they gave a valuably better service than others because I am so used to a completely reliable electricity supply (of course it would be different if the supply was somewhat erratic and one supplier was able to improve upon that). In these circumstances, the suppliers will try to segment the market. One may offer a service to low-volume users which omits the monthly fee. Another may target the highest users and pass on some economies of scale because servicing three very large homes with three large bills is easier than having to earn the same money from 20 small flats. Yet another may offer to fix the price for 18 months in advance in return for charging a small premium over the existing price. Others may target customers who buy both their gas and electricity from one supplier. That creates a veritable forest of possible costs with the result that there is no clear single route to a lowest price. It works where the buyers are small compared to the seller, but a major buyer may well demand much simpler prices.
Complex pricing can work particularly well in the area of Routine Work (although a preferable method is to adopt a drivers-of-value approach), but it can be less acceptable in Relationship Advice, where it cuts across the essence of fair dealing that is implicit in a genuine relationship. - The third strategy, when faced with a ‘budget airline’ competitor, is to take them on head-on and create a division or a subsidiary that offers a very similar (cut down) service under a different brand name. This strategy accepts that a proportion of existing customers will leave for a budget offering and that you would rather capture these (or a good share of them) by beating the budget carrier at its own game. This sounds acceptable in broad terms, but commercial history is littered with failures when this approach has been taken. The mind set of the management in a budget airline or any low-cost operator is very different from the traditional service provider. Even if you recruit such people and put them in a subsidiary, there comes a point where the parent becomes tired of its offspring poaching its customers for lower fees. At some point, the lower cost alternative is cannibalising the parent company’s customers, and doing so in order to offer them lower prices. For this reason I recommend to clients that initially they adopt a semi-revolutionary approach, as explained in the discussion of skim pricing, where a team is offered the opportunity to do things in a different way within the organisation, rather than trying to imitate a low-cost competitor. This opens up the opportunity to offer different levels of service within one brand (think of the different classes of travel offered by an airline) rather than jumping into the house-of-brands approach seen in the Volkswagen Group where brands (and prices) range from Skoda to Bentley. The latter approach may be necessary in your market but requires greater resources to pull off successfully.
Loyalty schemes
Also used extensively in the hotels sector, loyalty schemes are designed to give the customer a reason to use the supplier again, other than one based upon lowest cost. This works on two levels. First, it encourages loyalty by giving better benefits to the higher levels of membership. You repeat purchase so that enough points are awarded to reach the next tier or to remain there. Secondly, it gives rewards based upon usage so that customers will see value in repeat purchases irrespective of the tiers – for example, trading in points for free flights or hotel nights. A typical airline scheme might have levels and rewards as shown in the table below:
| Level | Rewards |
| Blue/red/green | An ability to collect points that can be exchanged for free flights, or for discounts off flights, or for other goods and services |
| Silver | Above plus the ability to reserve seats for free when booking a flight, priority booking and check-in, access to business lounges, bonus additional points on each flight |
| Gold | Above plus access to first class lounges, first class check-in, free extra luggage, etc. |
These schemes do actually create loyalty at a minimal cost to the airline or hotel. Free flights will be offered on quiet flights when there should be empty seats and similarly a hotel can fill up empty rooms during quiet periods. Business lounges and first class check-ins are already in place, so the marginal additional cost of another user is low. I would say that a key part of any successful loyalty scheme is to find benefits that are low cost to you but high value to your clients.
There is clearly a fair degree of cost and organisation associated with a full-blown loyalty scheme. If your business is one that can benefit from this then I am sure it will repay the investment. My experience of service businesses generally has been that only the largest could even contemplate a formal loyalty scheme. However, that should not mean that your loyal clients are given nothing. There are two really good reasons for this: first, loyalty schemes work because they drive loyalty and that is very valuable in profit terms to any business. They are a clear alternative to trying to attract clients with ever lower prices. Secondly, they can be a well-structured way of giving higher benefits only to your most valuable clients rather than their being handed out (often over-generously) by partners on an ad hoc basis.
