Jon Manning, CEO of Pricing Prophets and Sans Prix discusses with Darren the fourth and often forgotten P of marketing – pricing. They talk about the role of pricing and the behavioural economics insights on pricing, plus they explore how pricing works in professional services and particularly advertising and marketing services.
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Transcript:
Darren:
Welcome and today I’ve been joined by Jon Manning. Jon and I go back a little bit because Jon’s real interest is in pricing. In fact, your whole career, all focus, is pricing, isn’t it?
Jon:
It is, and I’ve recently done a few podcasts and I’ve actually stopped talking about the roles I’ve had and actually looked at my career as a journey through various pricing models.
So I actually started out with the NFI pricing model, which was in the oil industry. I don’t know where the prices came from; I still don’t know where the prices came from, hence NFI. I then went and worked in cost plus pricing at Ansett, pricing catering for international airlines that would pick up catering from seven flight kitchens around Australia.
Darren:
And now you’re founder of Pricing Prophets and Sans Prix.
Jon:
Yes.
The sustainable pricing model
Darren:
So you’re consulting now to all sorts of companies around pricing strategies and pricing models, yeah?
Jon:
Primarily value based, yeah so there’s been a couple of other pricing models back there on the journey but it’s primarily all about value based these days. You know, the sustainable pricing model.
Darren:
And that’s of interest to me because one of the things that I’ve noticed in marketing. They used to talk about the four Ps, apart from promotion which was the advertising part of my career, pricing is one of the four Ps and yet I often get the feeling that it’s an under considered or undercooked area of the marketing mix.
Jon:
It is and it’s commonly known as the forgotten P of you know, the four Ps or the seven Ps, whichever school you went to.
Darren:
So that’s the one that’s running down your leg. Sorry, I just had to throw that in.
Jon:
But I don’t know why that is, I think sometimes people that have gone into marketing like the sexy side of awards and advertising campaigns, and they’re all extroverts and so forth, but the pricing side has got these things called numbers attached to it and sometimes people struggle with numbers, particularly if you’re that artistic, creative type person.
Darren:
Well Jon it’s certainly the accountable and I mean, accountable part of marketing, because pricing will ultimately have an impact on revenue, but also on margin.
Jon:
Well wasn’t it Cobbler that said that, “Price is the only one of the four Ps of marketing that produces revenue, the other three generate costs”?
Darren:
Well that’s one way of looking at it. I’m sure the marketing industry doesn’t think that.
Jon:
And the brand equity calculators.
Pricing is more of an art than a science
Darren:
So, why do you think it is the forgotten P?
Jon:
It’s perplexing. I think some of it is all about numbers, it’s that thing called price elasticity that might have been done in economics 101 or marketing 101 and I didn’t really like that stuff. A lot of people say there’s a science to pricing but it’s an art. You’re dealing with people’s behaviour. If it was a science, you would be able to predict a price, the price that a Van Gogh sells for at an auction and you can’t.
Darren:
But you can’t because there’s an emotional decision. Well that raises the question of obviously in your field of expertise, behavioural economics has had a huge impact because it’s really the study of trying to understand that emotional decision making process.
Jon:
Absolutely and it just supports the hypothesis that it is an art rather than a science. You know, they call economics in general, the dismal science and so forth, but it’s still got to be replicable and with experiments and so forth, and you’d know that from your background. But that’s not always the case.
Darren:
‘Cause Dan Ariely called it, “Predictably Irrational”, that human beings are irrational but the great thing about it is that there is a level of predictability in that, and he uses some examples of pricing as a way of framing value for people.
Jon:
Absolutely.
The infamous economist pricing experiment
Darren:
Can you talk to some of those considerations?
Jon:
Well the one that has become behavioural economics folklore is the famous or infamous economist pricing experiment. So, apparently Dan Ariely went onto the subscription page of The Economist one day and there was an option for a digital only subscription, a print only subscription or print and digital and I can’t remember exactly what the price points were.
Darren:
Oh, they were the same for print and digital as it was for print.
Jon:
And digital only or print only, yeah. So he then rang up The Economist and said, “What are you doing here?” and nobody would take the call or answer his questions and so forth. So he ran a similar experiment with a group of students and the outcome, the second part of the experiment involved removing what has become thought of as the decoy product.
