Thinking twice about price - Schumpeter

WHEN bosses promise to make their companies more profitable they usually say they will do so by increasing sales or cutting costs. But a third road to profits is rarely mentioned: putting prices up. Managers often fail to ask how they might do better at plucking the goose to obtain the most feathers with the least hissing. The spiel from the management consultants who advise companies on pricing—whether specialists like Simon- Kucher or giant generalists like PWC—is that it is now more vital than ever to be smart at it.
In today’s austere age many businesses cannot depend on rising sales volumes to lift their profits. As for cutting costs, most have already pared them to the bone. Prices are all that is left. And a business can do a lot with clever pricing, to boost its share of the limited spending power that is out there.

Makers of high-tech products such as smartphones can opt to add whizzy new features and push up prices. In the case of luxury goods, their exclusivity is a large part of their appeal, and this in turn is a function of their price, so firms usually have scope for limiting supply and charging more: Ferrari, a sports-car maker, and Mulberry, a purveyor of posh bags, have both recently signalled that they plan to do just that. But raising prices by making products better or more exclusive is a strategic decision, open to only a few types of business. For all sorts of mundane goods and services there is much that can be done tactically, the consultants say, to charge more for the same thing.

First, firms should simply take pricing more seriously: have a clear policy and make everyone stick to it. Obvious? At a recent conference organised by Simon-Kucher, the 100 or so delegates were asked to put their hands up if their company had a written pricing policy. Just two did so. Setting prices, promotions and discounts is often left to junior people and local sales offices. Even where a policy is set from the top, the salespeople may ignore it because they are still being rewarded for maximising sales and keeping customers. Neil Hampson, a pricing expert at PWC, says he sometimes starts his client meetings by asking: “When was the last time you congratulated a salesman for walking away from a client?” Most have never done so.

Second, companies need to remember that, as the late Peter Drucker, a management guru,  once put it, customers do not buy products, they buy the benefits that these products and their suppliers offer to them. So, businesses that fail to identify what benefits they are offering each type of customer are likely to be undercharging some of them. Equipmentmakers who sell to other businesses can be especially prone to a “cost-plus” mentality, in which they charge the same margin to everyone instead of identifying those that are less price-sensitive and finding ways to earn more from them. Oil companies, for example, can suffer huge costs in lost drilling time if a pump goes down, so pump-makers could charge them a premium for guaranteed same-day dispatch of spares.

Airlines have learned to “unbundle” their product, charging separately for baggage and meals and increasing their overall takings. But industrial suppliers may still charge the same to customers who never call their technical helpline as to those who ring it daily. Makers of everything from aircraft engines to lorry tyres have gone further in selling benefits rather than products, by offering “power by the hour” contracts in which customers only pay when they use their goods. The suppliers earn more overall, while their customers preserve scarce capital.

A third route to charging more is to manage customers’ expectations better. In the early 2000s executives at General Motors were told to wear badges with “29” on their lapels, as part of a disastrous plan to get back to a 29% market share in America. This merely reinforced car-buyers’ assumption that GM would offer them whatever discounts it took to shift its metal off the forecourts, putting the firm on the road to bankruptcy. (Last year its market share fell to 17.5%, its lowest since the 1920s.) Once customers know that a firm’s price list is a work of fiction and that it will resort to discounts as soon as sales dip, it will be a

long haul to get them used to paying full price, let alone accepting increases. Simon-Kucher’s consultants praise DHL, a logistics firm, which spent years drilling into its customers that whatever the economic conditions there will be a rate rise each year.

You've been framed
Fourth, there are lots of simple presentational tricks that almost everyone is wise to but which still, miraculously, work. Restaurants add some overpriced wines lower down the menu to make the ones at the top seem reasonable. Makers of ice cream offer “33% extra free” rather than “25% off” the cost of the regular size, even though these are arithmetically the same thing. Buyers at big industrial firms are just as susceptible to such “framing” when reviewing a list of widget prices.

The pricing experts make it sound so easy. But there are of course limits to how far firms can go in tailoring their prices to the customer without appearing sneaky. Last year Orbitz, an online travel agency, was criticised for offering a costlier selection of hotels to people browsing its site on an Apple Mac because it assumed they were richer than PC users. Although a firm’s customers may not notice the odd price rise slipped in here and there, they will eventually notice if their overall bill starts to swell: Tesco, Britain’s biggest grocer, is now having to offer expensive discounts to win back a damaged reputation for value.

