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The Premium Pricing Trap

17.08.2020

What would happen if you had an irrationally high selling price?

I love mind experiments. Some years ago I started to wonder if our price had become irrationally high. Christensen’s disruption theory explains how companies can chase the premium segment of the market and be blind to an at-first inferior competitor until they become irrelevant. How would we know? Was it possible that our premium pricing and positioning had gone too far? If we had an entirely wrong price (too high) and yet still had customers and new sales, what would the business look like?

I decided to imagine a company that sold bookcases that were very similar to Ikea bookcases but were 10x more expensive. It was created at a time before there was regular, low cost alternatives of an Ikea quality. While there would still be some product differences, it is arguable how many people would benefit significantly from these differences. From its roots of obvious differentiation, how might our business look today:

  • Existing customers would say that our service (before and post sales) was excellent. Many would talk about the bad experience with another competitors or even Ikea. They would appreciate the personal touch and many of the high overhead components of the business. Trust would be a large component of the experience. The product quality would be appreciated, but many of the attributes valued might be exactly the same as an Ikea. (note, I have repeated this mind experiment for things that are not ornamental, eg. Software, and aesthetics + UX + style become important rather than “service”)
  • Customers would often be connected to each other– referral selling would dominate. Premium customers do not search in google “most expensive bookshelves” or “high service bookshelf suppliers”.
  • Non-referral selling would be extremely expensive. Instagram influencer + content strategies + other marketing & PR would have horrible cost / quality lead.
  • Cost of customer acquisition would be very high (even if there was little attempt to grow the business) because there would be so few serious prospects and thus so valuable– our service must be flawless and available immediately.
  • Product evolution would either trend toward A) improving profitability by using technique and components similar to Ikea, or B) adding features and benefits in order to justify the price even if customers do not ask for or need these benefits in large numbers.
  • Growth would be difficult to influence. Maximizing a referral network to its limits is highly labor intensive with expensive people. Each incremental non-referral customer through marketing becomes exponentially expensive relatively quickly. (Harrods adds less than 10 high-net-worth customers per year globally despite massive marketing, PR, and sales teams)
  • The buying process would involve no other competitors being evaluated at the same time– their bookshelf pain must be high enough or their time so valuable that alternatives to “the best” (that we sell) do not need to be considered.
  • There would be price insensitivity. 8x or 12x the Ikea price would have almost no impact on the buying probability. (fairness– that others were also paying the premium would be important)
  • We would conclude that our company could enter the “lower end” of the market at “only” 5x Ikea pricing, but there would be a number of “Innovator’s Dilemma” type problems. (eg. cannibalizing our high margin customers…)
  • Extremely high margins would make it always attractive to try to find incremental customers even if the acquisition cost were extreme. Likewise, any reduction in business would immediately have a huge and immediate impact on profitability and cash flow of the entire company that would be difficult to manage. Thus acquiring more and more of these high margin customers would always be the most attractive solution to almost any business difficulty until there was simply no choice but to find more to save the business.

I have found myself in businesses that match these attributes several times. A few times, the solution was a new business / division / product line that focused on the value-segment of the market. In the beginning, it was differentiated from the core product so that cannibalization was limited. Later, when it succeeded, the premium market could be converted or simply abandoned. In another, there was a long customer interaction time and we expanded this relationship over time to include “value products” (and increased volume) (eg. premium bookshelf, but then all the books were bought at more modest premiums– value of books would be more than even the premium shelves. In other businesses, we needed to recognize that the business lifecycle was “cash-cow” and that we needed to have discipline to maintain exceptional margins and resist temptations to substantially “invest” in acquiring more customers.

I love selling premium, I just need to make sure it is earned premium value. Earning your money with integrity is one of the best guidelines to a long term business.

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