Rob Doctors, lead author of the book, Contextual Pricing: The Death of List Price and the New Market Reality was my guest on the Business901 Podcast. Rob believes that pricing decisions need to be driven by customer context rather than simple list prices. Pricing is more than just an issue of margin and production costs, but rather a complex set of contextually factors best defined as an outcome. In the podcast, we discussed the outcome of four contextual factors: Situation, Objectives, Perception and Capabilities. 
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Related Podcast: The Irrelevancy of List Price
Transcription of the Podcast
Joe Dager: Welcome everyone. This is Joe Dager, the host of the Business901 podcast. With me today is Rob Docters. Rob is a recent co-editor of Contextual Pricing. Rob could you go ahead and tell me about what you’re doing, right now and a little background on why you wrote a book on Contextual Pricing.
Rob Docters: Sure Joe. I lecture and have been speaking at a number of conferences where people have been interested in pricing. Sometimes in an academic way, sometimes we review how they should improve the pricing in their businesses. Actually, there is some increasing interest in the topic.
Pricing hasn’t always been a popular topic as you have mentioned. In fact, you could say that in some cases, it’s viewed as an alien topic and you can understand why. Thankfully pricing is not really a popularity contest. There is a cartoon strip called Dilbert. They had a pricing discussion in one of those cartoons.
The lady with the funky hair said, “Well, let’s give customers what they want.” Then one of the other ladies at one of the tables said, “OK, what they want is a better product for free.” That sums up what a lot of people think about pricing is that it’s an insult to the customer to charge a price. I don’t agree with that.
Joe: What do you agree with then?
Rob: Well, it’s interesting because pricing has to wear a number of hats. It’s how our capitalist system runs. It’s the invisible hand. It’s the thing that frankly anybody who goes out to the supermarket has to face day in day out. It’s so many things. It has been a bit of a mystery for a lot of buyers. It is certainly a notion of higher prices is a familiar enemy to many.
My now – wife introduced me to her mother and her mother asked, “What do you for a living, Rob?” I said, “Well, I help companies with their pricing.” She was baffled and she said, “What does that mean?” and I said, “Well for instance, you live in the Verizon telephone service area. Well, I helped them stick the bundle that gives cellular plus land line and I helped them price it.”
She frowned a little bit, I said, “Well, for instance I helped the US Postal Service the first time they did a jump in price that was more than one penny.” I helped them do that. Then our firm became deeper, at which point my then fiance, now wife intervened and said, “I believe it’s time for dinner,” and she cut that conversation right off.
The point is it’s not a popular topic, but it’s really important topic. Not only is it important at a macro level of how our economy works, but it’s the difference between life and death for a lot of companies.
Joe: I think it is a mystery for many and I’ll take it really to the basics here for me. It used to be pretty simple that you build a product, you added up the material, the labor in it, and you put your overhead in it, and how much profit you wanted. There was your price. It was that simple. You might put in for discount, distribution and a few other things, but it was what it was.
I think that’s in a world that we lived in where there was excess demand. Now, I always look at that you have to create demand, and one of the ways you create a demand is through pricing strategies. Pricing has taken a whole different context, not to steal from the book. I think to me it has. Am I way off base there? Have I any foundational truths to what I’m saying?
Rob: I think there is a foundational truth there. For instance, there was a time when, if your name was Henry Ford and you had just invented the car or made it popular for the first time, you set the price. The Model T Ford was the price you set, and that was good for a good 15 – 20 years. The Model T dominated automobiles. Then Henry set the price, and his attitude was “You can have any color you want as long as it’s black, and you can have any price you want as long it’s the one I’ve set.” That was, of course, a long time ago. Henry got to do that for 20 years.
Apple, of course, released the iPhone, and they didn’t get 20 years of non-competition. There was already competition two years, two and a half years later. For some of their other products, the interval has been even shorter. Now, those have been very profitable brief periods of time, but considering that that’s one of the most innovative new products that we’ve seen in a while, it’s amazing how little price insulation there is.