And sticking to a pricing strategy takes guts. The irony, confides a senior management consultant, is that firms like his have such a taboo against letting go of a client that they are the worst at taking their own advice to be fearless in asking for more, and walking away if

they do not get it. 


Importance of founder-led firms seeing resurgence - Chris Zook

Chris Zook, author of management books and cohead of the Global Strategy practice at Bain and Co., has made a name for himself advising CEOs on developing a systematic and scientific approach to growth. He was in India recently to meet some founder- or promoter-run firms, because, according to Zook, “around
the world we are seeing resurgence in the importance of founder-led companies” and founders returning to save their companies, he said in an interview.

This whole trend of promoters returning to save companies in India. We have the recent example of N.R. Narayana Murthy returning to save Infosys Ltd. How significant is that?

I think we have seen more cases of founders coming back in the last five to seven years than I can ever remember seeing before. The Howard Schultz story at Starbucks is amazing in the sense that how fast the turnaround  appened in terms of performance. When you delve into it, (among) the things that he brought back was the culture of the barista, the person who makes the coffee, redesigning the equipment.

I am not sure it is a pattern: the founder having retired and then having to come back and rescue the business, but there are a lot of examples (of this) that we are seeing now. In a way, it may be a sign of failure (of the founder) to set up succession perfectly. What is interesting for me is how many times they (founders) actually help the case.
Another trend is going back to the founding mentality, without the founder coming back—(such as) the  rejuvenation of Lego or Burberry. I think it’s a very interesting thing to observe how businesses that lost the founding mentality, sometimes rediscover themselves by going back to the founding principles.

So, it doesn’t always take the founder?

We are talking about 5% of a phenomenon that feels like it happens more often by virtue of the story of Howard Schultz or Steve Jobs. In those cases, the founders had to reinstitute some of the beliefs and practices that have got lost along the way. Usually, these have to do with being more in touch with the customers. What Howard Schultz did to Starbucks was to refocus. First thing he did was that he shut all the stores…800 stores for an entire day, which is quite expensive, if you calculate the amount of money. He retrained the staff, redesigned the equipment, stopped cheese smelting in the stores to magnify the coffee experience...

Jobs wanted to get closer to what the customer would need in the future. I think he was amazing.

The impact of most of the founders coming back is to drive the company much closer to the customers, which is fundamentally a good thing for the business—but it doesn’t always take the founder to do that. There are a number of iconic companies, owned by families, where an outsider CEO came in and turned the things around by bringing back the founder’s original principles. So, I think that sometimes the founding mentality is lost and it takes a founder to bring it back, and sometimes it can be done by a CEO.

We also have a counter-phenomenon in India. Of promoters who continue to cast a long shadow on the business, who control every aspect, is that a good thing?

I think it is great. I think it’s the life force of the great companies. I remember a piece of a research, that I saw years ago, that we had done. It looked at great teams, business teams, development teams and some other teams and then poor-performing teams. For poor-performing teams, 80% of the comments were internally focused while 70-80% of the comments in the best performing teams were externally focused - on frontline behavior and the customers.

Every business begins with one founder, one product and one customer and over time there are natural forces which take the business away from the closeness of the frontline, away from treating businesses like your own, away from the real intensity of the customer and all the things that the founder does. I think you used the word control; I would use the term externally-focused and obsessed with the details of the business, which is incredibly important. I think these details really make the business. Ideally, what you would like to do is to transmit that to the next generation.

When you start to lose attention (to) those details and start becoming internally focused, then I think you are on the path to extinction.

Businesses, if they don’t fight against this, can turn into bureaucracies, lose the voice of the customers and make themselves very vulnerable to (competition from) founder mentality types of companies. You have seen that happening in Sony versus Apple, or Michelin versus Hankook.

Finally, a question on the current economic situation. You meet a lot of CEOs. Are they still cautious about the future? When do they see things improving?

There are huge amounts of cash that have built up. Companies, private equity and sovereign wealth funds—they are not sure of where to invest. Still, things are beginning to improve. We are seeing a return of the US economy. But Europe is still troubled except for a couple of economies and the developing world has slowed down. India is down from 8% (growth) to 5%. From the point of view of multinationals outside, that is still very attractive growth. I think when I look at the mix of work that we are doing at Bain and Co., during the more difficult recessionary period, the focus (of companies) was towards cost reduction but now they are shifting more towards growth projects.

It is more about the future.