Darren:
Yes, yeah, yeah.
Jon:
And the revenue, it’s really interesting. So he actually shares market share results so the percentage of students that would take up the option based on what they saw. The interesting thing is then to actually work out what revenue impact that might have, and nobody has really looked at that, but I did it once so I actually, (The Economist don’t break out their online subscribers and their print subscribers) found a total subscriber number and just made some assumptions. And based on the prices that were in the research, the revenue was about 30% higher with the decoy product.
Darren:
And the argument is that it allows people to frame value.
All pricing is relevant
Jon:
Absolutely, all pricing is relevant.
Darren:
The teasmade you know. It seems to me archaic but the idea of having the alarm clock that makes tea for you and they had it, it was like $395, and he said to them, “Can you add some extra functionality and we’ll put it in at a slightly higher price?” and sales went through the roof because people couldn’t come at spending $400 on a Teasmade because they had nothing in America to relate it to. By having a slightly higher priced one, suddenly they had that framing, that value comparison that allows them to buy.
Jon:
Absolutely, absolutely. And you see decoys everywhere. You know, there’s Norma’s Restaurant in New York, which has the $1000…
Darren:
Hamburger?
Jon:
Omelette! Caviar omelette.
Darren:
Caviar omelette.
Jon:
And it has underneath it, “We dare you to expense this”. But there’s also the $100 one. The $100 one sells really well because the $1000 is the decoy for it.
Darren:
So I’ve seen pricing models in this country especially, where the price is basically set by what the competitors are charging.
Jon:
Yes, the old chestnut of what the market will bear.
Darren:
Exactly, that’s it, that’s the justification. That’s what everyone else is paying, so that’s what we’re going to do.
Whatever you buy, you determine the value
Jon:
Yeah. And I’ve got a couple of comments on that. So, it’s not what the market will bear. Somewhere behind the scenes, someone like me is setting a price. It’s like the invisible hand. There’s no such thing as invisible hand.
Adam Smith only mentioned once in the Wealth of Nations, but there is no invisible hand, there is no market, there is actually somebody who says, “I’m going to charge that price”. So, that would be the first thing I would say about that. The second thing is, that there’s a couple of rules around pricing. The first one is that all value is subjective.
Darren:
Yep.
Jon:
Whatever you buy, you determine the value.
All value is contextual
The second rule is that all value is contextual. What that means is that if you put the right context around your prices, the right pricing communication strategy, the messaging and so forth, you can charge premium prices. But if you don’t wrap any value story or premium positioning and so forth around your product, you’ll be playing in the commodity end of the market.
Darren:
Yeah absolutely, because you need to give people some justification.
Jon:
Absolutely.
Darren:
To actually reinforce their emotional decision with a rational approach.
Jon:
I mean you take bottled water. I mean it’s the most amazing product isn’t it? But you see it at the airport and it is $5 a bottle. You see it in Coles or Woolies and …
Darren:
It’s a $1 a bottle!
Jon:
It’s a $1 a bottle. It’s the same bottle and it’s the same temperature! What’s changed? Well the context in which you’re buying it.
Hourly rate or value based compensation
Darren:
So one of the areas I’m interested in, being in professional services as a consultant, is the whole thing around where you get to pricing around selling your IP experience but largely, people want to reduce it down to their time. Whether it’s the buyer that’s doing that or the seller. But it comes down to this idea of hourly rates seems to be the way that people price professional services.
Jon:
And I think we see that in a lot of industries that there’s pressure coming up from the customer to say to these professional service firms, “You know what, I’m not buying your time. You know, I don’t, when I go and buy my latest Toyota or Holden or Ford and so forth, I don’t ask for the timesheet, so why are you charging me for your time and so forth?”
Darren:
I’m buying an outcome aren’t I?
Jon:
Absolutely.
Darren:
I’m buying solving a problem or delivering a particular thing.
Jon:
Absolutely so I think there’s a legacy of this pricing model in advertising, in accounting, in law and so forth. It is slowly starting to change from pricing the inputs to actually pricing the outputs, and you and I both know that Coca Cola and PNG moved toward value based compensation in their advertising in around 2009/2010.
