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The Money Makers: How Extraordinary Managers Win in a World Turned Upside Down


Anne-Marie Fink



9780307396303
Retail Price: $27.50
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Format: Hardcover, 320pp.
ISBN: 9780307396303
Publisher: Crown Business
Pub. Date: January 27, 2009

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Excerpt from The Money Makers: How Extraordinary Managers Win in a World Turned Upside Down

From The Value of Value: Responding to Customer Price Demands

Ask customers in any industry what they want, and most will ask for lower prices. Nothing illustrates more starkly the danger of listening too closely to your customers. Giving in on price demands often satisfies customers in the short term but risks your business in the long term. While certain situations may require you to lower prices, don't let this decision be driven by customers. My experience, as well as the experiences of other professional investors, reveals that the best metric to guide pricing decisions is internal return on investment, not the customer-centric metrics that most pundits promulgate.

Sometimes risking alienating customers with higher prices is right strategy for both your business and your customers. I know that remaining tough on prices is difficult. It often feels as if you'll lose your customers if you don't give in to their price demands. In reality, there's a reason customers are buying your products: they often lack acceptable alternatives. You have a edge. A competitor's price may not be significantly lower ours. Your superior quality or differentiated offering may keep them buying even if they don't like your prices. The key is not to panic when customers start to complain that your prices are out of line, and to consider whether you are charging enough for your effort and capital and whether it's feasible that anyone else could be doing it for less.

The experience of Cypress Semiconductor Corporation shows how beneficial taking a tough line on pricing can be for you and your customers. Led by its outspoken founder CEO T. J Rodgers, the company has thrived by innovating and finding fresh niches within the semiconductor industry. To execute this strategy, Cypress has had many "science experiments" going at anyone time-small products that often weren't profitable. In summer 2005, Brad Buss joined the company as CFO and set about evaluating Cypress's product lineup. At the same time, profits were down from the previous year as less profitable products had become a larger portion of sales. Rodgers, Buss, and other senior leaders decided to raise prices on the unprofitable products, intending to drive away customers and get out of the negative-return niches. A funny thing happened, though. Many customers chose to pay the higher prices. They had no other viable alternative sources for the chips, so they bit the bullet and paid up. Cypress's revenues and profits -- with some help from strong markets for its top products -- improved dramatically the following year.

Cypress Semi underestimated the value it was offering to its customers. At the same time, customers didn't let on about how good a deal they were getting. In fact, if Cypress had conducted a survey of its customers, I bet a majority would have complained that prices were too high. Only through a strategy designed to kill off unprofitable products did Cypress management discover its pricing power. Heeding its customers' actions, rather than their words, led Cypress to better decisions and be profits for its employees and shareholders.

Of course, not all companies are in Cypress's situation; many operate in broader markets where customers have more choices. How do the best companies prosper in the face of their customers' requests for lower prices?

First, they remember that customers buy value, not price. Focusing on price may be an easier strategy to execute, but it usually is far less profitable. Moneymakers find all sorts of ways to focus their clients on value. The most basic is to offer additional goods that equalize the value of the competing offerings. One of the classic examples of equalizing value occurred during the early days of Southwest Airlines.

An interloper in the then-clubby airline business, Southwest began flying in 1971 with a no-frills service between three cities in Texas. The company saw itself as competing with car travel rather than with other airlines. However, it wasn't long -- two years, to be exact -- before the incumbent airlines, notably Braniff, responded aggressively to Southwest's low price of $26.00 per ticket. Hoping to drive the upstart out of business, Braniff dropped its fares to $13.00 on routes where the two competed. Southwest could have responded by lowering its own fares, but without other routes to subsidize the fare war, it would soon have been bankrupt. Instead it responded by offering its customers a choice: they could fly for $13.00 or they could pay the full $26.00 fare and receive a gift, generally a bottle of liquor (it was the 1970s). Chairman of the board Herb Kelleher and his team backed the offer with a major advertising campaign that painted the fare war as a battle between David and Goliath. Not only did Southwest not lose business, its traffic surged because it offered more value to its customers than Braniff did. Since many fliers were traveling on business, the cost of the airfare did not come out of their pocket, whereas the gift was something they could use personally. Moreover, by buying liquor in bulk, Southwest could get lower prices than its passengers could, so the value of the gift to customers was greater than the cost to Southwest to provide it. The promotion was a huge success, and Southwest has since become one of the United States' largest airlines. Braniff, as you probably know, has ceased to exist.

Gifts can be a surprisingly effective alternative to capitulating to customers' price demands. Estée Lauder sells cosmetics in department stores and its own free-standing shops for far more than similar products sold by Maybelline and Revlon in drugstores. Most purchases come with a '"gift" that increases the value to the customer and enables Estée to maintain higher prices than its competitors'. In addition, this gifting tactic serves as an effective sampling program. If customers really like the gifted product, they may purchase it in the future.

Bloomberg L.P. is another company that sidesteps price criticism through a value-added approach. Though it's not a company studied by public-market investors, since it is privately held, it is a well-known provider of financial data and news services used on trading floors and in investors' offices. The Bloomberg service is eye-poppingly expensive, yet financial companies pay up because it includes a full package of data services and analytics, as well as high-touch customer service, for one set price. Its competitors -- financial data providers such as Thomson Reuters and McGraw-Hill -- offer their products in a piecemeal fashion; each separate data set has a separate cost. Bloomberg, on the other hand, charges one price whether you use one of its data streams or all of them. For a customer who uses more than two or three streams, the offering quickly becomes price-competitive.

Moreover the pricing matches the economics of the Bloomberg organization. Developing each data set requires a fixed up-front investment regardless of whether one customer or a million customers buy it. By requiring customers to buy a full suite of offerings, Bloomberg earns good margins on all the data sets it develops. Though customers are aware that Bloomberg is expensive and at times protest the cost, they also appreciate the value delivered by the all-service package -- when they suddenly need a yield-curve history or some other data that they would not have purchased (because it would be used so infrequently), they are able to access it because of Bloomberg's approach. Suddenly the price does not seem so high relative to the value provided.

Inside Information
  • Respond to customers' complaints about price selectively. Test the market, particularly if your profits do not cover your cost of capital, to see if you can charge more. If you can't, exit the business.
  • Focus on the value you offer rather than the price you charge. Be creative about what "extras" you might provide customers to bring the value proposition into line.
  • Consider your cost structure in determining additional offerings. Find products where your incremental expense is less than the value accorded to them by your customer.



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