A well-devised loyalty scheme on a smaller scale can be built around a Key Account Management Programme (KAM). In case you don’t have one of those, KAM identifies your ‘top clients’, usually based upon turnover (or clients that you think have the potential to grow substantially), and puts resources into better understanding their needs so that you can look for ways of increasing your share of their spend by satisfying those needs. Here’s a good question relating to the current position in your business: in terms of the quality of service, the best teams of people, the discounts and the added value, are these targeted at your KAM clients, or is it rather more haphazard? While I may not advocate handing out different coloured plastic cards to your clients, you really should be categorising them in terms of their value to your business as Group A at the top, then Group B and Group C, so that you can then carry out a comparison of prices and added value given to them (more about this in Chapter 11). Finding a Group C client who has a better deal from you than a Group A client should be considered to be a major issue (it puts the Group A client at risk because they would be rightly angry if they discovered this).
This type of categorisation also helps in two other ways. Clients may try to impose a ‘most favoured nation’ clause upon you. Such a clause says that as a major client of yours, you undertake not to give better terms (prices, added value or otherwise) to any other client and that, if you do, you will notify the major client and give them the same deal. I think these clauses are extremely difficult to enforce once an organisation grows in size (because of the difficulty of tracking the actual deals done by partners in every location), so they are worth resisting on that basis alone. If the clause must be conceded, then having a proper loyalty/KAM scheme makes it easier to keep track of deals for major clients and to say that the price match will only occur with a client who is providing you with the same type and volume of work. For example, a client who sends you twice as much work (or work of a higher value type) may have a better deal than that given to the client with the most favoured nation deal. Additionally, this should start you thinking about what extras you should give to your best KAM clients based upon their value to you. In creating these extra benefits it is important to think about what the client values, but is low or zero cost to you. For example, if you have city centre offices, clients may find it valuable to be offered the opportunity to use your offices for meetings. You might find it low cost to host a client’s team meetings but that might be highly valued by the client. It’s well worth a brainstorming session to create these options. In other words, look at the type of added value that airlines give to their top-level ‘Gold’ clients and think about what you could provide to your best clients that would be similarly valued by them.
Pricing by the client – in acceptable ways
Much has been written about the skills involved in pricing ‘by the client’, but that makes me nervous. It takes me back to the conversation I had with a plumber who said that he priced his jobs based upon the length of the drive leading to the front door. The longer the drive, the more the client could afford to pay. That doesn’t seem fair and appropriate. It would be like writing a book and then selling it at a different price depending upon the buyer’s earnings in the preceding 12 months. So the crucial issue when charging clients different prices is to make sure that the difference is justifiable. Let’s look at some real-life examples.
Airlines, and also flight search websites, are able to map and model passenger price sensitivities and therefore exploit the price sensitivity of individual passengers to better maximise the profit on each seat. The airline may use some or all of the following factors to create ‘dynamic pricing’ that reacts to actual client demand:
- Seasonality – this is demand driven. Those travelling in a high season will expect to pay a higher price, and are therefore less sensitive to the price. Flexibility on dates would often result in lower prices.
- Priorities – direct or indirect, time of flight, departure point and destination. The level of inconvenience that the passenger is willing to bear will affect the price paid.
- Flexibility in ticket – refundable, changeable tickets will come at a much higher price when compared to a non-refundable fixed one.
- Class of travel – airlines have different classes of travel to address the needs, and therefore price sensitivities, of each segment.
You should examine how you could import this type of thinking into your service business. Which clients are the most demanding in terms of service quality and speed? Try to separate out a different, higher priced, service for them which brings them the benefits they need but charges them extra for those benefits. What are the variables around your service?