Darren:
Yeah. And yet, because we don’t work on an hourly rate basis, we work on a project fee. We scope the project and we give a price. But when we deal with procurement people, they constantly want us to give an hourly rate and the conversation goes like this. “What’s your hourly rate?” and I go, “Well, we’ve given you a fixed price so it could be, depending on the number of hours we do, it could be $10 an hour if I’ve hopelessly misjudged this, or it could be $10,000 an hour if I can solve this problem for you very quickly, what’s your point?” and they go, “Well I can’t compare one to the other”.
Jon:
Because they’re sitting in front of a spreadsheet and they’ve got vendor one, vendor two, vendor three and the bottom line is hourly rate and they’re trying to get to a point where they can make a decision based on price.
I did some work with a law firm a while back and they had exactly this problem. There was a piece of work that needed to be done for a Chinese buyer and they don’t do pricing by the hour. They only do fixed value based pricing and they don’t even record on timesheets and so forth. And in the end, the Chinese buyer said, “You know what…”
Darren:
I can’t cope!
Jon:
“I can’t cope.”
Darren:
I don’t know what I’m buying.
Jon:
But you know what, that was not the kind of customer that they wanted.
Darren:
That they want, yep. Exactly.
Jon:
And good on them for saying, “Not my type of customer”.
Darren:
Yeah that’s right because as soon as you reduce it down to an hourly rate,
Jon:
You’re comparable to everyone in the market.
Darren:
And it then becomes, depending on your level of commoditisation. And this is, you mentioned advertising because the thing that advertising agencies always complain to me is, “Why can’t we get $650 an hour for our senior people when a partner in a law firm gets $650?” And I say to them, “Because the buyer in that case perceives that the lawyer partner in the law firm has one; done an educational standard to understand a complex issue, same with an accountant, and you’ll pay for more complex accounting, you’ll pay those higher fees. Whereas advertising, anyone, the perception is any fool could do it so isn’t that one of the things that commoditises the hourly rate in some professions compared to others?”
Jon:
Lemmings don’t innovate. You know, if everybody charges by the hour, everybody is just going to go, “Well, they’re charging that rate, we’ll charge that rate”.
Darren:
Yeah.
Jon:
You know in preparation for this discussion, I looked up, there was a survey conducted by the American association of advertising agencies a couple of years ago and they discovered that 98% of agencies track their job estimates. 94% track the labour hours and costs associated with their projects. But only 22% tracked their client’s business results.
Darren:
And I’m not surprised. I think that 22% is probably over estimated.
Jon:
Well they’re American numbers so yeah, absolutely. But these businesses, and it’s the same with accountants, accountants have one-on-one conversations with their clients, they can do one-on-one pricing which for many is marketing nirvana. And if they can see business results, they can price on the basis of business results.
Darren:
Absolutely.
Jon:
You know, in a B2B world, there’s three sources of value. You increase your client’s revenue, you reduce their costs or you minimise their risk. All three are quantifiable in accounting or economic terms.
How well do you back yourself?
Darren:
Now, it’s interesting you say reduce their costs, ’cause I just want to share with you a story. A very large advertiser in China phoned me up and said, “Could you help us, we want to look at our media agency’s fees” and I said, “Oh okay, well we can certainly help you with that”. “Well, what’s it going to cost us?” and I said, “Well, we have a fixed price model for that”, and I gave them the price. And they said, “Oh, your competitor has said that they’ll save us 10% of what we’re paying now and we’ll pay them half of what they save” and I went, “Really, you’re willing to do that?” and they said, “Yes” and I said, “I will save you 100% of what you’re currently paying if I can have half of it”. And the procurement people on the phone got very excited and they said, “Oh well, that would be great” and I said, “No it won’t”. Is that the danger? Especially with that focus. I mean, I understand reducing waste and improving efficiencies but a single minded focus on price or cost in that case, without an understanding of the quality, means that you’re, it’s one dimensional, isn’t it?
Jon:
Absolutely. And you know there are a range of alternative models out there relative to pricing by the hour and it really comes down to a question of how well do you back yourself? You know, do you back yourself better than that competitor that the client was talking to or are they backing themselves better? And the discussion moves actually away from charging by the hour to, what’s that percentage that I’m going to take as my price? Do I take 100%? For some companies, 10% can be a gold mine.