So, really, the differences between the model of “build it, price it, and they will buy” is the difference between a more competitive world and one that’s less competitive. So that leads to the question, OK, so how do you price them?
Joe: Let’s just take a second, and can you define what you mean? Is there a simple definition of contextual pricing?
Rob: We view pricing, or contextual pricing, as really an assimilation of a lot of thoughts on pricing. If we had been having this conversation in the 60’s, we would probably be talking about cost base pricing because the economists obviously worried about pricing and they really only saw two things. They saw the cost of the good and then they worried about the special case of monopoly, and that in turn binge somewhat on pricing.
We would be saying, “OK, the way you’re price is, you figure out how much it costs and then you try to add as much of the bonus to it as you can. In the late 70’s and early 80’s, there was the thought of hey, it’s not only the cost, not even mainly the cost, it’s the value that it brings. How do people perceive this thing? How much is it worth to them?
Then in the late 80’s, it started running out of gas, or actually the early 90’s. There was a whole group of academics saying that it really varies a lot. They came up with all sorts of marked evidence and experiments that show, for instance, people value the same thing very differently. For instance, if I tell you “Joe, I have allocated 30,000 frequent flyer points to you, and if you do not take flight in the near future you are going to lose them.”
That actually has a very different impact on you than if I say “Joe, if you take a flight in the near future, I am going to give you 30,000 frequent flyer points.” The research has shown all sorts of interesting things, like people fear loss more than they value gain. You would actually resent losing your 30,000 points more than you really valued gaining them.
There is a whole series of interesting situational, sort of narrow experiments conducted by Academia. So, as my co?authors and I were thinking about this book, we were saying, we’ve got this one group of people who are thinking about in cost terms, another group who are thinking about in value terms, a third who is thinking about it in reference terms, but sometimes each of those are right.
Sometimes cost matters. I’ve done work for steel mills, and I assure you cost is incredibly essential to their pricing. I’ve done work with some fashion items and some high tech work, and value matters a lot and I’ve done work for some online entertainment and I assure you that context matters or reference matters. If you pull them all together, what I would say is the context differs.
In some contexts, cost matters, in some contexts, value matters, in some contexts, the reference matters. So, this is an attempt to synergize those three views into something that works almost all the time. What we found was that there are a number of companies that have already been moving in that direction. Not a lot, but a few leaders have already started to do what we call contextual pricing.
Joe: Can you give me an example of one?
Rob: One of the most interesting ones we thought was The Coca?Cola Company. They were amazed themselves, at this experiment. What they did was, they did a promotion at Wal-Mart, and Wal-Mart let them put some Coca?Cola, not only in the beverage aisle where it’s always been, but in the sporting goods aisle.
They had a promotion where they had taken all the Coca-Cola plastic bottles and recycled them and provided that to some clothing manufacturers who created some sporting gear, some sweatshirts, sweatpants, that sort of thing. To complement those recycled goods, they gave crates of Coca-Cola.
Now, what was really interesting was, the prices that they got, by putting 6-packs and 12-packs of Coca-Cola in the sporting goods and clothing aisle, had been among the highest they’d ever gotten in retail.
Consumers could simply walk over a few aisles and get the same Coca-Cola, and one thing you know is one bottle of Coca-Cola will contain exactly what another bottle of Coca-Cola will contain. Few things we are sure of in this world, but one of them is the consistency of Coca-Cola. They would pay much less in that other aisle. So it was in this case, the context of, “Are you next to Pepsi, or are you next to some clothing?”
That was a very inspirational experiment, which we had nothing to do with, but we thought that that was a harbinger of other interesting possibilities. Then we looked further, and we found out that, for instance, with many goods, it matters who you’re selling to; same goods, same everything, but a different person.
So, for instance, if you sell long?distance phone services, like voice services, selling it to people who have to pay for their own access, their own broadband access, you actually get more money than if you’re trying to sell it to people who get free access.
