Rafi Mohammed

Hey Warren Buffett: Here's a Simple Pricing Idea That Will Make You Millions in Additional Profits

Posted on December 5th, 2006 (0 Comments)

I love Warren Buffett and his investment holding company, Berkshire Hathaway. What’s not to like about the astute and humble billionaire whose personalized license plate reads “THRIFTY”? As an economist, people at cocktail parties tend to assume that I am an ace at the stock market (sadly, I’m not). But whenever I am asked for a stock pick, I recommend Berkshire Hathaway. Its track record speaks for itself (see page 3 of Berkshire Hathaway’s annual report): if you’d invested in Berkshire Hathaway at its inception in 1965, your investment (up to end of 2005) would have enjoyed a whopping 305,134% gain! Had you invested in the S&P 500 during that same period, your investment would be up 5,583%. Now, can you understand why investors love Warren Buffett? And for me, it’s a nice plus that Warren is related to my all time favorite rock star, Jimmy Buffett.

In 1998, Berkshire Hathaway purchased NetJets, a fractional jet ownership company. I am a big believer in NetJets – it’s a classic case of how a new pricing strategy can generate growth by serving a new market. Instead of incurring the high expense and headaches of staffing/maintaining a private jet, NetJets allows you to buy as little as a 1/16 share of a jet (50 flying hours) and takes care of all the staffing/maintenance. As a fractional owner, your private jet will pick you up with as little as 4 hours notice. What a wonderful concept! This pricing strategy has attracted new customers. Prior to the fractional ownership concept, you had to be super wealthy or a Fortune 500 company to afford private jet travel. Now…you can be “merely wealthy” or a small business to enjoy the perks of flying at your own convenience.

One of NetJets’ primary financial burdens is the expense it faces during peaks in fractional owner demand (e.g., Sunday after Thanksgiving, Super Bowl Sunday). Everyone wants to use their jet. Since NetJets’ fleet cannot handle demand during these peak times, it charters additional aircraft to meet demand. These charter expenses adversely affect NetJets’ profitability.

What’s interesting is that a few simple changes to NetJets’ pricing can transform this challenge into higher profits. A wonderful attribute of pricing is its ability to change customer behavior. For example, while booking my upcoming holiday travel I noticed that I could save $200 by taking an 8 AM flight instead of my preferred 10 AM flight…care to guess which flight I’m now taking? Why doesn’t NetJets use price to sway its owners’ behavior by employing a peak/off peak pricing strategy?

Here are a couple peak/off peak pricing strategy options it could consider:

  1. Offer peak and off-peak fractional ownerships. Peak owners can fly anytime. For a discount, off-peak owners agree to not fly on blacked out dates.
  1. Offer one fractional ownership price, but add surcharges during peak travel times. These surcharges can be determined using the following methods:
    1. NetJets determines a peak travel surcharge.
    1. Customers determine the peak travel surcharge through auctions (auction off a fixed number of slots, for example, one month, 2 weeks, 1 week, 3 days, 1 day before peak travel time) or yield management (like the airlines do today, let price fluctuate according to demand). One additional variable NetJets could use in its yield management pricing program is “destination” to better utilize its aircraft.
  1. Combination. Offer both peak and off-peak ownerships. Allow off-peak owners to purchase peak travel as they need it. Peak travel surcharges could be determined by auction, yield management, or fixed price.

A peak/off peak pricing system offers several benefits to NetJets:

  1. Minimizes expenses associated with chartering additional aircraft during high demand times.
  1. Captures premiums from owners that value having unrestricted access to their jets.
  1. Better utilizes NetJets’ aircraft by attracting new customers through a discounted off-peak option. Small business owners that value a fractional ownership to travel to three small airports in one day for meetings may be willing to tradeoff the opportunity to travel in style to Aspen during a holiday week for a lower price.

A pretty straightforward and profitable fix to an expensive challenge, wouldn’t you agree? The upside of better pricing is not limited to NetJets, I believe that every business can uncover their hidden profits through simple pricing changes.

Have a pricing challenge? Please feel free to send me a question.

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