Wednesday, April 20, 2011

Strategic Planning Analogy #389: Ransom Pricing

My wife and I recently purchased the DVDs for all eight seasons of the TV show “24.” As you may recall, each season of 24 consisted of a terrorist attack on the United States. Jack Bauer and his co-workers at the government agency CTU (Counter-Terrorist Unit) had only 24 hours each season to stop the terrorists.

A common plot device used over the eight seasons of the TV show was the hostage/ransom situation. Typically, someone Jack Bauer cared deeply about would be taken hostage by the terrorists. The hostages would then make outrageous ransom demands. If Jack did not follow through on the demands, the person he loved would be killed.

This taught me something very important: Don’t ever let Jack Bauer care deeply about you. For when that happens, you get captured by terrorists and there is a good chance they will kill you.

In the TV show 24, terrorists could convince Jack Bauer to do things he would not normally do in order to save his loved ones. Jack was willing to pay a high price to get his loved ones released, including putting his own life at risk. Jack didn’t spend a lot of time trying to negotiate a lower ransom fee. Jack didn’t wait until the terrorists decided to hold a Clearance Sale on Hostages, where ransom demands were reduced for a limited time. No, Jack would ask what the demands were and then try to satisfy the demands as soon as possible (no matter what the price).

Most companies would love to be in the position of those terrorists when it comes to pricing. The terrorists could charge pretty much whatever ransom fee they wanted. There was no fear of getting into a pricing war. They never had to put the hostages “on Sale.” And the terrorists knew that Jack would rush to pay that price as soon as possible.

Unfortunately, most companies find themselves in the opposite situation. Intense competition gets them into price wars, where margins are eroded to next to nothing. And then customers wait for even further price reductions. If the company makes customers work too hard to get the product or service, the customers will lose interest and go somewhere else. Rather than being able to collect whatever “ransom”-sized fee they want, the companies find themselves having to pay whatever “bribe”-like incentives are needed in order to get customers interested.

The principle here is that if you want to be able to charge ransom-like fees for your product or service, then you need a strategy more akin to that of a terrorist holding a hostage. Otherwise, you will become a victim of low-margin price wars. This is not to imply that you need to become a terrorist. It just means you need to borrow some of their strategic tactics.

There are three tactics terrorists use to create a favorable pricing situation for themselves.

1) Create/Exploit Deep Emotional Ties
Jack Bauer would only cave in to terrorist demands if it involved people he cared deeply about. How deeply do your customers care about what you have to offer? Is there a deep emotional tie between your brand and your customer? To what extent will your customers go to maintain that emotional bond?

For example, would you pay a higher ransom to get back your mother or your refrigerator? Most of you, I assume, would pay more to get back your mother, in large part because you have a stronger emotional attachment to your mother than your refrigerator.

Most of the companies which command premium (ransom-like) prices have positioned their products to hold a strong emotional tie to their customers. Examples include Harley-Davidson (motorcycles), John Deere (tractors), and Apple (iPods, iPads, iPhones). The tie is so tight that one’s own sense of identity is wrapped up into the identity of the product. The product represents who you are as a person. Abandoning the product would be like abandoning a piece of yourself. You will pay almost any ransom to maintain that emotional identity.

Harley-Davidson owners have owner clubs (Harley Owners Group, or H.O.G.s). Even though other companies make higher quality motorcycles at lower prices, emotionally loyal Harley owners will never consider them at any price. It is common for these owners to get tattoos of the Harley Davidson logo. This emotional attachment allows Harley-Davidson to stay out of price wars and charge more ransom-like pricing.

There were lots of firms which came out with music players to compete with the iPod, but they didn’t stand a chance, because of the emotional bond and attachment between the iPod and image-conscious teens. To own another brand would be to commit severe damage to your coolness image. As a result, while the competition kept lowering prices to lure away business, the iPod kept both the business and the premium (ransom-like) price.

I have always been fascinated by the cars and trucks I see on the road with a particular decal posted on the window. The decal is of a young boy urinating on the logo of a competing brand. If you can create such a strong emotional bond that your customers see the competition as good for nothing but urinating on, then you know they will not be easily swayed to switch to that competing brand merely due to a small price reduction. You have earned the right to charge ransom prices.

