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Interview: Management thinker Hermann Simon on Power Pricing

How clever pricing tricks can lead to increased online sales

Management thinker and economics professor Hermann Simon is one of the leading experts on pricing in the world. In an interview with International Trade News, he shows how a small and medium-sized company managed to increase its turnover tenfold through the use of Power Pricing. Just how high the bar must be set to see the maximum benefit from this pricing strategy can be seen in the following mantra from the aviation industry: If I want to sell 2,000 seats and have 400 price points – then that I am short by 1,600 price points.

International Trade News: Professor Simon, if we are to believe Google and Microsoft, the digital transformation holds out a promise of salvation for small and medium sized businesses. From your standpoint as an international management strategist what do you think – will the digital transformation save us or lure us to our doom?

Professor Hermann Simon: I wouldn’t go as far as to say that the digital transformation will bring salvation but I would say that it offers a great opportunity. Its effects can be very positive as numerous impressive examples from the small business world have shown. On the other hand it can provoke an adverse reaction. Some businesses only manage to use the internet to maintain the current status quo or soften a reversal of fortune.

International Trade News: Nevertheless, it is a subject that every entrepreneur must deal with sooner or later.

About Hermann Simon:

Prof. Hermann Simon is the founder of the world’s leading pricing consultancy Simon-Kucher & Partners. As an expert in strategy, marketing and pricing and as an author, Simon has made a worldwide name for himself. In his academic career he was a professor of business studies and marketing at the universities of Mainz and Bielefeld.

Find the pricing expert’s latest tweets, news and thoughts on Twitter: @Hermann Simon

Professor Hermann Simon: Absolutely. Everyone has to decide what dangers and opportunities this “brave new world” has to offer and respond appropriately. Of course, everyone is aware of the relatively recent rise of entirely e-commerce-based ventures such as Amazon and Alibaba but even here, there are enormous differences: Amazon generated turnover of 89 billion USD last year but posted no profit. Alibaba generated around a tenth of Amazon’s turnover: 8.5 billion USD against a profit of 3.5 billion USD.

International Trade News: Many small and medium-sized businesses still don’t have an internet-based business model.

Professor Hermann Simon: That is true. A good example can be found in an industry sector that did not initially expect anything from the internet: the furniture sector. The company I’m talking about I’ll call Furniture Schulze – not its real name. Located in a rural backwater, it generates turnover of five million EUR with its traditional furniture store.

International Trade News: How did it become involved in e-commerce?

Professor Hermann Simon: The Schulze furniture store was quick to secure itself an internet domain name that communicated exactly what the business had to offer: attractive furniture at an attractive price. How high is its turnover today? 50 million EUR. It had managed to increase its turnover tenfold and was able to reach an entirely new customer group. Through its physical furniture superstore, Schulze was able to draw in customers in a radius of 50 km. Through its online platform, it could reach everyone in Germany and the German-speaking countries of Europe. It just goes to show that change is possible even in such a traditional sector.

International Trade News: Can this be boiled down to a simple formula?

Professor Hermann Simon: There is a nice story I can tell. Although I took Latin in school, I forgot something. What is the Latin word for price? It is “pretium”. And what is the word for value in Latin: it is also pretium. Those clever ancient Romans had the same word for price and value. That is the key to pricing. The price or the price that the customer is willing to pay always reflects the inherent value as it is perceived by the customer. Both are presented and advertised quite differently online than in the physical retail world.

International Trade News: We like to talk about everything the internet can and should do. However, companies are made up of people. How do they cope with these changes?

Professor Hermann Simon: Some manage very well as we have seen in the example of the Schulze furniture store above. However, others find it harder. That means: We are dealing with a critical selection process. Furniture Schulze has now raced so far ahead it is hard for others to catch up. It now has a team of 20 people who understand how the internet works and know the right tricks to use. Furniture Schulze doesn’t advertise its prices. Instead, customers submit orders for the items they would like and receive an individual quote within seconds. This makes it impossible to compare prices directly with competitors. A good trick. The price offered by Furniture Schulze is valid for three days. The pressure to decide quickly is increased by offering an extra 3% discount for customers who place their order within 24 hours. This is a particularly clever tactic. Any customer who has half made up his mind won’t be able to resist ordering within the prescribed 24 hours in order to take advantage of the extra 3% discount. That is what we call Power Pricing!

International Trade News: Has price competition increased in general because of the internet?

Professor Hermann Simon: Yes, it has increased across the board: However, greater price transparency is just one factor. The other side to the story is of course the fact that there are completely new players coming into the market or existing competitors have increased the radius of their activities. If you need a new suit you can now order one direct from Hong Kong. The Hong Kong tailor visits German cities once a month to measure up his clients. The finished suits are delivered to Germany by DHL or UPS within a few days. Once the measurements are in the system then new orders can be made any time via the internet. These sales are lost to made-to-measure tailors or clothing shops here in Germany – the business goes to Hong Kong. Costs there are of course much lower but the quality is the same. Value for money is significantly better.

International Trade News: Let us take a look at the subject of price models, the internet and the digital transformation. What are your thoughts here? Do the same pricing models for power pricing apply in the internet era as did in the analogue age?

Professor Hermann Simon: The simple answer is yes and they are in some cases even more easily implemented. Things like price differentiation are much easier to implement because you can change the price with the click of a button – based on time or target audience. Price bundling is also easier to present and implement. Take book retailing for example: Online it is easy to communicate that two titles are frequently bought together. Have you ever seen a shelf or display in a book shop with a sign saying: people often purchase these two titles together? I haven’t.

