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Changing prices, changing value?

March 19, 2014 by Dale Furtwengler — President, Furtwengler & Associates, P.C.

A newscast recently reported that some companies are changing prices as often as 5,000 times a day. Why are they doing this? How well is it working? More importantly, what implications does it have for your business?

Theory

Why are some companies changing prices so often? The theory, as it was explained to me, is really a form of dynamic pricing. The greater the demand for a product, the higher the price. Conversely, when demand drops prices drop as well.

Intuitively, that makes sense. Indeed, most of us flashed back to Econ 101's demand-supply curve. So, theoretically, the approach seems sound. How well is it working?

Practice

Amazon, a company purported to be one of those frequently altering its pricing, from 2009 to 2012 enjoyed an impressive 26.3 percent compound growth rate in revenues and saw its operating margin decline 30 percent from 6.6 percent to 4.6 percent.

During that same time interval, Walmart, whose price rollbacks have become its hallmark, experienced a much more modest 3.5 percent compound growth in revenues and a mere .1 percent growth in operating margin.

Let's contrast that to Apple, a company that rarely adjusts its pricing, which experienced an amazing 44.3 percent compound growth in revenues and a whopping 63 percent improvement in operating margins from 22.9 percent to 37.4 percent.

The airlines, an industry that has been employing dynamic pricing for three decades, continues to struggle to achieve sustainable profitability. Continued industry consolidation is further evidence of the industry's inability to achieve that goal.

So if the greatest success, measured in terms of revenue and profit growth, appears to lie with companies that rarely alter their pricing, what does that mean for your business?

Implications

The theory, while seemingly sound, is misleading. More importantly, it's surface-level thinking. A little exploration on our part and we'll realize that:

Purchase ≠ Demand

Demand is a trend, a purchase is an isolated event. When we talk about demand we speak of it in terms of increasing or decreasing. You can't make that determination from one purchase — a recent purchase doesn't portend another purchase. A series of days of consecutive sales growth or decline, however, can be an indication of future demand.

Even if a single purchase could indicate demand, it doesn't consider the supply side of the equation. Readily available supply will thwart a company's desire to raise prices as long as that supply exceeds the growing demand.

Controlling Supply

Savvy companies often limit supply to maintain higher prices and margins. Excellent restaurants have limited seating which adds to the appeal and sustains a premium price strategy.

Corvette is considering limiting its production in 2014 for the same reason. Consumers paid well over the manufacturer's suggested retail price for Nissan's Leaf and Chevy's Volt because of their limited supply. Toyota's Prius also carried a premium to similar size cars.

How well are the companies employing frequent price changes controlling supply? Not at all, based on what I'm seeing. Consequently, their price increases will stifle demand while their price cuts create expectations that will be reversed when new purchases occur — the worst of all possible worlds.

Value Confusion

These frequent price changes leave customers wondering, "What is this item really worth?"

As consumers we look to price as an indication of value. It's how we get the sense that Polo has more image value than St. John's Bay, Mercedes more than Camry, iMac more innovation and image value than Windows-based PC.

When the price continuously changes but the product doesn't, customers lose that sense of value. They don't enjoy their purchases as much because they're:

• Concerned about whether or not they're overpaying for the purchase.
• Wondering about service after the sale.
• Wondering whether there is something different about the item they're buying which might be an indication of inferior quality.

As a seller, when you introduce uncertainty into the mix, you raise customers' concerns which reduces their satisfaction in doing business with you. I doubt that's what any of you want your customers to experience.

The key is to establish your pricing on value — the value to your customers, then hold firm on that pricing while controlling the supply. Your customers will have a more enjoyable experience and you'll enjoy greater profits with less effort.

About Dale Furtwengler

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