Many financial institutions are starting to experience a stronger loan growth, which has caught the media's attention. The media is increasingly reporting future expectations of loan interest rate hikes, and consequently, depositors are now demanding higher interest rates. A recent report by Darling Consulting Group concluded that it was only a matter of time before banks' deposit costs would increase.
Meanwhile, banks report relatively low liquidity ratios well below the 20% regulatory benchmark, a ratio that is expected to decrease even further as a result of the currently low deposit rates and increasing loan growth.
To address the low liquidity ratios, banks essentially need to generate more funds that are not reinvested into (the increasing number of) loans. As deposit costs increase, net interest margins are consequently expected to get lower, and thus, it will become increasingly harder to increase liquid assets with the earnings from loan activity.
We previously argued that banks need to look for alternative revenue sources, and this can be a great way for banks to address to low liquidity ratios. Here's a list of suggestions for alternative revenue sources that can do just this.
In previous blog posts, we touched upon all the possibilities online retailers have when it comes to pricing, most notably their ability to price dynamically and apply sophisticated algorithms that recognize patterns in customer data. But the fact that all prices online are available for everyone to see with a single click also means that price monitoring is much more accessible and affordable.
Initially, one will probably think that this increases the price competition further in the market as every price decrease will be undercut instantly be a price monitoring competitor. However, research suggests this is not the case -- quite the contrary, in fact.
To see why, let's think about price monitoring in terms of game theory. In the airline example below, the profit maximizing outcome is where both airlines charge a high price (yielding a total profit of £240m), however, both airlines have an incentive to charge a low price to maximize their own profit, (i.e. getting £140m rather than £120m), and so it follows that the outcome will be the suboptimal low/low that yields a total profit of £200m.
This hurts both players, which is why there is an incentive to enter collusion agreements and agree on a fixed, high price. Of course, fixing prices is prohibited by antitrust laws, but research found that online retailers enjoy similar benefits from price monitoring: that is, price monitoring increases the likelihood of obtaining a high-high outcome.
Typically, when ecommerce firms monitor each other's prices, they will indirectly peg their prices to competitors'. And so, when one decides to raise the price, the others will follow, increasing everyone's pricing power since this is in everyone's interest. A win/win outcome for all parties is obtained, not a lose/lose one as some would intuitively think.
Uber recently launched a new pricing model called "route-based pricing", where the driver pay is no longer based solely on how much passengers pay. This new pricing model allows Uber to charge a higher price to passengers based on time of day and destination. What is interesting about the new pricing model is that it is much more focused on aligning prices with the willingness to pay of passengers. Prices will to a greater extent be based on historical willingness to pay data which factors in a much broader range of factors than the previous one.
In particular, this will result in higher prices for passengers ordering Ubers in high-income neighborhoods, and moreover, this new model should result in slightly lower fares for UberPool, where passengers share Ubers with other groups, while the premium service UberX, will become slightly more expensive.
Clearly, Uber is addressing the increasingly broader target group for its services. While traditionally, the key competitive priority of Uber has been its lower prices, especially the premium segment is getting bigger. And thus, this new pricing model allows Uber to reach a very price-sensitive segment with its UberPool service that now has become cheaper, while capturing more profits from the premium segment that are traditionally used taxis or private chauffeurs.
Ultimately, as drivers are no longer paid a fixed percentage of the fare, Uber will be able to put more profit in its pocket -- and since the pricing is based on sophisticated willingness to pay research, the decrease in market share will be insignificant.
After the Australian government decided to levy an additional tax on banks that in 4 years is expected to amount to $6.2bn, share prices have dropped significantly as the banks are not expected to be capable of increasing their interest rates due to fierce competition in the market.
But analysts agree that this share drop is an overreaction as banks do have high pricing power, which they have demonstrated on numerous occasions when economic turmoil such as the Eurozone crisis or Brexit has increased the banks' own costs.
In most markets, there is a relatively small oligopoly, and big incumbent banks have a big market share. In Australia, for instance, the four biggest banks Westpac, Commonwealth Bank, National Australia Bank and ANZ Bank have 80% of the market share. When costs increase, be it a tax or a Eurozone crisis, banks need to, like any other firm, pass some of it on to the consumers. They can, and they should.
