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Newsletter: February 18, 2010
Curt Knows That Sometimes You Just Have to Cut Prices | How to Make Price Increase Feel Like a Discount | It's Time to Think About Pricing Communications | You Mean We Actually Have to Run the Business?| Good Reading!
Curt Knows That Sometimes You Just Have to Cut Prices
Commentary by Dr. Reed Holden
From “Battling Back, Builders Work Fast, Cut Prices” by James R. Hagerty and Dawn Wotapka, The Wall Street Journal, February 3, 2010
There was an interesting story in The Wall Street Journal recently about how builders are cutting prices to compete with competition from low-cost foreclosed homes. The article makes a number of important points for all of us.
With the economic crisis, lost jobs, and tightened interest rates, the number of new home buyers has dramatically declined. To make matters worse, the source of the crisis was debt that was too cheap, too easy, and ballooned high, forcing lots of people to let the banks foreclose their property. This resulted in a glut of cheap houses. In the inevitable swing of supply and demand, home builders are caught in the middle.
Some home builders just decided to shut down. We know of one in Florida, one of the worst markets, who just decided to shut down until the market turns around in a few years. He was lucky–his wife works, and he has a bunch of rental properties that he has to manage–full rental properties.
Some of you know that because of the downturn, we decided that it was a good time to buy a distressed piece of property (buy low, sell high!) and see if we could find a high quality contractor who was willing to shave his prices and get his subcontractors to do the same.
As we were interviewing contractors last year, we were amazed at the number of contractors who just stuck to their high margins and high prices and ended up having no business at all.
It worked out great for us. We found a real treasure–Curt Farnsworth of CNC Builders (his partner Chuck was a find, too!). Curt knew he was going to have to shave margins and get his subs to do the same thing to win the business. For example, we saved over 25% on roofing–and we had a lot of it. When we saw that he was smart and high quality, we selected Curt to do the work. With only a few inevitable exceptions, we got good quality work at a low price.
Well, now some of the national home building firms are reporting that they're following Curt and Chuck's lead with good results. They're producing houses cheaper and faster. That makes them more competitive with the foreclosed property, and they're educating buyers on the problems associated with foreclosed property. The result? They're staying alive, and they're making a profit. D. R. Horton–one of the top US builders "swung to a surprise quarterly profit" in the middle of this terrible recession.
While we spend a lot of time talking about the need to stabilize prices in a downturn, sometimes you just have to sharpen your pencil to keep busy. A little profit is better than no profit at all. I've been amazed at the number of professional services companies that have a) kept their prices high at the same time they b) laid off people. Too bad they didn't learn what Curt, Chuck, and the guys at D. R. Horton did. How to Make Price Increase Feel Like a Discount
Commentary by Mark Burton
From “Your Cell Phone Company’s Dirty Little Secret,” cnnmoney.com, February 10, 2010
Lately, wireless providers, such as Verizon and AT&T, have been making a big deal out of significant reductions in the prices of their unlimited voice plans. With cuts ranging from $30 to $70 per month, who can blame them? As always, there is a catch. Many customers that benefit from these price cuts will actually see their monthly bill increase, as they will be required to buy data plans. In addition to this new requirement, carriers are increasing the monthly charges for these plans.
I know what you’re thinking. “Who are they kidding? The only reason such a transparent ploy can work is because customers have so few real choices.” This may be true to a point, but there’s another set of reasons about why this strategy, transparent as it seems, will work. It has to do with how the new pricing plans are being presented and how we perceive them. As you might expect, both carriers have done a lot of advertising promoting their voice plan price cuts. By focusing on savings, carriers create a feeling of found money. “Gee, I’m getting a $99 plan for $69. I have $30 in my pocket that I didn’t expect to have.” Now laboratory experiments show that people are notoriously irrational when it comes to found money. We tend to put much less value on the $30 the wireless carriers are “handing” to us than we do if we have to go take that same $30 out of an ATM.