2) Create a Unique or Irreplaceable Offer
I think there is another reason why you would pay more to ransom your mother than ransom your refrigerator. You have only one mother. She is irreplaceable. By contrast, you can always get another refrigerator, perhaps even better than the old one. And the food inside is also easy to replace. Why pay a huge ransom to a terrorist to get the old refrigerator, if you can just go to a store pay less to get a brand new replacement?

That’s why terrorists hold up for ransom items which are unique and difficult to replace, like your mother. It is worth more to you, because you have no way to replace it. And the same idea applies to business. If you want to be able to charge ransom-like prices, you need to offer something which is unique—where there are few alternatives.

It sort of goes along with the idea of The Godfather in wanting to “make an offer he can’t refuse.” You cannot refuse an offer if there are no suitable alternatives.

That is why there is such a big movement among retailers to sell unique products and brands not available at any other store. If the retailer can convince you to desire that product, then the retailer knows that you will have to go to them to get it. With no other options, the retailer stays out of price wars. They can charge a higher price, because you have no other choice if you want that product.

Apple products link the hardware to the software to the apps to the app store. If you want a unique killer app, you have to link into the whole Apple system (no matter what the price). There are no other choices, because it is a closed system. Even though people did not prefer the AT&T mobile network, they accepted it as part of the cost of getting an iPhone in the US, since at first it was the only system iPhone worked on. You cannot haggle on prices for the various parts because of the unique linkage.

General Motors is the only firm in the US to offer the OnStar service on its cars. If you are the type of person for whom the OnStar service is critically important, than you have to own a GM car, no matter the price.

If people see your product or service as no different than the competition, then you become a commodity. With no perceived difference, sales go to the firm with the lowest prices. The only way to get out of that price war is to find a way to differentiate yourself from the pack. Find some sort of unique added value that a group of people will pay more for. Or link up and bundle yourself to other desirable products. Make it impossible to do direct comparisons with competition. Only then can you extract ransom-like prices.

3) Have the Power to Follow-Through on Threats
Usually, the terrorists told Jack Bauer on 24 that if he did not do as he was told, they would kill Jack’s loved one. Jack obeyed because he knew that these terrorists had the will and the power to carry out their threat. These terrorists were used to killing and had no qualms about killing a loved one of Jack.

Conversely, if the terrorists did not have the will or the power to carry out their threat, the ransom demand loses value. If you know that the threat to kill is a hollow threat they will not carry out, then you can ignore the demands. I’ve often seen this with children in public places. When parents tell an unruly child to behave “or else”, some immediately behave while others continue the bad behavior. Although there can be many reasons for this, one reason is because children know whether the “or else” is a hollow threat. If it is a hollow threat, then there is no reason to take it seriously.

One of the reasons why Best Buy was so profitable at its peak was because its vendors knew that Best Buy followed through on its threats. When a new technology was developing, Best Buy would tell all the vendors in the field that they would not support all of the brands trying to claim a position in this space. They would point to history, where the brands Best Buy supported thrived, and the ones they did not back usually failed. Then, they would essentially ask the vendors how much of a “ransom” they were willing to pay to get the support of Best Buy (and avoid not getting their support). Because Best Buy carried out its “threats”, people took these negotiations very seriously, and Best Buy reaped higher profit margins.

Lots of people procrastinate and wait for sales when they know that a retailer does not have the will to resist holding a sale. However, if a retailer gets a reputation for following through on a threat of not holding sales, then customers will tend to not wait and buy early at full mark-up prices.

If you want to escape endless price wars and instead charge prices with healthy margins, think like a terrorist in a hostage situation. Terrorists can extract a huge ransom price because they:

1) Choose Hostages with High Emotional Value
2) Choose Hostages with are Unique and Difficult to Replace
3) Follow through on their Powerful Threats

As a company, you can do similar things to create your ransom-like pricing.

1) Create Strong Emotional Ties Between Your Brand and the Customer
2) Create an Offering which is Unique and Irreplaceable in the Marketplace
3) Follow Through on Your Threats.

A strategy to follow the leader will never set you apart in a manner which allows ransom-pricing. Instead, strike out on your own and create a unique offering which has high emotional appeal.

1 comment:

  1. Gerald Nanninga,

    As much as it might sound repulsive to some readers, the metaphor of following terrorist approaches to extracting high prices for their hostages is true. The mixing of high emotions and prestigious products to what we sell is a recipe for securing high prices.
    Your dictionary check underlines in red your surname. Rather, it should highlight your great ideas.