I had lunch the other day with a friend who just got a job as an electronics buyer for a major retailer, and we got to talking about demand forecasting and pricing models. She has some interesting challenges ahead – consumers are more cost-conscious in this slow economy, and even with our stimulus checks, flat panels and Wiis seem like a luxury that many people will forego in order to keep food on the table. I was reminded of a post I’d recently read, encouraging companies to raise prices significantly and frequently. This is not an activity that should be undertaken lightly, and I got to thinking about the intelligence required to do this well.

Rising Costs are Here to Stay

Consumers and businesses are already feeling the impacts of the current economy – disposable income is shrinking due to rising oil and commodity prices, and our summer European vacations have to be scaled back due to a weak dollar. Many of the causes of this – from rising commodity demand in China and India to the Iraq War – aren’t going away anytime soon, so both groups need to adopt a long-term view and adjust their economic decisions accordingly.

Unfortunately, consumer incomes and business profits are not rising as fast as prices, so the proverbial “pie” is shrinking – which means companies’ pricing and positioning decisions have to be smart in order to maximize market share and profits.

Prices Need to Consider Customers and the Competition

Customers are likely to cut back on luxury items, focus on the essentials, and increase their use of discounts and coupons. But not all customer segments act the same, so companies will need understand the needs and preferences of each segment, including the products they value, then determine which segments they want to be in and adopt appropriate strategies. As an example, American Airlines is experimenting with software to identify flights for which passengers will pay extra. This insight will allow them to more aggressively market high-margin flights (products), as well as identify the customers willing to pay the premium. Applying even stronger analytical techniques to this data could help them determine the variables leading to consumer willingness to pay a premium, which they can use to enhance the margins of other products.

Competitors will be increasing their vigilance – looking for ways to keep their share of the shrinking pie and to steal a few bites of the rest. Without actively managing prices while costs are rising, competitors will eat your lunch by adopting smarter pricing strategies. It doesn’t just have to be the customer-facing price that goes up; companies use other techniques such as new package pricing, consignment pricing, fees vs. list prices, reducing product size, and cutting back on promotions. I did some research on using Behavioral Economics to present offers that maximize profits. Actively monitoring the techniques your competitors are using and the success they are having will also provide valuable insights into market activity.

This Capability Needs to be Developed, Institutionalized, and Continually Managed

Amassing this insight about customers, products, competitors, and overall economics is no small task, and there is no off-the-shelf solution that will get you there. Instead, companies should be developing or enhancing their forecasting and pricing models to take advantage of the all of the data available. In a recent article in Consulting Magazine, a senior executive in Accenture’s pricing group mentions that more companies are addressing pricing “not as an initiative but as a capability they want to build.” He goes on to say that they are embedding it into the C-level, as through a chief revenue officer or chief pricing officer. This type of action helps ensure active pricing management becomes a part of a company’s overall strategy and helps maintain a competitive edge.

We think the use of online coupons deserves a harder look. Emailing your customers and prospects with newsletters, product updates, and coupons is certainly nothing new, but it’s now well-positioned for even greater success:

• Companies are getting good at it. After dabbling in techniques like SEM and direct email, firms have gotten better at driving profitable growth from these methods, and many are increasing their focus on online advertising as a cheaper way to spend their marketing dollars.
• Consumers want more of it. During these uncertain times, consumers plan to increase their use of coupons to save some money. Sending these options straight to their inbox or mobile phone accomplishes that goal and positions you as a preferred provider.
• Consumers who use it are attractive prospects. Compared with consumers who only use offline coupons, Forrester reports that users of online coupon tend to have higher incomes, shop online, like to try new products, and influence peers. Younger consumers also use coupons, and they can be a good avenue to get the word out about your product.
• More data is available to help you win at it. More firms sell marketing lists (or can help you run campaigns to get new lists), segmentation data helps you understand consumers’ preferences and desires, and syndicated data helps you understand purchase behavior. Combining this data gives you incredible insight into consumers to tailor unique marketing messages.

