Rafi Mohammed

Blue Ocean Pricing Strategy

Posted on September 17th, 2007 (0 Comments)

As many of you know, Blue Ocean Strategy is a bestselling business strategy book by W. Chan Kim and Renee Maubourgne. The key idea of the book is to avoid entering a highly competitive industry (a “red ocean”). Instead, create a new product in a market with little or no competition (a “blue ocean”). Makes sense right? Examples of companies successfully employing a Blue Ocean Strategy include Home Depot (offering wide wholesale low price selection along with expert advice to help do-it-yourselfers), Cirque du Soleil (high priced theatrical circus), and Southwest Airlines (low price airline that initially catered to untapped markets where people would drive instead of fly).

What Blue Ocean Strategy comes down to is serving a “hidden segment” within an industry that is not currently served. When you think about it, that’s exactly the key punch line of my favorite pricing strategy, segment based pricing (…trust me, I often wake up in the middle of the night wondering why I didn’t come up with a catchy moniker like Blue Ocean Pricing). The goal of segment based pricing is to activate dormant customers by offering a new pricing strategy. My point is that customers may be interested in your product, but your pricing strategy simply doesn’t work for them. A new pricing strategy can activate these customers.

Case in point: health insurance. While everyone wants health insurance, high premiums just don’t work for many. Chad Terhune wrote an interesting Wall Street Journal article (“New Insurance Plan has Novel Pitch - Get Sick, Buy More”) about a new health insurance plan being offered by American Community Mutual Insurance (ACMI). ACMI is targeting the 40% of uninsured who are 19 to 34 years old and healthy. Instead of paying an average annual individual policy premium of $2,836, ACMI offers plans that are about $1,100 a year. Here’s the catch: ACMI’s plans have annual benefit caps of $1,000 - $5,000…peanuts if you get seriously ill. But here’s the unique pricing twist: if you do get ill, ACMI’s policies allow you to buy an additional $5 million of coverage for a surcharge premium of $9,000 - $10,000 a year. Note the “a year” small print: you have to pay this surcharge every year you want the extra catastrophe coverage. It’s an interesting policy; cheap limited coverage with a safety net option to pay an admittedly hefty premium for coverage after bad luck hits (serious sickness).

ACMI recently rolled out this policy under the name “Coverage on Demand” in Texas, a state where 27% of its population doesn’t have health insurance. By targeting young and healthy customers, ACMI stands to benefit in two ways: (1) Dormant customers are activated with a Blue Ocean pricing strategy and (2) The young and healthy demographic is highly profitable – ACMI estimates that less than 70 cents of every premium dollar will go towards medical costs.

Everyone can benefit from reexamining their pricing. It’s clear that a 1% – 2% increase in price can have a dramatic effect on net profits. But if you want to hit a true home run, start brainstorming about what Blue Ocean pricing strategies you can implement to activate your dormant customers. That’s where the huge money is…

My sincere thanks to Jordan Rich for having me on his radio show last night. He’s genuinely a nice guy and we had an enjoyable hour long chat about pricing.

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