The context in one case is, you’ve got this broadband bill, and paying for the voice on top of it is just a small increment. But if you pay zero for broadband, the increment is now the entire focus of your attention, for voice, and you become very price sensitive. The same way that a car radio in a BMW is highly price insensitive, a car radio in an economy car is very price sensitive.
Joe: You alluded to that, but the definition of contextual pricing, I think in your book, was defined as an outcome. You based it on four factors. Could you touch upon those four factors?
Rob: Contextual pricing is a function of the frame of reference as seen by the customer. In other words, he looks at it from the point of view, “Well, what do I know about this service or good? What are my alternatives?” These may include competition or may include just not doing it, or something in quite a different category. He or she looks at their own minimal effort; they look at their different emotional reactions.
It’s the amalgam of all the perspectives that they have on a particular purchase choice that’s come together. Usually, there’s one that predominates. It’s usually not that they’re thinking about certain things. It just varies, what the thing is that drives their purchase. The important piece, of course, is that if you know what that perspective is, then, in fact, you have the right pricing.
If you don’t know what that perspective is, you base it on something that happens within the four walls of your company, be it costs, be it whatever your advertising was, and that sort of thing. You’ll probably have the wrong price, and you will miss the opportunity to get really remarkable return.
In some industries, failing to get that remarkable return is fatal. Interestingly enough, sometimes it’s the most competitive pricing. For instance, in commodity plastics, if you don’t take advantage of rush orders by your clients, or some special requirement they have, you will go bankrupt, because the average commodity plastics sale is below full cost.
It’s above variable cost, but it’s below full cost, and what they do is, they live on this stuff, the crummy below-full-cost sales, basically to keep the wheels going, and then every so often a customer walks in with the magic words and says, “Rush order, I really need it now. Can you please make the following tweaks?”
Then, yes, they will command a nice premium, even though it’s a cut?throat nasty business because that’s the moment when the context has changed and they can command a nice price
Joe: I have been talking to a couple people about it, and I had to come up with a way of remembering what I call the definition or the factors that you talked about there. I just use C.O.P.S. Capabilities, objectives, perception, and the situation. But you used some great terms in your book that I really enjoyed. One of them that I thought was rather unique that you say that life without list price is easier. That probably grabs a few numbers’ guys wrong.
Rob: It does; it’s funny. I stand by that statement, but I also know why they are not so happy with that idea. The fact is not only do people like certainty, and sure it is convenient to have a list price. But the truth is, it’s believing in something that just doesn’t have the reliability that people ascribe to it. Because the fact is almost never do people get their list price.
I mean, as you mention, Henry Ford got it for quite a while; Apple got it briefly. But that’s a very small minority of the total range of companies in the world. Most of us, unfortunately, have a very bitter experience of being out priced by a competitor.
The fact is the times we can get our list price we value highly. It’s funny; one of the things I wish my editor had done at McGraw Hill was put the footnotes where they should be at the bottom of each page. Unfortunately, thanks to the advent of E?Books, there is no such thing as the bottom of a page anymore, so they all ended up being in chapters.
I think some of the more interesting aspects kicked below the main text, were in the footnotes, and one of them was, the New York Times reported, that there was lot of superstition in pricing, and they gave a great story. Eric Clapton’s guitar, used for Layla and lot of other songs, recently sold, and it sold for over a million dollars. The person who bought it said, “Well, of course, I’ve now got Clapton’s guitar. I can’t wait to start playing.”
What’s even weirder is there were many replicas of that guitar, they were selling for $30,000 and $40,000 even though Eric had never touched them. The Times quoted a number of psychologists who said that is superstition. In primordial times, people believed that if they have a replica of something like a voodoo doll, they can control some of the power of that.
I really believe that there are a lot of residual beliefs that the list price is what will bring people profitability. I think they’re completely wrong, and I think they’re out of date. In fact, some of the companies that cling most tenaciously to list price fair rather badly, if they no longer have the market power to support it. But the truth is people change slowly.