Alternatively, banks can look for other sources of revenue: PriceBeam gives you a few ideas here.
Recently, the Bank of England reported an inflation rate of 2.7% in the UK, predicting it will reach 3% next year. If we look at UK's inflation history, this is quite high, and firms are now eyeing an opportunity to hide their price increases behind this inflation.
The beverage manufacturer C&C group announced a 3.5% price increase, which was followed by competing firm Diageo. Analysts expect that Heineken and AB InBev will follow soon, utilizing the blurriness caused by the inflation.
By blurriness, we mean that the fact that consumers are expecting nominal price changes (i.e. prices rise along with inflation), which makes it much harder to see who are making real price increases, i.e. increasing the inflation-adjusted price.
Of course, most consumers do not go around thinking about inflation all day, and so, they do not automatically attribute a price increase to inflation. They also may stop purchasing products due to price increases, but that would happen with a nominal price increase, too, even if real prices do not increase.
As input cost will go up under inflation, most firms find they should increase prices, and so, the nominal price increase is often inevitable -- some firms even use inflation explicitly to justify price increases. Note, justifying price increases with inflation does not mean you cannot increase real prices, too.
If you see declining profitability a price increase is the way to go -- and in such times, you may as well make a "real price increase" too.
Netflix is cheap -- very cheap -- and it has seemed clear for a long time that Netflix has room for quite substantial price increases. Now the streaming-service has been "caught" experimenting with higher prices for new customers, and as this lead to newspapers speculating about Netflix implementing "weekend surge pricing", which a spokesperson denied:
“We continuously test new things at Netflix and these tests typically vary in length of time. In this case, we are testing slightly different price points to better understand how consumers value Netflix. Not everyone will see this test and we may not ever offer it generally. These tests vary in length, and they are NOT weekend only.”
Regardless of Netflix' intentions, the move is very interesting as firms such as Netflix typically focus entirely on market share rather than profit. And now is a time where Hulu and Amazon are aggressively trying to win market share, so why on earth would now be the time to increase prices?
Truth is, it's not -- Netflix should have increased prices a long time ago, but better late than never. What the streaming-service probably now realized, which Amazon realized a long time ago, is that a company NEEDS profits to compete with the big boys. You can't take on Amazon, or any other giants with a new funding round -- you need profits to reinvest in activities and features that create value.
Typically, the term "dynamic pricing" is associated with retailers, particularly e-tailers, and other businesses that rapidly adjust their prices to trends in the market landscape. While profit maximization is definitely one of the major advantages of dynamic pricing, it is also very effective for controlling, and redistributing, demand.
For many businesses, demand fluctuations are costly. Overbooked restaurants lose out on first-time customers, who potentially would have developed a preference for the restaurant; fastfood restaurants lose out on customers if the queue is too long; and webshops experiencing irregularly high demand may increase delivery time, which translates into a worse customer experience.
The City of Boston experienced similar problems with traffic, and while this is not your typical business example, it is a great demonstration of how dynamic pricing can be used to reduce "demand" fluctuations.
A report carried out by the city council estimated that 30% of the inner city traffic were cars looking for a parking spot. Imagine that -- 30% additional traffic due to limited parking, which creates traffic jams, frustration, and may even cost lives (one of the Council's arguments for reducing this traffic was to make it faster for emergency services to get around). Of course, one option would be to increase the number of parking spots in the inner city; but this is often not a very good investment as this extra capacity will only be needed at peak-times. Instead, they decided to implement dynamic pricing, where the parking price was adjusted according to demand.
During peak-hours, parking will be so expensive that only those who is willing the pay this high price will get a parking spot, i.e. the people with the highest willingness to pay.
Let's look at how this can be applied to business by using McDonald's as an example. When you pass a centrally located McDonald's around lunch time, you often see mile-long queues of 20 people, maybe even more. In this queue you have a varied mix of people; the student, looking to buy a couple of cheeseburgers; the banker, looking to buy a "premium" menu; families with children who have a VERY clear idea about which items they want from the menu; and so forth.
