Pretty close, it turned out. The tea was more bitter than the CTC variety, and there wasn’t quite enough chocolate, but it wasn’t a bad approximation. It was a little more work and a little less elegant than the official version; and a lot cheaper.
I worked out what the ingredients had cost me. About 6p for the teabag and 5p for the chocolate – far less than the 60p it would have cost in a supermarket. Admittedly there was no teapot with it, but did I really need one?
I emailed Maggie to discuss. Her reply came back within a few minutes:
From: [email protected]
Subject: Re: homemade teapot
Date: 19 June 22:35
Hey Leigh
Sure, the ingredients are cheaper on their own. Though you can’t get exactly the same varieties of tea and chocolate as we source them direct from the growers. It’s all about bundling. You can take away a whole category of price sensitivity by combining more than one product into a bundle which is different from anything else on the market. Have a look at your mobile phone contract.
Best
Maggie
Mobile phones are indeed one of the clearest examples of bundling. The companies know that their basic service is a commodity – a one-minute phone call on one network is not very different from a one-minute call on another. If they sold all their services by the minute, it would be very easy for customers to simply compare one price with the other and pick the cheapest. Each network would lose most of its business if it didn’t cut its rates to compete – and soon enough, all the networks would be operating at breakeven point and making no profit. (If you’ve studied economics, you’ll recognise this as competitive equilibrium – the point where all suppliers are fully competitive and none makes any profits. A major role of the marketing function in any company is to make sure this doesn’t happen.)
Networks avoid this competitive pressure by bundling a range of services into one contract. Take the most basic offering you could imagine from a mobile company:
• 13p/minute for calls within the UK
Now compare it with a typical (actually, a fairly simple) contract from a real network:
• Handset (iPhone 4 16Gb) cost £89, or £129 for 32Gb
• 900 minutes of free calls to any network or land line in the UK
• Calls charged at 10p/minute thereafter
• Calls to non-geographical numbers charged at 25p/minute
• Unlimited free texts (subject to reasonable use limit of 3,000 per month)
• Additional texts charged at 12p each
• Picture messages at 35p each
• Texts to overseas at 24p each
• Receiving calls abroad costs 19p/minute (within the EU)
• Making calls abroad costs 38p/minute (within the EU)
• Variable price in other locations, from 20p to £2/minute
• 750Mb internet data allowance per month
• Additional data charged at £5/500Mb
• When travelling within Europe, 25Mb/day data allowance
• Outside Europe, £5/Mb for the first megabyte each day, £3/Mb thereafter
• Minimum contract length 24 months, eligible for handset upgrade after 18 months
• Contract costs £40/month (including VAT)
Is £40/month a good price for that deal?
If you can answer that, you’re a step ahead of nearly everyone else in the country. And if you try looking for exactly the same package from another mobile provider so that you can compare them on price – well, you won’t find it. There are so many permutations of services that, regardless of whether the networks were to collude or simply put bundles together randomly, the chance of finding exactly the same deal elsewhere is vanishingly small.
One reaction is to add up all the individual components and try to calculate the total value. But this is very difficult to do accurately. How much is a text message worth to you? The answer is probably different depending on whether you’re on a night out forwarding a joke to a friend, setting up a date with a new partner, or stuck on a mountain trying to get rescued. And how many messages will you use this month? What’s a phone call worth to you? How about the chance of having a better signal when you’re travelling to meetings in another part of the country?
Because these things are impossible to work out accurately, you fall back on rules of thumb. Once we’ve made the decision that we really need a mobile phone, we use some basic approximations to figure out whether this particular phone is a good deal.
Does it have a reasonable number of free text messages included in the plan? Well, where do I fit in the range of text-message users? Personally, I see myself as a low to medium user: I can imagine that the 3,000 text messages in this package are designed for teenagers who use text as a basic communication protocol; but the alternative package with just 500 texts might not be quite enough – better safe than sorry. How often will I go abroad? A couple of times a year, but that might increase during the two years of the contract if I do more business in the USA and southern Europe. How much data will I use? I have no idea, but 750Mb seems to be the most they offer, so I guess that will probably cover me.
This process is called satisficing, a word coined by decision theorist Herbert Simon to combine the ideas of ‘satisfying’ and ‘sufficing’; we satisfy ourselves that the product suffices to meet each of our needs. Once we have checked that the basic features of the product are likely to roughly meet those needs, we then check the price. Sometimes we use price as a way to estimate value because there are so few other accurate ways to quantify the benefits of a product. In a case like this, price may become a fairness check – ‘Am I getting a reasonable deal?’ rather than ‘Is this the optimal package I could buy?’ In any case, I can always ask myself: ‘Will I get more than £40 of value out of this phone each month?’ The answer is undoubtedly yes.