Darren:
Oh absolutely. If I got paid 10% of everything I saved, I wouldn’t be doing this job anymore, but because I made a philosophical decision to do a fixed fee, we recently did a regional review of agency fees. A client came back and said, “We saved 12 million dollars”. Now our fee for that was about $45,000 so as a ROI, it’s off the scale. But if I had’ve gone for 10%, that’s 1.2 million dollars, I’d be like, “Okay I’m finished for this month” or maybe next month too and the one after. It really is interesting because as I started off saying to you, pricing seems to be so under considered and yet it has such a profound impact on businesses.
How neglectful some companies can be on pricing
Jon:
Oh absolutely, absolutely. Sometimes it leaves me speechless as to how neglectful companies can be on pricing. I walked into a workshop one day, a manufacturing company in Glen Waverley here, industrial heartland of Melbourne and sat down. I had CEO, CFO, CMO, and so forth in the room, it was one of the first questions I said was, “When did you last change your prices?” and they all looked around at each other and said, “Seventeen years ago”. Seventeen years!
Darren:
Well, CPI has been going at about 3%, compounded over seventeen years, that’s a significant increase, isn’t it?
Jon:
But at the end of the day, customers don’t care what your costs are, they care what your values are so in many ways, CPI is irrelevant.
Darren:
Yeah, that’s true.
Jon:
Anybody who prices on the basis of costs and CPI is actually missing the point. The drivers of price changes should be structural changes in your industry, new competitors coming in, new products being launched, the value proposition changing, the best way to increase your price is to increase your value and so forth. Nothing to do with costs.
What is the role of pricing in advertising?
Darren:
Well, except CPI is used to work out the cost of something in real terms over a period of time because money, what is it, money doubles every ten years, so the ability to buy. So one of the things that I raised earlier was about pricing in advertising. So we will cover that. What is the role from your perspective of pricing in advertising?
Jon:
That’s a really good question. So I think there’s a role for advertising in pricing and there’s a role for pricing in advertising. So when you advertise a price, it actually makes a statement of what the vendor thinks this is worth and hopefully that aligns with the perceived value from the buyer’s perspective.
That expression of a price can also be an expression of quality. So particularly for new revolutionary products for which there’s no point of reference in the market at all, a high price is going to be associated with a quality product rather than a cheap price point.
Darren:
Which is where luxury goods, you do quite a bit of work in China. You know, luxury goods in a country that you know, will commoditise almost anything, they will spend $5,000 on a handbag.
Jon:
Yeah, absolutely. But then you can, sometimes you can have advertising without pricing and now I think it was Rolls Royce that said, “If you have to ask the price, you can’t afford it”.
Darren:
Yeah, yep.
Jon:
So it moves in funny circles.
Darren:
Makes it elitist.
Jon:
Yeah, and another company strap line that I love is the John Lewis partnership in the U.K. “Never knowingly under salt”. And that was invented by one of the founders in the 1930s. What does that say? Does that say they’re cheap? Does it say they’re top end of the market? It doesn’t really matter, it works across…
Darren:
It’s competitive.
The pay what you want pricing model
Jon:
That divide. Absolutely. And then, I think that strictly the purest form of value based pricing is a pay what you want pricing model.
Darren:
Yeah, now that’s interesting.
Jon:
So I didn’t realise this and I only realised it from listening to another podcast a couple of days ago. Jon Bon Jovi has a pay what you want restaurant in New Jersey.
Darren:
Oh, okay. You go in and have the meal and then at the end of it, you pay what you think it’s worth.
Jon:
Yes so we’ve had ‘Mental as Anything’ here in Melbourne for years and years and years. It’s a pay what you want restaurant and recently they had a whole lot of people march in there and pay $2 and not a penny and so forth and they had to cop that. The interesting thing about Jon Bon Jovi’s restaurant is, you pay what you want for your meal, but if you can’t pay, you spend an hour doing the dishes.
Darren:
Oh okay, that’s fantastic.
Jon:
Absolutely. And it’s positioned as a soul kitchen as a place where the less well-off can actually get something good to eat.