If you schedule work for months ahead, do you charge the clients for cancellation? If you do then that means that you could offer a ‘no cancellation fee’ option at the outset at a higher cost. Let’s say that clients book training workshops from you, but the reality is that some will cancel with relatively short notice for one reason or another. You may well have standard terms which say that cancellation is free if 10 weeks’ notice is given, but incurs between 20% and 75% of the fee for cancellation between 10 weeks and two weeks before delivery, then 100% of the fee if under two weeks’ notice is given. That seems reasonable but it also may be somewhat theoretical – in practice, good relationships with clients may mean that you find it difficult to charge cancellation fees. In such a case you could offer ‘no fee cancellations’ provided that 10% of the cost of the workshop is paid as a ‘flexibility’ fee. This should represent marginal extra income (especially if you have found it difficult to impose any cancellation fees in practice). You can calculate the necessary additional fee by looking at past experience and you may want to charge more to a client who regularly cancels or reschedules than one who does it rarely. Or you could offer clients a reduced fee for a workshop if 100% is paid in advance and it is inflexible (no refund if the workshop does not take place). This is similar to the airlines fees for flexible tickets as opposed to lower-cost inflexible ones. This neatly brings us into the issue of service add-ons.
ADD-ONS AND AFTERCARE – DOUBLE THE PROFIT
Anyone who has had the pleasure of shopping for electrical goods and appliances will know the hard sell of a salesperson who tries to persuade you to buy an extended warranty for a product that, not 10 minutes previously, they were praising for its build quality and reliability. There is a reason that the salesforce are often given targets for sales of extras and aftercare products like this. This marginal extra income (all of their expenses in running the business are there anyway, whether they sell you an extended warranty or not) can be a very substantial source of extra profit. It is not unusual for the business to double their profit on the transaction if they are able to sell add-ons to you at the same time as they sell the primary product.
Let’s look at some easy examples. In the past, a fast food outlet might have offered to supersize your meal (or offered you fries if you haven’t already ordered them) this is an easy way of substantially increasing the profit on your visit. The idea of ‘supersizing’ is often credited to David Wallerstein, the manager of a chain of cinemas in the 1960s in the United States who wanted to increase sales of popcorn (and bearing in mind that, at the time, only one size was offered). He found that people were unlikely to buy two bags of popcorn each, but when he offered also a large size, sales increased dramatically. He was then recruited to work at McDonald’s and is credited with introducing the supersize offer (although supersize meals ended up being phased out). If you examine the economics, it shows the dramatic difference. If the profit to be made on a $5 meal is $0.50 and the customer supersizes for $0.75 extra, then if the extra ingredients cost $0.25 you just doubled the profit you are making from this transaction. Car dealers are well known for offering optional add-ons and there is no doubt that persuading you to add air conditioning, metallic paint or satellite navigation to your new car can make a very real difference to the total profit that the dealer makes on the sale. In many cases the dealer’s profit from add-ons is greater than the entire profit made by selling you the base model of the car.
In addition, there are ‘aftercare’ products and services which involve you in paying for something which is going to take place after the sale, such as maintenance agreements, extended warranties or the supply of consumables (for example, it is possible to sell you an inkjet printer at a very low price in the knowledge that you will have to pay a lot for the supply of ink cartridges).
How does this play out for a services firm? I have found it useful to think of these extras in two groups: add-ons, which enhance the service that will be delivered (‘supersize me’ or ‘do you want fries with that?’), and aftercare, which relates to a follow-on service which is sold at the same time as the main service (even though it will be delivered separately and after the main service has ended). They are particularly powerful with larger pieces of work because the initial budget might be able to cover the extra cost, whereas if you try to sell these additional services afterwards you may find that the client has no budget from which to draw the cost.
Let’s look at some possible examples. If you are working on a major project with a client then a useful add-on could be that you would lend them a member of your team who would work alongside them and help them to manage their end of the project. This person will be embedded in the client’s team and, because of their previous experience, will help to ensure that the project is a great success. For clients who are having their first taste of such a major project, this could be assistance and reassurance that is well worth buying. Or you could offer the client a ‘dedicated team’ for the duration of a project so that (in return for an additional fee) named members of a core group agree not to take on other work during this client’s project.