Most businesses do not want, or need, the bundling complexity of a mobile phone contract. But you should consider it as a way to change the conversation in your customer’s head.
If you sell a product or service which is easily compared to that of your competitors, customers can play a game against you. You’d like them to think about whether your product is worth enough to them to justify the price. Usually your £3 product will create enough value to be worth substantially more than £3 to the customer; a ratio of 3:1 is typical, so that the customer gets £9 worth of benefit from your £3 product. If they think about it in this way, they should be happy to pay £3.
However, if there’s another product very similar to yours, the customer will not focus on the total value of what you offer; instead, they will fixate on the price of the competitor’s product. If the competitor is selling for £2.50, they’ll expect you to charge £2.40 – the competitor will have to cut their price in turn, and in the end you will both be driven down to the lowest possible cost and make no profit. Most customers are not overtly aware of this game they play, but it is implicit in how they buy things.
How to apply it
The way to defeat this game is to make sure that your product can’t be directly compared with that of a competitor. And bundling is one of the best ways to do this.
By adding extra features to your product, you will defeat the competitor who wants to undercut you: but, more importantly, you will defeat the subconscious tactics of your customers. Have a look at the benefit matrix you built in Chapter 1, and work out how you can fulfil those values by bundling additional, low-cost product features or extras.
A credit card company – whose values include convenience, deferral of cost, and whatever emotions are associated with their brand – could tempt their customers not to compare on interest rates alone by bundling:
• free air miles or similar usage-based benefits
• insurance for purchases made through the card
• discounts on holidays or other services from partner companies
• free roadside assistance if you hire a car with the
card and so on.
A fast food company might – and most do – bundle several complementary parts of a meal together into a single purchase. The classic example is the hamburger, chips and drink; usually these are priced at a discount of 50p–£1 to the price of the individual items. A key point here is that the prices of the individual items are nearly always visible to the consumer – there is a strong expectation of fast food merchants that they should offer each item as a standalone option as well as in a bundle. Thus, the bundling offer is quite transparent and this constrains the freedom of the retailer.
They must be careful to ensure that the price of the three-item bundle is less than the three individual items, but more than the price of any two of them. Otherwise people who want only two of the items will save money by buying the third. Although it doesn’t cost the retailer much to serve a free drink to buyers of a hamburger and chips, it disrupts the psychological purchase rationale presented to the consumer.
An accountant – whose values include compliance, reduction of stress, tax savings, reduction of workload and security – could differentiate their product by including:
• free insurance against tax investigations by HM Revenue and Customs
• a free tax audit to find and report on the key areas where the customer can pay less
• free online accounting software to reduce the data entry burden and allow a faster turnaround of the annual accounts
• free company secretarial and registered office service.
Most of these services are offered by most accountants anyway. But they are usually tempted to split them out as individual options, each with its own price. This destroys the power of bundling. It enables customers to compare, line by line, each of the services with the price from competitors – and to drive down the price of each of them. Instead, the accountant should wrap all of these services up into a single fee – a fee which will be higher than the cost of each item added together.
Should you charge more or less for a bundle than the cost of individual items?
This is a common question asked by people designing product bundles. In the Chocolate Teapot example, the bundle price is much more than the competitive price of the individual components (11p). While in the mobile phone contract, the price is (probably, though it’s hard to tell) cheaper than the price that would be calculated by adding up the individual components.
The short answer is: if you have high fixed costs and low variable costs (like the mobile phone networks) your bundle should be cheaper than the cost of the individual services, because it encourages people to buy and use more of the service. If most of your costs are variable (like the teapot company) you should use bundling as a way to increase the total margin you can achieve per sale – and thus charge more for the bundle than the individual products.
A bundle price higher than the sum of its parts will be more persuasive if the parts reinforce each other and jointly create a value which would not be present in either component on its own. For example, in the accountancy case, having all of your information handled by one company saves time and negotiation and reduces the number of potential mistakes. The chocolate teapots create a joint experience which (for those who enjoy it) is preferable to either the tea or the chocolate on its own.
Note the use of the word ‘free’ in the list of bundled services above. This will be the subject of the next chapter.
Chapter summary
• Bundling is a way of differentiating your product from competitors’ products.
• Bundling also makes the cost of the product harder for customers to work out, giving you more control over the value that customers perceive in it.
• A bundle can give customers good value for money, especially if you have high fixed costs and want to increase total quantity of usage, or, in a service context, if most customers are likely to use some items in the bundle and not others.
In focus
Name your own price
It seems strange to let the customer choose the price for a product or service, when this is normally one of the supplier’s main strategic choices. But in some scenarios it works.
There are three different versions of this approach.
