Don't Fall for Scary Stories and False Correlations

Unsplash_massimo-mancini-113100.jpgLast week Andy Kessler wrote an article in the Wall Street Journal, The High Cost of Raising Prices, which might scare you into thinking you will ruin your business by raising prices.  While I usually enjoy reading his articles and I found a few valid points, I mostly disagree with this article. Don’t fall for the scary stories and false correlations that could make you afraid to raise your prices. When the value you provide to your customers is greater than the price you are charging them, you can and should increase your prices to match the value.

In my opinion, there are a couple points Mr. Kessler got right in his article: 

  1. When you are highly successful and profitable, you encourage new entrants to compete with you

  2. There is some level of price elasticity in most things

Unfortunately, those are not the causes of the results he cited in his article.  Prices may have gone up during the periods he is referring to, but they were not the cause of declining buyers.  In most cases, volumes have been lost due to changing customer tastes or changes in technology and capabilities.

Let’s start with the Disney/ESPN example. Kessler’s article says people have been leaving ESPN because they raised prices.  Over the past 30 years, ESPN has become a sports juggernaut.  We are a sports-crazed nation, and ESPN initially provided sports news and updates and some second-tier events.  Their anchors had lovable personalities and everyone enjoyed getting their sports fix.  And yes, ESPN raised prices during that time as customer value soared.

During the last 20 years, the internet has blossomed and a plethora of new options became available for sports addicts.  YouTube, Hulu, and other sites became viable sources for sports news.  In addition, Twitter and live streaming have made sports information available in real time, making the news shows less helpful.  Furthermore, TV audiences for all sporting events have decreased even while live sports attendance has increased.  As a result, ESPN viewership has been decreasing.  The important point is pricing is not what created new capabilities or caused viewers to leave.

It’s also interesting to note that Kessler did not cite Disney’s theme parks.  They have consistently raised prices over the years, while park popularity remained very high.  In the past few years, they have adopted dynamic pricing, with even higher prices during peak periods, and lower prices during slow times.  If price increases are bad, why haven’t they harmed the Disney parks?

The US Postal Service was also cited for egregious price increases that further drive customers away. Talk about misunderstanding correlation and causation!  First, the price increases of first class stamps have increased an average of 2.3% per year during the last 16 years.  That is about even with CPI increases during that period.  Also, $.49 to mail a letter anywhere in the US is still a bargain.  More importantly, people mail fewer things because they can do it electronically.  People write fewer letters and checks because electronic options are more efficient and convenient.  Does anyone really think more people would mail letters and checks if the cost of a stamp was still only $.34?

The Kessler article also discussed the problems facing Kellogg’s, Nestle, P&G and other consumer packaged goods (CPG) companies.  There is no doubt those business models face challenges.  Certainly, there are segments of their customers that are very price sensitive.  Over time, those customers have gotten more comfortable with house brands and generics and have switched away from the brand names.  However, there is an even larger segment that finds value in the quality and reliability of the brands, and those customers will not switch.  Lowering prices on the brands to keep the price-sensitive customers would result in huge profit reductions or losses on the loyal customers too, and total profit declines would be much greater than they have experienced today.

The other problem the CPG companies are dealing with is changing consumer tastes.  Many customers have consciously decided to reduce their packaged food consumption in favor of fresher options; and many are simply eating out more often.  I am sure there are prices at which those trends could be reversed, but just like competing against generics, the price cuts would go to everyone.  That would mean much bigger losses on the customers they kept.  CPG companies have done the opposite.  They have raised some prices to reflect the value to customers who still want their products.  This at least provides a little profit and enables them to invest in adjusting their business models to adapt to the new realities.

I agree with Mr. Kessler that there are limits to how much prices can be increased.  Just ask Turing Pharma and Mylan!  That said, it is important to price to the value your customers receive from your products and services, and recognize that different customer segments receive different amounts of value.  Equally important is to evaluate how sales results are driven by price changes as opposed to changes in tastes and technology.  Don’t simply assume changes in volumes are caused by your price changes.  Get the facts!  And, don’t be afraid to raise prices when your value warrants it.

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