So what happens when a customer that has been primed this way, walks into a wireless store and finds out that they have to sign up for a $50 data plan? The customer will likely offset the $30 savings on the voice plan against the $50 data plan and walk out of the store feeling like they are getting a pretty good deal. And the wireless carrier has just increased their revenue per user by $20 per month. Accomplishing this while banking on customers to behave irrationally seems like a pretty neat trick. Here’s the thing, these kinds of behaviors are consistent and predictable. An entire school of theory, behavioral economics, has grown up around uncovering patterns of behavior such as this. It has already had a dramatic impact on pricing of consumer products and is becoming increasingly influential in business-to-business markets. If you’re interested in finding out more, drop us a note, and we’d be happy to recommend some reading for you. It's Time to Think About Pricing Communications
By Dr. Reed Holden
We've been so focused on getting through the recession that we need to realize it's time to get ready to deal with the implications of being out of it. An article caught my eye in The Wall Street Journal about price increases that are happening in the steel, iron, and coal industries. Some of those increases are quite dramatic–in the range of 30-40%. Given such dramatic increases coming in raw material prices, manufacturers mentioned in the article, like Ford and Whirlpool and many others, are going to have to get ready for some proactive "constituent pricing communications" (CPC).
There are three targets of CPC–salespeople, customers, and competitors. When you anticipate having to increase prices due to raw material price increases, it's a good think to be proactive about it. We saw many companies hit in the downturn, having previously held on price increases. They tried to increase prices during the downturn, when costs were coming down. They got hammered by competitors and customers.
The best time to have an increase is when the raw materials prices are going up. AKA, NOW! That's because your customers are aware of the increases. The increases are therefore credible and more likely to get accepted, once you get beyond the blustering of the procurement people.
Importantly, before you actually do the increase, it's a good idea to let your constituents know your plans and why there will be an increase in prices. Yes, there is a problem of customers loading up on inventory when you do that, but it gives salespeople a chance to sell the increases, competitors a chance to follow (make sure the communications are legal), and customers a chance to prepare for increases of their own.
One thing to think about–if you live by cost increases, you may die by cost increases. Quite a few companies undermined customer relationships last year when they didn't decrease prices. At that time, every customer knew that costs were coming down across the board.
By the way, the increases coming in the steel industry are due to good capacity management of the major producers and from good constituent communications. They had one slip several months ago where they anticipated growth that didn't come. This caused a drop in prices, but they quickly got in line and are now riding the wave of increased demand, as global inventories begin to once again fill up. You Mean We Actually Have to Run the Business?
Commentary by Mark Burton
From “P.E. Should Forget Financial Engineering,” NYTimes.com, DealBook, February 11, 2010
Perhaps one the most overlooked consequence of the recent economic conditions is that supposedly sophisticated investors, focused on fancy financial footwork, got distracted from the fact the companies that they were investing in and sometimes running, actually have to be managed. When debt was cheap and plentiful, private equity firms could focus on finding financing that allowed them to keep an investment alive, hit their financial goals, and head for the exits. Now with credit so tight, they’re faced with actually having to run businesses.
A pretty frightening comment at a recent conference illustrates this point in spades. “In the future, we’re going to have to actually know what we invest in,” said David Roux Co-CEO of Silver Lake Partners. “It doesn’t seem like a radical notion for this to be the basis of a differentiating strategy. But in fact, people who invest in things they know and understand today are a minority of our private equity industry.” Wow. From where I sit, any major investor or senior management team that doesn’t understand the business they are involved in deserves to lose their shirts. Unfortunately, while they are in the process of losing their shirts, a lot of good people lose their jobs. This is beyond tragic, because the solutions are so simple.
What should the money people and senior management teams do to ensure great returns for share holders and employees? They need to remember that success comes not from fancy financial models but from understanding, in very concrete terms, how you create value for customers and be resolute in getting paid for that value. We have worked with a number of private equity portfolio companies, and probably 90% have overlooked this basic rule of business. Sometimes all it takes is a few hours with a management team to get them to define how they create value for customers and define reasonable options for getting fairly compensated for that value.
I sometimes walk away from these sessions thinking, “How on God’s green earth can you build a business without understanding customers and the value that you provide them?” Yet it happens all the time. The result is a lot of mediocre businesses that limp along, without ever reaching their potential. What is encouraging is that just about any business can break out of the cycle of underachievement. All it requires is a focus on the basics of Pricing with Confidence: define your value to customers, deliver that value, set prices to capture it, and give your sales teams the tools that they need to properly frame and defend those prices.
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