In other cases you could be the intermediary who benefits by taking a fee from an add-on from another supplier (as is the case when a retailer sells a customer an extended warranty). Estate agents, for example, may earn fees by introducing clients to suppliers of legal services, removal companies, sources of finance, home design or furnishing.
If you are something of a ‘deal junkie’ who carries out one-off projects for clients, then it can be valuable to step back and think of what happens to the client after your involvement in the deal has completed. There may be issues over implementation of the work or important dates and milestones that need to be followed up. These are typically left for the client to handle (the deal junkies by this stage being wholly engaged on their next deal), but it could be valuable to offer the client some support from your own (separate) implementation team. The client may find it possible to add in this expenditure at the outset as part of a global fee, in cases where they would find it impossible to access a budget after completion. If there are key dates and milestones then it should not be difficult to persuade a client to effectively buy some insurance against missing them by having a clear aftercare service from you that will provide timely reminders to them – provided, of course, that you have insured yourself against missing them!
There really shouldn’t be any area of your firm where you cannot think of genuinely valuable add-ons and aftercare that could be offered to clients. Similarly, there may be particular methods of working with individual clients to better meet their needs during a major transaction, in which case there are opportunities to offer extra support for an extra fee.
If you are successful in developing a range of add-ons and aftercare services then you now only have one more obstacle to overcome – your own partners! Despite clearly pricing these additional services, within a short time of their being announced some partner will have already offered all of them to a new client for free, with the explanation that it was essential in securing this important new client. There will be a variety of reasons why the partner has done this and some of them do have apparent validity. For example, a potential client may have been genuinely influenced into choosing you by the array of free add-ons, but it is worth challenging this, as I consider that the client’s actual choice is more often about the core service.
To get to grips with some of the issues here, it is probably useful to draw an analogy from the car industry. For example, imagine a situation where Ford and General Motors have competing models in a particular market segment, and let’s say that they both enjoy a 40% market share. The Ford dealer and the General Motors dealer have a series of different models within the range and also have a number of optional extras which would be an additional cost for the customer on all but the top of the range models, which include items such as satellite navigation, air conditioning, metallic paint, leather seats and so on.
If Ford were now to recruit a services firm partner as a car salesperson, targeted in the same way as the average partner would be (on turnover rather than profit), then they would see a dramatic improvement in their sales. The basic model would soon be being sold with the completely free addition of satellite navigation, air conditioning, leather seats and auto-parking at the very least. This would result in a greater number of sales and the market share of Ford might reach 50% or even 60% before General Motors even understood what was going on. The partner will claim that customers are, time and again, choosing Ford because of these extras.
The only problem with this huge success is that effectively the partner has been making substantial price cuts but disguising them by charging the full price for the basic model (no price cut there), then throwing in the extras. This is really just a variation on price cutting, and cutting prices is very successful until the competitor reacts. The likely end result in the car contest is, of course, that General Motors either adopts the same strategy on its add-ons or effectively does the same by cutting the prices of its basic model. Both Ford and General Motors suffer greatly reduced profits in this area of the marketplace – and any market share gained by Ford would be very short term indeed.
So what is needed are some real controls on the abilities of partners to give away these valuable extras. In one firm that I worked with, this came down to allocating very clear and communicated costs to each add-on and aftercare service, and then circulating lists to all partners where these had been given away. Once again it was a question of using transparency and peer pressure so that partners saw a benefit in selling extras, rather than giving them away.
UNEXPECTED EXTRA COSTS AND PENALTIES
Bjorn Hanson, a clinical professor with the New York University Preston Robert Tisch Center for Hospitality and Tourism, estimated that in 2014 hotels would charge $2.3 billion in additional fees, up from $2.1 billion in the preceding year. Mimicking the airline industry, which had learnt to charge extra for printing a boarding pass or choosing your seat, hotels were adding ‘resort fees’ (a daily fee for using the facilities at the hotel), and fees for early arrival and late check-out, luggage storage or parcel receipt.