Darren:
So I’ve actually heard though that typically when you introduce that model, the average price per customer goes up.
Jon:
I’ve heard that too. I’ve heard that there are…
Darren:
That’s anecdotally. I haven’t had it proven anywhere.
Jon:
I’ve heard that as well. So people that run a pay what you want restaurant have also had a fixed price restaurant and the pay what you want generally has higher revenue than the non one.
Darren:
Because, in another application of that, I remember reading Maverick, the book about running businesses like people are adults where they actually allowed people to decide in a very open environment, what their salary would be and that he said, average salary increases were less under that model than they were when management offered. So management would still budget for what they would be willing to pay people but when they said to people, “Well what do you think your salary would be?” it would typically be lower and this is not just women, so it’s not an issue about uneven pricing, it was, typically people would set their salaries lower than what management was willing to pay them.
Money distorts perceptions of value
Jon:
And that’s really interesting because we were just talking about behavioural economics and one of the behavioural economics findings is this thing called the endowment effect where if you’re selling your house, you will tend to value it a lot more than everyone else will value it. It’s called the endowment effect of a car and so forth like that. That’s interesting that those findings have been discovered with salaries compared to more tangible assets.
Darren:
Yeah. So, speaking of behavioural economics, one of the things that I’m really interested in, and again Dan Ariely raised it, is the idea of the way money impacts people’s behaviour.
So the first experiment he did was he got his students in and he said to the first group, gave them a task to do, “I’ll pay you $5, work as long as you think that’s worth” and the second group he said, “I’ll pay you 50 cents, work as long as you think it’s worth” and then he said to the third group, “I’ll give you a chocolate bar”. And what he found was that the 50 cent group worked about half the time of the $5 group, not a tenth of the time. But the chocolate bar worked the longest amount of time and the hypothesis is this idea of social contracts that are messed up by financial contracts. Introduction of money.
So Jon, could you come over to my place on Saturday and help me move some furniture? You come over, we spend an hour doing it. If I gave you $20 for doing it, how would you feel compared to if I gave you a bottle of wine that was worth about $20?
Jon:
Yeah, interesting stuff isn’t it?
Darren:
Because money, he says, money distorts perceptions of value. Money changes the idea of what’s worth you know, valuable to someone.
Jon:
Yeah, and I was recently reading along a similar point that if you asked someone, if someone valued something at $10, they wouldn’t necessarily value it twice as much at $20.
Darren:
No.
Jon:
It actually needs to go up to $40. It’s like a non-linear scale.
Darren:
Exponential.
Jon:
Yeah, to go up to $40 for them to double the effect.
Darren:
So this is a mechanism that I think is at work in advertising agencies and the way they work with their clients because for a long time on the media commission, they never talked about being paid ’cause it was just commission taken.
So they would have these very deep personal relationships and you would often hear and still do, of agency people regularly going out socially with their clients and sharing a personal relationship where money was never considered.
The freemium model
Jon:
I wonder if the virtual equivalent of that is the freemium model. So you’ve got the people on LinkedIn who are not paying for it are the chocolate consumers and so forth because 75% of people on LinkedIn don’t pay for it but 25% do. They’re the people that are paying the 50 cents and the $5 and so forth.
Darren:
Yep. Yeah well I think software developers have known that for a long time. Give people a cut down version for free.
Jon:
Take out some functionality, yep.
Darren:
A freemium and then just keep adding it in, offering to upgrade, upgrade, upgrade and the very first step has to be non-painful at all. It has to be a very small step and then the pricing steps increase a lot as you move along from that.
Jon:
Yeah.
Darren:
So I’m thinking in advertising that you know, there was a time where the account management person never had to worry about asking their client to pay for something because it was automatically paid in the background through the media commission but now if a client asks for something, they have to sit there with their calculator working out how many hours that’s going to take and the rate per hour that they need to recoup to be able to get paid for it and how that totally changes the relationship.
Jon:
So it’s a bit like what we’ve seen in the aviation industry where you used to buy a ticket and it had your seat in it, and it had your meal in it, and it had your entertainment in it, and it’s all now been busted out and unbundled and so forth. Airlines in the U.S. make 40% of their revenue from these ancillary revenue streams that have been busted out of that all-inclusive ticket price.