There is a great quote in my book. One of the things I’m very happy with is quotes at the beginning of each chapter. It’s a quote by Max Born, the famous German physicist. What he says is, “The way science progresses are not that scientists learn a new truth. Science progresses by all the scientists dying because a new generation comes behind that never learned the false truth.” In this case, the reason it’s simpler is because list price is a myth in most companies.
For instance, marketing may set a list price, but immediately that’s split up by channel. Different ways of selling it get different prices in many cases. Then there are special circumstances like volume purchases. Then you get the final level of insult upon it, which is sales discounting. So, for instance, it’s quite frequent that you have companies who end up with many more times prices than they actually have customers because it just proliferates.
That’s, of course, a disaster on all fronts. It destroys the value of the message. Obviously, you lose revenues that way. It makes it confusing, and you’re going to see a problem for like their list price, find it annoying that the price that they think is the list price has no relationship to what the revenues are coming in the door.
Joe: When I first looked at the book, I thought, “Here we go. Here’s another one of these feel?good approaches that…
…we price it over here. We price it over there, and then we just justify everything, of why we did it that way. Are there tools? Is there a process you can use that a normal company can really achieve contextual pricing?
Rob: There are. There are actually some very simple frameworks, and it’s interesting because some companies as I say, like Proctor and Gamble, have been doing this all by themselves without any consultant’s help. That is, I honestly think that product developers need to come up with a single price because, frankly, they’re busy developing the product. That’s the last person who should ever be granted that rather self-indulgent luxury.
Marketing knows that, in some markets, they’re going to be strong and in some they’re going to be weak. Let’s acknowledge that right up front. Let’s say, “Here’s the price that we would expect where we’re strong, and here’s where we expect where we’re weak. Here’s where loyal subscribers will pay more, and we expect that new customers, with no idea of what the value of what we’re selling is, will pay less. In large bids, we’re going to get less, in other cases we’re going to get more.”
There usually aren’t more than half a dozen or so circumstances, which are pretty well known to everyone in the company, that represent the range of prices. Once you get a dozen prices that actually work, you can stick with them.
Primitive approach, which is saying, “Here’s one price,” but no one will stick with it, means that every time anyone touches it there’s a new price. Better to start with a dozen or maybe 20 prices and just hold the ground, because you can. You’ve already got your price in case you have low market power. You’ve already got your price in case you’ve got high market power. Just stick with them.
What literally happens is a proliferation into thousands of prices occur from larger companies if they pretend, initially, that there’s one price and then “wink, wink,” allow it to proliferate into a million prices.
Joe: Do you stand the risk of alienating a customer, though, when he sees “I could have bought it over here for this, and I walk into this store, like the Coca?Cola example, the next aisle I could have bought it for that.” Do you stand that risk of alienating him?
Rob: The answer is, let me be blunt, yes. Any time you have price variation you have that risk. But of course you’ve got price variation now, so let’s not kid ourselves in thinking, “I am perfect now, and what’s the consequence of being imperfect?”
I also have another theme in the book, which is, not only does the circumstance of being in a strong position versus a weak position suggest a high or low price, one of the things that we see over and over again, is that, inside the company, they focus on the actual price level when, in fact, that’s not usually the most important decision they’ve got on their hands. It’s often the price structure.
What do I mean by price structure? It means the terms under which I sell. For instance, let’s talk about one of the most brilliant pricing innovations in a long time. It doesn’t come from Apple, by the way. It’s singularly product-oriented in how they price rather than brilliant in their pricing, but highly competitive area, jet engines.
For a long time, if you wanted a jet engine, Joe, you’d have plunked down $2 million and good news, that was your jet engine, they carved your name on it. But then they came up with a really cool idea, which was, airlines don’t really care if they own the engine, all they want is an engine to be working as the plane chugs from point A to point B.
