Last month I attended two Major League Baseball spring training games with some long-time friends. Of course, our experience included beer, because ball parks and beer go together so well. Buying the beers also reminded me that in pricing strategy, how you structure your prices is just as important as the prices you set.
One friend, Tom, was the first to buy a beer. When he arrived at our seats with a pilsner-filled souvenir cup, he told us the first beer cost $10; however, if he brings his cup back, the 2nd beer would only cost $6. I have written many times that although the prices of food and drinks seem high at sporting events relative to other situations, the stadiums would be fools not to have high prices for them. It is primarily the event and the ticket prices of the event that determine whether people will attend. Once there, if they are hungry or thirsty, they will pay high prices for food and drink. So why would this stadium offer a lower price?
The answer to that is simple. The stadium was trying to get their patrons to consume more than they otherwise might. This is similar to a common car-wash incentive. If you bring your car back within 7 days, the price of the 2nd wash is greatly reduced.
The beer offer is somewhat similar to a movie theater offering a substantial increase in the amount of popcorn in a bucket for a fairly small increase in price. The theater and stadium both offer incentives, but they structure them differently for good reason. While the stadium certainly could create a double-size cup for beer, they would have fewer buyers because the beer would get warm before it is finished. Since there is a break in the action every half inning, it is easy for a patron to return to the concession stand to buy another. Conversely in a movie theater, the popcorn will taste just as good at the end of the bucket as it does in the beginning; however, most people do not want to return to the concession stand in the middle of a movie.
Let’s contrast those with two other examples where pricing incentives are offered to entice customers to buy: bundles and column pricing. A bundle is an offer of multiple products for a single price, where the price of the bundle is less than the cumulative price of all products in the bundle. A value meal at a fast food restaurant is a bundle, and the Microsoft Office suite is a bundle. Professional Pricing Society (PPS) offers bundles of on-line learning. To be effective, the bundle should include an anchor product that is the primary item sought by the customer, plus complementary items that often are not purchased, such as french fries or Microsoft Publisher. In the PPS case, the complementary products are additional, deeper training courses.
The point of a bundle is to entice the customer to buy more than the anchor product. The size of discount that is needed depends on how many customers would buy the complementary products without a discount. Most fast-food customers will already buy a drink and 3rd item with their sandwich, so the value meal discount is small. On the other hand, most customers don’t need Publisher and it takes a large discount in the bundle to get them to buy it. The other important point for a bundle to be successful is the incremental sales value must be greater than the incremental cost of adding the complementary item. Microsoft’s incremental cost of Publisher is near zero, and PPS’s incremental cost is near zero.
The last example, column pricing is a pricing structure that gives customers an incentive to purchase more at one time than they otherwise might. Uline offers column pricing on most of their products where, as an example, the price per box of 3 boxes of paper towels is lower than if a single box is purchased. With column pricing, customers may not increase their total purchases for a year, but they buy in larger quantities, and lower the cost per unit for order processing, fulfillment, warehousing, and working capital for the selling company.
In all of these examples, the seller is trying to encourage customers to buy more, but not all structures work in all situations. It would not be practical or cost effective to bring back an empty paper towel box to refill it, and it would not be economically sound to offer a discounted price for buying three beers at a time, instead of one. Column pricing for beer would also reduce control of underage drinking. Clearly, the pricing structure and how incentives work are clearly important.
One final point. There are limits to incentives. At the baseball game, Tom suggested that if he went back for a 3rd beer, the price should drop even further; however, that was not the case. First, there are diminishing returns. Whether it is beers or cases of paper towels, discounts must keep growing to get customers to continue increasing their purchases. Customers run out of room to store their products, and in the case of food and drink, they get full. And for sellers of tangible products, with increasing discounts it does not take long before the incremental sales value is less than the incremental cost.
When developing your pricing strategy think about how the structure of your incentives will best encourage more customer buying, and how it will affect your cost structure and existing sales. Your profitability depends on it.