The most spectacular, but probably the riskiest, is to provide a service or product to the customer and ask them afterwards to pay whatever value they put on it. A few restaurants occasionally use this method, and the band Radiohead had success with it for their album In Rainbows in 2007. Some theatres in London use this policy one night of the week. And in a sense, this is the model used by museums which ask for a donation of your choice, and service providers who expect you to leave a tip at your own discretion. The success of the approach depends on a strong culture of trust and goodwill existing between you and your customers, and runs the risk of exploitation if the product’s marginal cost is high. And customers will usually seek some kind of anchor price to guide them on an appropriate amount to pay – so it may be useful to display a ‘recommended price’ or some examples of what other people have paid.
The second is to let the client make an offer, and then decide whether to sell your product to them or not. This model is used by the website Priceline, and in a way is reflected in the standard employment model, where a company advertises the salary it is willing to pay and waits for applicants to show up. It tends to drive suppliers into tough price competition with each other and may be a good idea for the customer but probably will not make a viable business for the supplier. Many hotels and airlines use Priceline to get rid of last-minute inventory which they would not otherwise sell.
The third is to let the client tell you their budget – most common in a business-to-business situation – and then tailor your service or product to fit it. In many public tenders the client will provide a guideline price. This may backfire, as it can encourage cheaper suppliers to raise their prices to use up the whole budget. But as a supplier it takes away much of the price risk in your negotiation. This approach by a client reduces the likelihood of suppliers competing on price – they will tend to cluster their prices close to the stated budget. As a supplier, you might sometimes do well by lowering your price to around 10% below the budget, as this is likely to be as low as anyone else will go. In general, submitting multiple price options is a good idea even in response to a formal tender – this gives the client options and a degree of control which they are unlikely to have with most of your competitors.
Except for the last of the three variations, this kind of approach is unlikely to form a stable business model for most suppliers. But for promotions, spare inventory or low-marginal-cost extras, it can be a useful part of your pricing mix.
Chapter 13
Free offers
In July I managed to collect 23 teapots and pay for none of them.
I did it as a bet with myself, but also to experience the range of promotional offers that CTC had been launching in the last few weeks. It felt like Maggie might be planning something. But she hadn’t been available to meet me, so I thought it might be time to use my research skills and see what was going on myself.
It started three weeks ago…
I visited my usual Cosanostra Coffee for breakfast and bought my usual chocolate teapot – vanilla with white/milk chocolate blend was the variety I’d been fond of recently. With my receipt was a loyalty card. I’m sure you know the kind – they give you a stamp with each purchase and when you have collected 10, you get a free drink.
This one was different in one detail – instead of 10 spaces, it had 12. And instead of stamping just the first space, the cashier stamped the first three.
I smiled at Maggie’s ingenuity. Although the card still needs the same nine more purchases to get my free teapot, the three stamps seemed to create a “sunk cost” effect, which made me feel a lot closer to the goal.1
Although I have about 15 of those loyalty cards sitting around in my kitchen drawers, I rarely change my buying behaviour based on them, except when they’re
already nearly finished. But this month I found myself using that card again and again, and before the end of the third week, I had free teapot number one.
My second free pot was in the supermarket. I stopped in on the way to the office to pick up a teapot to drink when I got there. But when I looked at the shelf, there was a special offer there which I hadn’t seen before: buy two, get one free. I decided I couldn’t miss the chance for another teapot, so I picked up two more and took advantage of the offer. I ended up drinking two of them at the office that day, so the offer had persuaded me to consume more than I normally would have. And when I looked at the receipt, I realised that the price of the teapot had gone up from 89p to 99p. So keen was I to get the free offer, I hadn’t even noticed the change in price.
Having got myself one free teapot and started on the path to another, I thought it would be a cute game to see how many more I could pick up within the month. By now it was 10 July, so I challenged myself to somehow get hold of a free teapot every day for the rest of the month. With two already in the bag, I needed 23 in total.
The next time I saw an offer was at a bookshop, of all places. I went along for an author signing – the new travel book about Tajikistan by one of my favourite authors – and the shop was offering hospitality, as well as an autograph, to buyers of the book. They’d discovered that one of the CTC teas was grown in the Tajik mountains, and, according to the store manager, CTC had been happy to do a good deal on 36 teapots. The shop was able to sell a fairly expensive, quality hardback book without discounting, and customers seemed pleased to get the free gift. There was a clear consensus among the other customers that online bookshops – even if you can save a few pounds – don’t offer free tea with their orders.
Number four was not exactly a free teapot but free tea, as I got a large pot for the price of a medium. I asked for an orange-flavoured pot in a different chain café – I was travelling and not at my local Cosanostra – and they offered me a free upgrade to a large pot if I bought a cake with it. So I had a slice of lemon tart (quite good with an orange chocolate tea, if you ever have the chance to try it), got my large pot, and ended up staying in the café for two hours writing an article. I bought lunch there and they ended up making twice as much money out of me.
The Psychology of Price Page 12