The
Price of "All You Can Eat" Can Be Steep
The
strategy seems smart: attract customers by offering more for less. But it's not
for all products and all businesses. Here's a four-point test to see if the
pricing is right for your product.
Recently I was watching the scene in the final
episode of The Queen's Gambit where a collection of Beth
Harmon's buddies, boyfriends, and boosters gather around the phone in New York
City to talk to her in Russia about strategies for the big chess game the next
morning. The conversation continues for some time and then Benny Watts, who's
hosting the gathering, says to the other guys that they have to wrap things up
because the international call was "costing him a bundle".
It's a great scene, but it left me
wondering--when, exactly, did the concept of costly long-distance calls, along
with so many other things we all grew up with and took for granted, disappear
from our lives? It was just a given-- our parents beat it into our heads -
that the further away the person you called lived from you and the longer you
spent on a call, the more it was going to cost. Just like driving a
car-- more miles, more gas, more time - simple math. Distance and duration
meant you paid more money.
And then one day, they didn't. Was it some
magic of physics or advances in technology that overnight shrunk the world and
enabled us to use our cellphones to call anywhere - near or far - at no
incremental cost? Was it due to deregulation or increased competition? Nope. It
was mainly math, or to be more precise, accounting.
The change occurred when phone companies
realized they were spending so much money each month to track and bill
individual customers for their long-distance calls that it was more
cost-effective to convert the entire pricing structure to a flat monthly fee,
especially because that change actually meant that every customer
was paying a little more, whether they took advantage of the opportunity to
make distant calls or not. Not only did the new structure cut the telcos'
operating expenses, but it also permitted them to grow their aggregate
revenues. And the customers - by and large -thought they were getting a
bargain. The dirtiest little secret, of course, was that distance never
did matter in the phone business because you were merely connecting circuits
whether the calls were next door or halfway across the country.
There's an important lesson here for new
businesses as well. While it's generally thought of as a bad joke these days to
say that your pricing strategy is to make up any early operating losses by
growing your volume, there are times when simple pricing strategies like
"one fee fits all" or "all you can eat" do make a lot of
sense and don't hurt the bottom line. It all depends --as most things do. The
trick is to understand your customers and to understand the underlying
economics of your business.
In terms of customers, many years ago when I
was first selling various services to car dealers, they would almost
universally balk at paying fees on a per-vehicle basis. We had our own theories
about why they were so hesitant, but it was clear that they didn't want to be
surprised with a bill at the end of each month that might be higher than they
had expected, or budgeted for, based on the number of cars sold or serviced.
They were very good at doing the quick math and they would explain to us that
if they sold 300 cars a month, their aggregate monthly fee would be some huge
number, which they certainly couldn't afford.
But we also knew that the vast majority of our
dealers and prospects would be lucky to sell more than 150 cars in their best
months. They wouldn't necessarily admit that to us, but it was undoubtedly
true. So, we basically used their own math (and hubris) against them, did a
little reverse jiujitsu pricing, and proposed a flat monthly fee, which divided
by 300 meant that their per-vehicle service charge would be a fraction (less
than half) of what we had initially proposed. And they ate it up and thought it
was a steal. And not one of them ever sold more than 200 cars a month for the
next 5 years. We made out like bandits.
In the case of Cameo,
the CEO, Steven Galanis had a similar problem. He was trying to attract
athletes and celebrities who made millions in their day jobs (or used to) to
work with his startup and create short, personalized videos for his customers.
They could set whatever price for their videos they wished, but, of course, if
the prices were crazy, no one would use the service. So, he took a different
approach. He analyzed those multi-million-dollar salaries and figured out how
much each of the players made per minute during the season, since it only took
a few minutes for any of them to make a Cameo video. And it turned out, they
could make more money per minute doing the videos for his
company than they were being paid by the NFL or the NBA. Once again, some
clever math to the rescue. And, of course, the pitch worked, and the business
exploded. By the middle of last year, in the midst of the pandemic, more than
40,000 celebrities had joined Cameo's platform and more than 1.2 million videos
have been purchased by consumers.
On the other hand, when Groupon first
launched its two-fer coupon program for restaurants, it was one of the worst
things a restaurant could sign up for. Basically, the restaurant was agreeing
to sell two meals for the price of one. The theory was that the customers would
come back and maybe bring their friends. The reality was that the deals
attracted, not foodies, but cheapies who never came back. Long story short-- it
was the restaurants whose lunch got eaten, but not in the way they anticipated.
They had all of the costs and virtually no comebacks. It made no economic sense
because it didn't match their business model.
But there's an equally important lesson here
if you're in the right kind of business. It's all about the
incremental/marginal cost of serving additional customers. If you're filling
seats in a class that has space, if you're streaming an online performance on
the web, if your product is digital and replicable at almost no cost, or if
you've got people and resources just sitting around or excess capacity, then
these are the kind of economics that make sense.
And those are the criteria you need to use to
evaluate any "two-fer" or "all you can eat" deal.
·1 The deal needs to drive new users and
incremental revenue. It can't replace or cannibalize existing full-margin
revenues.
· 2 Your business can't be subject to
capacity or size constraints.
· 3 The deal can't require you to spend
or invest a great deal of money upfront.
· 4 The deal can't give you cash
flow or other float problems.
If these few tests are met, it makes a lot of
sense to take a look at the opportunity. If not, it makes more sense to walk
away.