And you have all the people going to the Burger King next door because the queue was just too long, i.e. foregone profits. If we attach an average "cost" of losing customers due to high demand, e.g. $0.50 in foregone profits per customer above the average number, it becomes clear why dynamic pricing is desirable to remedy this. In the absence of dynamic pricing, the customers that buy during peak-hours are those willing to wait the longest (or circle around the parking lot, accept the longest delivery time etc.); but one's willingness to wait in line is not positively correlated with one's willingness to pay in many cases (for McDonald's, the correlation is probably negative).
However, with dynamic pricing, it will be the customer with the highest willingness to get served, which is great! If you have limited capacity, you may as well use it on the "best" customers, right? Remember, a student queueing for a cheeseburger uses more or less the same capacity as a banker queueing for a Big Tasty and a Frappucino milkshake, i.e. the cost in terms of foregone profits is the same.
Most businesses do not sell their products or services to one segment alone as they can be used by a variety of people with very different needs. However, in order to position their brand clearly and consistently in the consumer's mind, most companies choose to target segments not too far apart. E.g. while IKEA may appeal to many different age groups, IKEA customers are all price-sensitive.
But some companies try to sell their products or services to very different segments. Maybe because their primary target group simply isn't profitable enough, or big enough to generate sufficient revenue, or simply because it makes sense. This is sometimes referred to as "category segregation" due to the need to draw a clear distinction between the products/services targeted at Segment 1 vs Segment 2.
Some companies experience enormous success with category segregation. For instance, Ralph Lauren has been incredibly skilled at targeting both the price-sensitive consumer looking to treat himself, and, at the same time, the high-end consumer looking to put clothes on her body.
And some companies fail badly at it. The Danish high-end electronics manufacturer B&O crashed and burned when it tried to address the shrinking purchasing power of the upper-class segment during the financial crisis by launching a much cheaper product series "B&O Play". It was an absolute disaster that almost ruined the brand the company had built over the last century.
One of the reasons Ralph Lauren's category segregation is so successful is that the "cheap" category is "justifiably cheap". Ralph Lauren cannot offer a low-quality product as that would compromise its high-quality branding; however, it cannot offer high quality at a much lower price either, as this would make the "expensive" category seem, well, much too expensive (even people with lots of money still look for the value they get).
To get around this, Ralph Lauren's more premium categories contain luxurious fabrics and are typically more "modern" designs, as is preferred by the high-end target group, who can afford to buy new Ralph Lauren clothes on a regular basis, even from the premium category. On the other hand, the "cheap" category is still of high quality, although the fabrics are more "standard" and the designs are classic. It is clear to customers what they get and don't get when buying either brand.
However, for B&O, this was not clear at all. B&O historically appealed to customers with its state-of-the-art products and modern design, and with B&O Play, you got all that, just at a much lower price. This price wasn't "justifiably cheap" as it made it seem like B&O had been charging their premium segments a much too high price in the past.
B&O Play sold fairly well, but B&O's premium products did not. Consequently, B&O made a fatal, but common mistake, that is, lowering the price to increase sales. Of course, lowering the price to increase sales of a premium product is not going to work, which B&O found out the hard way.
The key really is to draw a clear distinction between the two product groups; i.e. make sure that the premium segment know what they're getting for paying a higher price; and that the price-sensitive (but also the premium segment) knows what it is NOT getting when buying the cheaper version. Especially, it is important to understand the value drivers of the premium segment, so the higher price can be justified.
Read more about value drivers here.
As we have previously pointed out, customers buy the value they get -- or more precisely, the value they perceive. If you are selling a product or service, one step to increase prices it to maximize the value customers get from it -- but maximizing value won't get you anywhere, if your customer doesn't see it, i.e. perceives it.
For some services, the value is fairly obvious -- e.g. if you go to a hairdresser, it is clear that the value you get is a new haircut. However, for many services the value is not as clear, especially those aiming to provide value in the long-run, and not just in the short-run. If a company hires a human resources consultant to optimize their recruiting process, this company will not see the value of this service before this recruiting pays off in terms of increased output of new hires. New hires have to be trained, gain experience etc., before they can truly start seeing the value they got from paying the consultant, which may take years.
