Why Pricing Matters for Investors

Adjusting your pricing strategy just a little bit can have a profound impact on the bottom line. In his book, The 1% Windfall, economist Rafi Mohammed shines a spotlight on a number of effective tactics, most of which can be seen in action all around us.

Netflix already knows this stuff
When fellow Fool Rick Munarriz caught Netflix (Nasdaq: NFLX  ) in the act of testing different pricing plans for its DVD and digital plans in certain markets, the strategy came right out of Rafi's first chapter. To wit: "A profit maximizer analysis involves first determining revenues, costs, and profits at different price levels. After these data are available, the next step is to select the price associated with the highest profits."

That's all Netflix is doing here -- running a controlled set of pricing tests to see just how far its customers will stretch before dropping the service by the busload. Rick warns the company to "tread carefully here," and I believe that's exactly what the company is doing. Instead of simply rolling out new pricing plans across the whole customer list at once, there's preliminary research going on. If it turns out that Netflix would increase its churn significantly with even a small change, I don't think we'll see any price boosts at all on a national level -- for the time being.

By contrast, I don't think the old management team of Netflix rival Blockbuster bothered to run through this sort of careful planning stage when the Total Access plan was a hot tamale. No matter how many new customers the stunt brought in, Blockbuster lost money on each one while also gutting its store shelves of vital disc inventories. Even a cursory test run would quickly have shown how monumentally unsustainable Total Access was as a day-to-day business model. We all know how that story ended.

Are you awake, Steve?
Steve Jobs might want to read Rafi's book as well, because Apple (Nasdaq: AAPL  ) could use some adjustments to its pricing strategy.

Traditionally known as a high-priced but flat-out better alternative to gray Windows boxes or hard-to-handle Android phones, Apple has always enjoyed strong selling margins. If you know that you want an Apple gadget, you will pay extra to get it. But that's changing now. Jobs now contends that Apple's strategy is "all about making the best products at aggressive prices, and that's what we will do." But thanks to low prices and expensive components inside the iPad and recent iPhones, Apple's profit margins are coming under siege. A hasty buildout of Apple's retail store network doesn't help much, either: Retail is an expensive business to run.

Mohammed uses traditional retailer Wal-Mart Stores (NYSE: WMT  ) throughout the book as a prime example of businesses that could profit handsomely from experimenting with their retail pricing tactics. Perhaps unwittingly, Jobs is moving his beloved company away from the luxury-flavored space he's used to and closer to the low-rent ghetto. Rafi would argue that a premium product deserves, nay, demands premium pricing in order to capture the business value of the product and to maintain its high-end status at all.

Look out, cable guys!
And then there are entire industries in dire need of pulling their heads out of the sand and take some appropriate pricing action before they make a laughingstock out of America at large. I'm talking about broadband Internet service providers.

If we could buy network connections on a global market with open competition, Verizon (NYSE: VZ  ) and AT&T (NYSE: T  ) would be forced to make some drastic changes or perish. Here, we contend with paying $100 or more per month for a measly 50-megabit connection. That's if we're lucky enough to have even that available. In Britain, Virgin Media is taking flak from media and competitors because its 100-megabit is overpriced at the equivalent of $72 per month.

In Sweden, a single provider can give you a choice of getting 100 megabits via cable modem for $44 a month with no long-term service contract or $10 a month for a plain Ethernet connection if your neighborhood is properly equipped. 3G data plans from the same company top out at 16 megabits, or about 60% faster than the peak bandwidth of Sprint Nextel's (NYSE: S  ) purported 4G connections over here -- for as little as $34 a month. Swedish 4G coverage is still in its infancy but will reach speeds of "50-80 Mbps on average." You do the math.

And if you don't like what that company is selling, you have at least two competitors available with similar product portfolios. Any cable operator, telecom giant, or wireless upstart that would offer one of these options at anything like European prices would steal millions of customers from its so-called competitors. But nobody has done the cost-to-risk analysis to see if this strategy would be worth it. Could somebody please give this book to Dan Hesse and Ivan Seidenberg, pronto?

Highly recommended for investors and business leaders alike!
All things considered, pricing strategies can make an enormous difference to the success of a business, from lemonade stands to multinational conglomerates. If you buy The 1% Windfall from Amazon.com (Nasdaq: AMZN  ) , the value-added Kindle edition with full-text search and other advantages over dead-tree books is actually 12% more expensive than the hardback version. It doesn't matter that it costs approximately nothing to distribute the e-book text. Is that ironic -- or a conscious pricing strategy? Only Rafi knows for sure.

Fool contributor Anders Bylund holds no position in any of the companies discussed here. Sprint Nextel, and Wal-Mart are Motley Fool Inside Value recommendations. Apple, Amazon.com, and Netflix are Motley Fool Stock Advisor selections. The Fool owns shares of Apple and Wal-Mart. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. You can check out Anders' holdings and a concise bio if you like, and The Motley Fool is investors writing for investors.


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