Darren:
I experienced that just recently with Scoot. I ended up flying with Scoot and it was interesting because it was like, well here’s the ticket and now if you want entertainment and you’d like to upgrade the food, there’s the standard package or the premium package, and they just had this oh, internet access.
Jon:
Was that on the plane?
Darren:
On the plane.
Jon:
I bought tickets on Jetstar a couple of weeks ago and within 5 minutes I’d found what I wanted but it took me another 25 minutes…
Darren:
Oh to go through all the options?
Jon:
Yes! Just take me to the pay page please!
Darren:
And did you select any of them though? Did it work on you?
Jon:
No, no, I didn’t want carbon offset, I didn’t want a car, I didn’t want a hotel, I didn’t want the ability, it just went on and on.
Darren:
Yeah. And look, I think one of the issues is that when we talk more and more about customer experience, that perhaps that pricing isn’t being considered as part of the customer experience and it should be.
Jon:
Oh absolutely and I’m a big advocate of “why not” pricing so you’re going back to the airport this afternoon, you have the radio on in the taxi or something and you hear a song you like and you go, “I’d love that on my I Phone, it’s $1.69”, push the button, why not buy it? It’s so easy to do it and so forth and I think as great as Apple are, there’s a lot of people that can learn from that sort of simple “why not” approach to pricing. Make it easy for customers to buy and buy frequently whether it’s transactional or on a subscription model. You know, there are some people that just try and monetise every little nook and cranny in their business models.
Darren:
But it leads to fatigue, doesn’t it?
Jon:
Oh, absolutely, absolutely. And the resources involved in closing a sale and things like that.
Alternatives as a future pricing model
Darren:
So, if you were giving advice and this is something I get asked all the time. Agencies say, “Well if we’re not using the head hour pricing model, what should we use?” What are some alternatives that you think professional services, advertising agencies, that type of thing, should be looking at as a future pricing model?
Jon:
One of the things I tell a lot of people to do is to jump onto Google and search the term ’77 Inspirational Pricing Pages’ and you end up on this website. I tell them to do that because I can’t remember what the website’s name is, but you see, as you can imagine, 77 different pricing pages from various websites and some of them are so out of date now it’s not funny.
But you see all these packages that people have built and how the packages specify which features come in which packages. Sometimes the most expensive is on the left, sometimes it’s on the right, sometimes the most popular is highlighted and so forth but it’s just a great little resource on how people are presenting their pricing.
So I think, one of the first things I would recommend is putting three options in front of a customer so if you’re doing a pitch, there is a small version, a medium version and a large version. Because if you put one version in front of a customer, you’ve got a fifty/fifty chance of closing the deal. You put two in front of a customer, you force them to make a price-based decision. You put three options in front of a customer, one can be a decoy, and you force them to go, “Which one do I buy” not, “Do I buy” and you force them to make a value-based decision.
Darren:
Yeah because the other thing with one, especially in a pitch, is that they’re going to be making their own selection of choices, which is your competitors as well, aren’t they?
Jon:
Absolutely, absolutely.
Darren:
They’ll automatically, if you only give one price, they’ll start comparing to what else is on the table.
Jon:
I’ve even heard of the extreme case where someone’s gone, “Thank you, we don’t actually need any more quotes because one company has given us three quotes. We’re required to get three quotes, they’ve all come from one company. Fine, let’s pick one of these”. So I think those approaches to packaging would be one thing I would look at. Play to your strengths, back yourself. If you know that you can deliver,
Darren:
Results, either efficiencies or increased revenue.
Jon:
Yeah absolutely, back yourself. And I would always recommend, don’t try and boil the ocean. So don’t do a 100% backing myself upfront. Put 50%. 50% is a fixed price and the other 50% is performance based. Don’t do it with every single client. Do it with one client or one practice area and start small. Make your mistakes on one client and then fix it. Do an analysis afterwards of what went wrong and what went right and then take it from there.
Darren:
Well that’s fantastic advice, thank you Jon.
Jon:
My pleasure Darren.
Darren:
Thanks for your time. It’s been good to catch up.
Jon:
Likewise.
Darren:
One last question, what do you charge an hour?