This is very hard to comprehend for a customer, and so, it may be hard for him to see why he should pay such a high fee. This is where "quick wins" become important.
Quick wins are basically short-term benefits that arise from using a service. For the example with the HR consultant, this may be immediate HR cost reductions or immediate increases in number of applicants that the given company attracts.
Big consulting agencies such as McKinsey use them all the time to justify their high fees, and it has become a key part of the way they present solutions to clients.
There are two parts to using "quick wins": actually creating quick wins (part of maximizing the actual value of your service), but also communicating big wins (part of maximizing perceived value of your service).
Creating quick wins should be embedded within the way you construct your service: you need short-term benefits to show to clients. Without them, you will lose out on substantial profit as the willingness to pay for a service which solely delivers long-term benefits will be significantly lower. Customers perceive a much higher risk when buying such a service; after all, if they don't actually get these benefits after x number of years, you will be long gone and so is the fee that you charged them.
With short-term benefits, i.e. quick wins, this risk is much smaller, and clients will feel more comfortable when they can see an immediate impact.
Communicating quick wins should play a key role in your customer value proposition. Even small ones should get attention when presenting your service to clients, also if it means leaving out larger long-term benefits. Typically, if pitching a solution to a client, the quick wins go first to build up to the long-term benefits, which, of course, should still be mentioned.
Eventually, you should see that clients will perceive your service to be much more valuable, and consequently, you can increase prices while the customers stay happy.
Despite the iPhone 7 making up the majority of Apple's smartphone sales, the iPhone 5S is still sold all over the world. However, the segments that purchase the iPhone 5S in developed countries are very different from those purchasing it in emerging markets, and so is the pricing.
In developed countries, the iPhone 5S is somewhat outdated, and yet, Apple keeps the price constant at around $280. On the contrary, in emerging markets, the price of the iPhone 5S has been decreased to around $230.
Developed Countries: Late Stage
In developed countries, Apple uses its pricing to incentivize consumers to buy the more premium iPhone 7. Thus, the goal with the iPhone 5S pricing is not to boost profits and sales for the iPhone 5S; it is to boost sales for the iPhone 7. The iPhone 5S price is an anchor or a benchmark if you will, which consumers use to compare the price of the iPhone 7. By keeping the price consistently high, not only does Apple "force" those who prefers the iPhone 5S (maybe because they are accustomed to this phone and don't want to upgrade) to take the risk of trying out a newer model, it also increases the perceived value of the iPhone 7. When consumers compare the $750 price tag of the iPhone 7 to the price tag of the iPhone 5S, they want to see that the additional features that come with the iPhone 7 are worth the higher price; and if the iPhone 5S price is decreased, the iPhone 7 will seem too expensive.
Emerging Markets: Mid-Stage
In emerging markets, many consumers can't afford the $750 price tag of the iPhone 7. In theory, Apple should then lower the iPhone 7 price to align it with the lower willingness to pay in these countries, however, this would not only damage Apple's premium brand, it would also lead to parallel imports from developed countries, who would buy the iPhone 7 in India, for instance, and sell it on the US market, where the price is still $750.
To meet the demands of the more price sensitive segment in emerging markets, Apple is, therefore, actively targeting the iPhone 5S at these markets. At $230, this phone is affordable to a big part of the smartphone segment in emerging markets, and since the demand for the iPhone 5S in developed countries is low, the risk of parallel import is significantly smaller. The above-mentioned risk of diminishing the value perception of the iPhone 7 does not exist to the same extent in these markets, either. The iPhone 5S segment in emerging markets largely consists of customers who simply can't afford the iPhone 7, and don't compare the iPhone 5S to the premium model. Instead, they compare the iPhone 5S price with rival smartphone brands, and if Apple can't offer a competitive price, they will choose the alternative.
This is a great example of how pricing strategies not only vary between countries because of differences in willingness to pay, but also due to differences in where the product is in the product life cycle. Read more about life cycle pricing here.