Rafi Mohammed

Pricing is Really About Focusing on Customers' Next Best Alternatives

Posted on January 6th, 2010 (1 Comments)

Which movie rental should Blockbuster Video price higher: an obscure 22 year old documentary that grossed less than $1 million at the box office or the latest Hollywood hit release? A popular film that crossed the $100 million revenue mark on its opening weekend, right? Not exactly…

Over the holidays I was interested in watching a fascinating interview of Bruce Springsteen describing his experience of being the backing band for rock pioneer Chuck Berry. This interview is in the documentary Hail! Hail! Rock “n” Roll. Recalling that Blockbuster had sent me an email announcing 99 cent movie rentals until December 31, I felt set.

Scrutinizing the fine print of the Blockbuster email, I was surprised to see that the 99 cent deal was only valid on new releases. “What are they thinking,” I mused after realizing that my obscure rental was now going to cost me close to $5.

When you think about it, Blockbuster’s pricing strategy makes perfect sense and illustrates a key feature of value-based pricing that many managers miss out on: the right value-based price depends on what the customer’s next best alternative is. As I have previously written, Redbox is now offering $1 rentals at its video kiosks. Since a typical Redbox video kiosk stocks 200 titles (but holds 700 DVDs), the majority of titles are popular new releases. As a result, the next best alternative for customers who might rent a new release from Blockbuster is to pay 99 cents at Redbox. However when it comes to renting an old film, movie buffs have fewer “in-store” alternatives. Because of Redbox, the new trend in video rental pricing is that long tail films should be higher priced compared to new releases.

The key takeaway is to set prices by thinking like a customer. This involves understanding what next best alternatives customers have and then setting a price that reflects the value of your product or service relative to this next best alternative. For stores with several locations, this usually involves setting different product prices at each store - the next best alternatives (hence the value of products sold) - that customers have are usually different at each location. Sure, it is tedious to spend a day or two to re-price products to match the value that they deliver. However if you can increase your company’s operating profits by 10% or more as a result of two days of work, it’s worth it. Best of all, prices can be changed on Sunday night and new profits will start rolling in on Monday morning.

Many thanks to Cord Cooper for mentioning The 1% Windfall in Investors Daily.

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Readers' Comments on This Blog Entry

From Norman on January 9th, 2010
Great perspective and a great way to boil it down to the bare essentials in the customer's decision making process. Norm.