International Trade News: You also mentioned potential dangers. Can you describe these in detail?

Professor Hermann Simon: The danger lies in missing the opportunity to join in with this “new” world and thereby falling behind the competition. Sales that Amazon is now chalking up in its online stores are largely sales that have been lost by other retailers. If a customer buys an electronic device from Amazon he isn’t buying one from Mediamarkt.

International Trade News: Let us talk about Power Pricing. You coined this term 18 years ago in your book “Profit through Power Pricing”. You described four Power Pricing dimensions: Strategy, analysis, decision, implementation. If you wrote a new book today – would the digital transformation be the fifth dimension?

Professor Hermann Simon: The answer to that question is a definite no. The digital transformation is not the fifth dimension but an integral part of the four existing dimensions. I am currently working on the fourth edition of my book “Price Management”. In the third edition I added a chapter on pricing and the internet. It has now been omitted. The subject of the internet is dealt with throughout the book.

International Trade News: What influence is the digital transformation having on these dimensions?

Professor Hermann Simon: A key part of the strategy is asking the question: “How do I negotiate and behave as a retailer, how to I combine my online and physical presence?” Manufacturers must also think strategically: “Do I need to go through a retailer or can I reach my end customers directly?” Analysis means testing prices in the internet. It is possible to carry out more tests online in a week than can be carried out in the real world in half a year with the aim of finding out how customers will respond to different price points and pricing structures. Price decisions can be differentiated according to time and in relation to specific customers. Price elasticity varies according to the customer. Of course, we mustn’t forget that there is instant feedback on the measures that have been used and this makes controlling more efficient.

International Trade News: Is this subject an important one for your consultancy or is it only touched on in passing?

Professor Hermann Simon: It is very important for us, across the board. In the case of e-commerce or mobile telecommunications it is absolutely crucial. Even in the automotive sector, the digital transformation is playing an ever more important role. An important question here is price transparency and how prices are communicated. Even more important is how benefits are communicated. Through online feedback and evaluations, the changes are even greater than in price communication. With regards to customer satisfaction, we have access to a wealth of information that is unimaginable in the non-digital sphere.

International Trade News: How does this look in practice?

Professor Hermann Simon: Before, you had to buy a buyer’s guide or test reports. Now, when you book a hotel room via a Hotel Reservation Service (HRS), you can immediately see the reviews of previous clients. On Ebay you can see seller ratings. This aspect is even more important than the price. Even the lowest price can’t compensate for a low seller rating. For customers, quality, service and the value of a product are more important than the price.

International Trade News: Can you name an industry sector that has implemented the concept of power pricing with particular success, perhaps the hotel industry?

Professor Hermann Simon: A better example is the aviation sector. Its aim was neatly described by the CEO of an American airline when he said: If I want to sell 2,000 seats and have 400 different prices, then that is 1,600 price points too few. The aim, therefore, is to sell each seat for the best possible price. The hotel sector has also evolved quite far in this respect but the aviation sector is much more professional in its approach. That is where the concept of Yield Management was born.

International Trade News: Let me ask another question about power pricing. Where is it easier to apply – in the B2B or B2C arena?

Professor Hermann Simon: It is hard to generalise but if you have clear and demonstrable advantages in the B2B sphere then you can certainly charge a higher price. An example is Enercon, the technological leader in the wind power sector. Enercon charges 25% more for its equipment than the industry average. Despite this, Enercon enjoys a market share of 55%. Why? Because the advantages of its products can be backed up by indisputable facts and figures. Mostly these concern the reliability and availability of the equipment or, in other words, demonstrable technical factors. Customers are prepared to pay more for these advantages. In the B2C arena, price differentiation tends to be easier. It is mainly justified by things such as brand image, prestige and symbolic values rather than objective differences in product quality or demonstrable features.

International Trade News: What role is played by the willingness of customers to pay more for a product than they initially planned?

Professor Hermann Simon: That is exactly what we do. Using sophisticated techniques such as Conjoint Measurement, that is the question we try to answer: How much is the product worth to the customer and how much is he prepared to pay for it? According to Conjoint Measurement you can offer trade-offs. That means: if you pay more, then you get more and if you pay less, you get less. With a car that could mean less speed or performance. It is up to the potential buyer to weigh up the differences. Using the data collected we can precisely calculate how much customers are willing to pay. The calculation is very reliable. That is the heart of the matter. That is what it is all about. We are right back at the Roman semantic formula pretium=value=price. The most important thing about pricing is always the value, the benefit to customers it represents and not the price. The price is just a reflection of the perceived value.

International Trade News: What do you think on the other hand about the culture of people expecting something for nothing in the internet?

Professor Hermann Simon: Expecting the internet to be free started as a childhood disease and has grown up into an adult affliction. The difference between something costing nothing and costing a euro is far greater than the difference between costing one or two euros. Getting away from a free culture is incredibly difficult as you have to overcome the sense of entitlement on the one hand and put a payment mechanism in place on the other. You have to persuade people to give you their credit card details or convince them to join a payment scheme. I believe that this hurdle is even greater than the philosophical objection to paying. There are customers out there who would be prepared to pay a euro for a download but they are reluctant to hand over their bank details to a company they don’t know. The situation is very different for cash payments where I can put a euro on the table and the transaction is completed anonymously.

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Related Keywords

Turnover

Digital Transformtion

Power Pricing

Price Competition

Pricing

Profit

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