It can be tempting to follow suit, but in terms of fair pricing (sustainable and believed to represent reasonable value by your client) there is a great difference between being offered an opportunity to have a late check-out at 4pm in return for a (reasonable) fee, and being charged a daily resort fee which is not optional and was not made clear it was going to be an additional cost at the time of booking. If I reserve a room at a hotel for £200 a night then it is not appropriate to make that £230 because of a compulsory resort fee, even if that does include free Wi-Fi and a bottle of water.
When you start thinking in terms of extras, they must be truly optional, clearly explained and fair. For example: you need to rent a car for a week and you compare prices with two or three major car rental companies before settling upon one that seems to offer a good deal on the car that you want. As usual you buy full collision damage insurance so that you won’t have anything to pay in the event of an accident. Several weeks later, you arrive at the rental location to collect your car and you are offered optional collision damage waiver insurance. You explain that you already bought that, only to be told that the collision damage waiver insurance which you bought online when booking the car does not cover the first £2000 worth of damage. The extra cost insurance you are now being offered covers that first £2000. The cost of the extra insurance is 50% of the total cost of the car hire! How does that make you feel? Will you ever use this car rental company again? On paper they just increased their prices and their profit.
So, bear that in mind when creating extra charges.
INSURERS AND THE POOL
It is worth looking at how life insurance developed different prices for different groups of people. Insurance is essentially a pooling of risk so that, in return for a premium, the insured obtains cover against a risk – the greater the number of people in the pool, the safer it is to be able to estimate and average out the risk. Initially this was a simple pool where the risk was averaged based upon age and everyone charged accordingly.
However, some companies decided that if they could actually just insure the good risks, those with a lower than average death rate, then they could offer them lower premium rates and still make a very good profit. For example, they could offer life insurance only to 18 to 60-year-olds, in the knowledge that the mortality rate would be less than if they offered cover to all, including the over-60s. They might additionally use geographic data (because where you live has an impact upon your health and life expectancy) to find those with better than average chances of survival. Having carried out that exercise, the insurer could offer lower rates to their chosen market segment than a competitor who just averaged risks across all. In other words, the good risks will not be subsidising the bad.
In general, service firms tend to be closer to the original broad pool approach in that we put too little effort into distinguishing between the actual amounts of work that different clients cause for apparently similar tasks. I can think of one example from my own experience, where we were carrying out a similar work type for several different banks. However, the way that the banks were organised internally meant that although we were charging all of them the same price per transaction, the actual work involved varied quite dramatically.
Separating the work out into different elements, and looking at the cost to you of carrying out each part of the work, enables you to refine your prices. Clients who choose everything on the menu (or simply cause more work) are offered a higher price (reflecting the greater amount of work, and hence staff you have tied up in carrying out the transactions), but with the option to reduce the price (even to lower than the average) if they change working practices to reduce the amount of work for you.
PRICE MATCHING PROMISES TO (ACCIDENTALLY) STOP COMPETITION
We can all recall examples of situations where companies have launched price promises. These take the form of saying that ‘no one will be cheaper than us’, or that ‘we will match any competitor’s prices’, or that ‘we will check our competitors to make sure that you get the best deal from us’ and so on. I am sure that none of these companies ever intended to stop price competition in their sector, although that can be the consequence. These types of campaigns come in two varieties: genuine price matching and partial price matching. I want to examine them separately.
Genuine price matching
Imagine a situation where you have commodity or generic goods (water, fuel, sand, cement) or branded goods (televisions, computers, food). I want to look at petrol first, so you are going to be the owners of a petrol station. You have just two local competitors who have been coexisting with you over many years. There is sufficient local business to keep you all profitable but then one of your competitors is taken over by a national chain. They start a price war. The clear and obvious purpose is that they take market share from you. After all, petrol is petrol and it is going to be very difficult for you to show a valuable differentiation in what is seen as a generic product. If you don’t match the price you may find that too much of your business is lost; if you do match the price then you (perhaps also your other competitor) are now both selling fuel at lower prices, so your profit is reduced, if not removed. If you do match the competitor’s price, maybe they will cut again. You are in a bad place. Your customers are being taught to shop around and start actively checking prices. You are in a race to the bottom.