What they did was instead of selling by the engine, they started selling by the hour of jet engine time. Instead of paying $20 million for a big jet engine, you might pay $20 million for 5,000 hours of jet engine time.
Actual numbers in both cases would be no more than a few million dollars. In any case, the point was a lot of airlines said “Wow that was exactly what we wanted! We now don’t have to worry about spare parts, or all the other stuff with ownership.”
We just know our fleet will be in the air X many, hundreds of thousands or millions of hours in the next year that is how many hours of jet engine time we will have to buy, and it’s now Rolls Royce’s problem on how to get that done. The result was Rolls Royce picked up market share, and when all the math was done, they got better pricing on their engines.
So, yes, at a given moment someone at another airline would look over at Delta and said “I wonder whether the price they are getting is higher or lower.” But it is really hard to compare $X millions per engine to $X per hour of jet engine time.
There are consumer examples, as well. In cars, one gets rented by the mile and one by the day, and who knows who’s paying more. The same thing with bananas in the store, some sell by the banana and others by the pound. Who’s getting the better deal, if you have a calculator and you got the time for checking, you could figure it out. I blame sellers for having the same structure they ought to vary it with the situation and concept.
Joe: This goes along with what I talk about, and most of my listeners will recognize this with the service design and the value and use concept. There is little value to a product or service; it is just an enabler of use. The easier you make use and the higher value of the use, contextual pricing supports that. Doesn’t it?
Rob: Completely. The non-business example is a life jacket is worth a lot to you, Joe, if you are on a sinking ship. However, it is worth nothing to you at your next fancy dress party. In fact, it’s worth is negative. Same goods, same everything, it’s the context. In a business example, for instance, we found that a provider of financial information…
When we actually looked at their numbers, it turned out when they sold that financial information to an individual manager or someone who was an analyst; they weren’t getting as much money as when they sold it to someone who’s managing a huge portfolio.
The reason is, in the case of the huge portfolio, that piece of information is important to optimizing that 100 billion whatever dollar portfolio. If you send it to an individual money manager, you might produce a $10,000 trade or some advice to clients but even though it’s exactly the same information, the context in one case is far more valuable than in the other.
Joe: If I need to change my pricing structure and look at contextual pricing, what would be a compelling reason for me to go that direction, right now?
Rob: Better margins in a nutshell. Because, think about it, once you’ve set a list price, the traditional way of doing it. It’s really tough for anyone in your organization to sell above that list price. I’ve set a list price on, whatever, my plastic clam shells for holding food in a supermarket. The next moment, a customer, runs in saying “Rush order, rush order, I desperately need clam shells. I’ll pay you a million dollars per clam shell!”
You look in your book, and you say “I’m sorry. I can only charge you $0.30 for this clam shell because that’s our list price.” You immediately cut off the benefits by setting a list price. By the way, what’s amusing is, we’ve found in a lot of investoral — this just shows that the world has many different types of people in it. There are some sales people who enjoy selling above list price.
The first few times, I thought that was just flukes in the data, but every time I’ve run into this I just have to chuckle because I’ve talked to these guys – not really guys but a lot of gals – and they said “Yeah, I like the challenge of selling at the highest price possible.” It’s a little tougher for them to do that with a list price in the works, but they do it anyhow. Most don’t bother, and they sell at list price or below. So don’t forget when you set a list price, you’re depriving some people of aspirational pricing.
The first part is, I would say, you’re now suddenly going to get a bunch of add-ons because people understand the situation when they’re in it. Somebody, who’s coldly setting up a price schedule that’s harder for them to do unless they think about context and most don’t.
That’s one aspect. The second aspect is you tend to change a lot of other behaviors because suddenly your sales force isn’t going to be measured on their adherence to list price. They’ll do what IBM has done for years, which is they measure sales forces by their total revenues. So if I’m the IBM account rep selling to Smarter Blog Corporation, I’m being measured whether my $20m that I got last year went up or down. Again, list prices can only be an impediment to that.