You don’t just want to throw promotion dollars at existing customers to give them discounts on things they were already going to buy; rather, you likely want to use those dollars to deliver positive returns and achieve business goals – such as acquiring new customers, increasing market share, or increasing wallet share. Doing this requires targeting offers to customers based on their stage of the customer life cycle:

1. Acquire. Coupons can be a good tool to help consumers overcome the risk associated with trying a new product; if a new product is cheaper than the one they normally use, the savings might be worth trying. You can use them to attract entirely new customers to your firm, or to get your existing customers to try a new product line. Targeting early adopters can also help generate buzz, as they will influence friends and family to buy the product as well.
2. Grow/Stimulate. Once you’ve acquired a customer, you want them to maintain or increase their purchases. Two ways of stimulating usage are encouraging them to try a different variety (e.g., color, size, flavor) or showing them new uses for the same product (e.g., using Q-tips for craft projects in addition to hygiene). In this stage, the focus should be on the marketing message, the coupon being used to help seal the deal and drive the customer to the store.
3. Manage. In this stage, your customers are steady-state users, and couponing may not be required to retain them. However, these consumers present a good opportunity to test new offers on an already loyal customer base and measure the response before using them on the general public. You might test them using different demographics, layout, or wording, perhaps even running controlled experiments to determine which of two offers is more effective. We’ve done some research on the use of Behavioral Economics to improve offer design, which might be helpful in performing this testing.
4. Reclaim. If customers reduce their consumption or begin to try competitors’ products, you can use targeted offers to reintroduce your product and retain them as customers. However, depending on their needs and your product pipeline, you may otherwise opt to move back to the beginning of the life cycle and acquire them as customers of another of your products.

This strategy requires a high level of customer insight to understand preferences and stages in the life cycle. You can gain this insight by applying segmentation schemes to your lists of customers and prospects, and by analyzing your customers’ history of purchases and coupon redemption. Applying a rigorous testing approach will help you identify the most effective offers for each customer and stage.

Applying this framework to understanding your customers and targeting coupons will deliver several benefits, including:

1. Strong ROI potential. Campaigns that are more effective and lower-cost, targeted at attractive customers, have a stronger potential to deliver a positive ROI.
2. Better data to analyze results. Results of online campaigns are easier to track and measure than traditional campaigns, particularly if your coupons lead customers to purchase from your own website. Analyzing results from campaigns that involve multiple partners may require a different approach, as Vishal outlined in his earlier post on trade promotions.
3. Better customer relationships. You can use the insight you’ve gained about your customers’ behaviors, preferences, and purchase history to continually develop targeted offers. This level of personalization will help you deliver the right offers to the right customers at the right time, and ensure that your promotion dollars are spent most effectively.

Note: This post has been adapted from my earlier post on Analytical Engine.

This is not the first time that cues such as pricing and packaging have been applied to marketing. We recently collaborated with Professor Ariely (also quoted in the article) to explore the impact of applying behavioral economics principles to online marketing strategies. One of the concepts we discussed in the resulting paper, is “Framing,” and we explored how consumers evaluate their options on relative terms, and make purchase decisions based on the cues given to them. In the paper, we highlight the example of a magazine publisher who was able to steer consumers toward a higher-cost option simply by presenting a lower-cost one. Even though no one chose the lower-cost option, it was an effective cue in that it showed the relative value of the higher-cost one. In the drug experiment, price was the cue, and the higher price led consumers to find it a more effective (and valuable) product.

In Diamond’s market segmentation work, we have found that different consumer segments require different value propositions, and that marketing messages need to emphasize factors such as features or pricing to appeal to their target markets. Many generic, store-brand products are actually the same as the name-brand products, but are packaged differently and sold at a lower price to appeal to a different consumer segment. The drug experiment highlights the same concept – and 61% of the patients who thought it was a cheap drug still reported that the product was effective in relieving their pain.

In developing marketing strategies, it is important to carefully consider the market segments you are targeting, along with the value drivers for each. Understanding these drivers allows you to apply behavioral economics principles to maximize ROI through optimal pricing and product framing for each segment.

Note: This post has been adapted from my earlier post on Analytical Engine.