There is a neat alternative which can stop price competition: that is, to display a large sign at your petrol station announcing a price match promise. So it might say ‘The lowest prices in town – we guarantee to match local prices’. Now your customers don’t need to shop around and, more to the point, your competitor needs to stop dropping prices, because you have also very effectively signalled to them that whatever price they drop to, you will match it, and so price cutting by them is pointless. It will not win them any extra business (because you will match the lower price), it will just lower their profit. Unless their intention was to drop to uneconomic prices to drive you out of business (and then put up prices now there is less competition – something that most competition regulations forbid), they will stop price cutting. In fact the lesson they will learn is that if they put prices up you will follow, with the end result that price competition ends and you both make higher profits. So that is a really interesting side-effect of price matching and the next time you see this, think about whether someone is trying to stop their competitors cutting prices. To work effectively it needs to be communicated loudly, so that the price cutting competitor gets the message that cutting prices will not win them any market share because you will immediately match the cut.
Partial price matching
More recently, I have seen price matching defences (particularly around branded goods) become a bit more sophisticated. A supermarket may guarantee to match a competitor’s price on branded goods but say that you have to go online to recover your excess spend, or it might give you vouchers that represent the excess, but you can only use those vouchers on your next visit. They might also work hard with the manufacturers of branded goods to produce slightly different sizes and specifications, so that the ones that you bought fall outside of the promise. In all these cases they are trying to create the impression of lower prices, while relying upon inertia to reduce the actual cost to them – for example, many customers will not actually use the price matching vouchers they were given or bother to go online to claim the reduction. That reduces the total cost for the seller while still trying to persuade its customers that they need not shop around to find the best prices.
This price matching is not a first-line solution for most services firms, but well worth bearing in mind. If you have a ‘dumb competitor’ – one who is initiating a race to the bottom on price – it can be effective to make public that you will match prices and (in the process) accidentally halt pure price-based competition.
POWER BY THE HOUR – CHANGING THE SUPPLY DYNAMIC
Created by Rolls-Royce in 1962, ‘Power by the Hour’ was a revolutionary approach to the pricing of aero engines. It meant that instead of buying an engine, an aircraft operator paid by the hour of actual flight time – which aligned the interests of the operator and the manufacturer in having maximum reliability of performance. Later enhancements included providing replacement engines while the originals were being serviced and having continuous monitoring of engines in flight so that peak performance could be maintained. This takes a single, one-off purchase and converts it into a long-term relationship with annual fees. Moreover, the fees are tied to actual usage so that the client can see the value in what is being supplied.
This ‘total care’ approach is one that can also be used by service firms if they think about the variety of day-to-day dealing that they have with their clients and how that might be converted into a single deal. For example, I was intimately involved in the creation and management of just such an arrangement with a client when I was appointed as client partner to Tyco (the American headquartered conglomerate) in a ‘retainer fee’ deal which involved the supply of legal services to the company in more than 30 countries for a single annual fee, replacing (overnight) some 282 existing law firms. If you are thinking of offering a retainer fee, you need to consider the following:
- You need to be careful, because once you have a fixed fee for future services you have created an ‘all-you-can-eat buffet’. Having agreed the fee, the client sees that the more use they make of the services, the cheaper those services become. You need to create clear incentives so that the client also benefits from underuse of the services by sharing savings (and penalising excesses).
- If you are giving the client a level of certainty on fees then you need to get something in return. For example, if the retainer fee covers Relationship Advice, you might seek to have the opportunity to carry out more profitable Rocket Science work as a clear part of the deal.
- You need to have a very clear arrangement to work on reducing the level of fees by reducing the demand for services. Spend reduction workshops (which will take time and resources on both sides) can enable you to manage spend, producing savings on an annual basis and underpinning a long-term relationship.
Well structured, these retainer fee deals are a real opportunity to tie a client into you on a long-term basis and provide a framework for true partnering between you and the client. This neatly leads us into the next chapter, in which we will examine in more detail the whole topic of saving clients money.