Joe: Is there something that you’d like to add that maybe I didn’t ask you about?
Rob: It’s interesting, because I think everything goes full cycle. There was a time when all pricing was contextual. What we need is a harmonica in the background and some nice Country and Western music maybe, but think back to the wild west, or, if you like, early England, et cetera.
There was one store in town, and what happened was, you walked in, and you picked up your frying pan, or your branding iron, or whatever you were buying, you walked up to the counter, and you said, “How much is this?”
The clerk, who was usually the owner, looked at you and thought, “Looks like Joe the cowboy, and you’ve had some successful cattle runs lately, I’m going to charge more. Furthermore, that is the last branding iron, better charge more.”
That was contextual pricing, because the person staring you in the eyes really understood where you were coming from, what motivated you, what was important. That was very successful as a business model.
At some point, actually it was a Quaker, who decided that was unfair, and it was actually a Quaker who invented the idea of price tags. Suddenly prices tags started going into stores. Again, you had moved away from contextual pricing.
Then you got stupid computers, by that I mean that computers weren’t very smart for a lot of their history. In the 1960’s, a huge computer was dumber than my Apple Computer today. You had dumb computers who couldn’t handle much complexity, so everything got dummy downed even further.
Now, we’re at the other side of that valley of profit death. We now have smarter computers, smarter systems, and I think an increasing realization that pricing had better be smart or you’ve got problems.
So, you have people doing very clever things. One of my favorite examples is Toys”R”Us. Toys”R”Us, as we all know, is a toy store that’s facing just crushing competition from Wal-Mart, who have managed their supply chain and other things really well. They’ve lowered costs. They’ve got more throughput, blah, blah, blah.
In response to smart other things, Toys”R”Us got smart, and one of the things they do in some of their stores is, there are no price tags on the toys, which brings us right back to the 1850’s. What you do is you pick up the toy you like, and there are little kiosks. You take the toy over to the kiosk, the kewpie doll or whatever, you scan the bar code, and it says “kewpie doll, $13.00 or whatever.”
Why is Toys”R”Us doing that? What they’re doing is varying their prices over the time of the day. Sometimes that kewpie doll will come up as $8.00, sometimes it’s $20.00, whatever. They measure how many of those kewpie dolls make it between the scanner and the checkout counter.
If none of them make it to the checkout counter, they know they are priced too high. And, if too many of them do they know they are priced too low. It’s a clever way of getting around all the dumbifying assumptions of a list price by measuring demand directly.
Lots of industries do that. The airlines do it. Every six minutes airline prices are recalculated on most major airlines, because they measure supply and demand. In other industries, there’s increasing sophistication of sales force tools, sales force psychometer. There’s a lot of information that previously was known to the salesperson, but that’s sometimes where it ended.
Increasingly, I believe, businesses are smarter and smarter, and we have a whole chapter that talks about how systems get smarter. I think contextual pricing has become easier and easier, in addition to some of the, reasons I mentioned why it’s easy.
Joe: I have to tell you that I did enjoy reading the book. I’m somewhat of a numbers guy. When I read it that part of it was fine, but even since then I’ve had more time and I’ve reread several other chapters, and it’s amazing how much more I acquired from it.
I wanted to compliment you on that. Though I think when you first read it, it comes across as a good read, some good information to go forward with, but there’s a deeper side to it that I don’t think you get in the first read. I want to take my hat off to you on that, it was a very good book to read.
Rob: That’s very kind of you. We tried to pepper it with a little bit of humor, we quote comedians like Mitch Hedberg and a whole bunch of other folks, So hopefully, it breaks up that a little bit. Pricing books are not known for being great reads.
Rob: There has been some very nice reviews that said, “Hey, this isn’t what I expected out of a pricing book.”
Joe: No, it certainly isn’t, but I think it’s got the depth for someone really to spend some time with. Again, I want to compliment you for it.