Purchasing and Negotiation Training

Robert Menard, Certified Purchasing Professional, Certified Professional Purchasing Consultant

Editor’s note: this is Part 2 of a two part series; it presents the second four of eight popular pricing strategies.  Part I presents the first four.

Revenue Management

This one shines with sophistication.  The transportation industry provides a superb example.  The very name of this strategy strikes mystery and fear in one’s heart, much like lawyers conversing in Latin terms or physicians engaging in pharmaceutical-speak.  Every profession has its jargon to separate it from mere mortals.  As one famous, if quirky American politico once observed though, things are more practical where the rubber meets the road.  We will heed Ross Perot’s advice here and reduce this strategy to familiar terms.  Here is how it works in the case of airlines.

Under certain advance purchase conditions, most airlines offer a super saver fares.  Usually, it is the personal traveler who enjoys the schedule flexibility to take advantage of these deeply discounted fares, especially if they involve a Saturday night stay over.  The fare is often just a fraction of the full coach ticket.  Say that $500 is a reasonable fare for a coast to coast round trip advance fare.

The business traveler, who favors Saturday nights at home, suffers the additional disadvantage of minimum advance planning.  I once had a client call on my cell phone on the way to the airport and drastically change our whole itinerary.  With less than an hour before the flight and in a hot sweaty hurry, I purchased a round trip coast to coast coach ticket for about $3,500.  Can you imagine the conversation I had with the gal who sat right beside me?  She purchased her ticket for $500.  I paid seven times that amount.  Thankfully, she never asked me if my seat was really ten times better.  I also never gave her my book on negotiation.

Yet, the airlines make eloquent and in part, logical arguments that this pricing strategy is not only sensible, but required.  Otherwise, too many passengers would show up for some flights and not enough for others.  Therefore, this strategy, which effectively penalizes the businesses traveler, was actually maintaining order where chaos would otherwise rule.  Well, you be the judge.  The important point is that here is an opportunity to clarify buyer and seller interests.  Large travel brokers smooth out these price swings in fare by purchasing blocks of seats and reselling them.  Consolidators peddle seats on line, to tour agencies, or to the public, thereby filling the gap between the super saver and at-the gate price.  How does your supplier price its product or service?  Is it by some arcane method such as Revenue Management?  If so, this needs to be addressed in negotiations.

online training in purchasing, negotiation, and sales

Yield Management

This strategy is totally counter intuitive, and therefore defies common sense.  The hospitality industry is the leading case in point here.  Suppose you operated a 300 room hotel, and one night you had a 50% vacancy.  What is a better for business?  Do you demand the ‘rack’ rate (usually the posted rate), because you need the revenue, or do you offer the lowest rate possible just to get butts in the beds?  The answer is that you give the deepest discounts when the occupancy is the lowest, and demand the rack rate when the occupancy is highest.  It seems odd, I know, but here is how I learned.

One early November weekend in the early 90s, I attended a meeting at a New York airport hotel.  Air traffic was slow in advance of the madcap Thanksgiving Day holiday, so the hotel had many available rooms.  Upon check-in, I asked the clerk about the room rates.  Bear in mind that I had pre-registered at the ‘convention rate’ of $150.  She told me that I could have a room in the convention wing for $135 or in the remote wing for $115.  Curious, I inquired pleasantly about the distinction.  Without further ado, she offered me a room in the convention wing at the $115 rate.  So much for Yield Management, I concluded.

About five months later, I was at the same airport again.  My father and brothers, who lived across the US landscape, were all to meet in Miami to catch a flight to Costa Rica for a four day fishing retreat.  Soon after I arrived at the same NY airport for my connecting flight, a rogue Nor’easter blizzard blew in and all flights were cancelled.  The entire airport was shutdown at 3 pm.  Being a smart fellow and experienced traveler, I immediately hopped the taxi to the same hotel.  Upon arrival, I suffered the indignity of long lines, impudent amateur travelers, and general unpleasantness.

At the check-in desk, realizing the situation, and being the realistic purchasing and negotiation pro, I graciously offered to pay the full price rack rate.  To my chagrin, the clerk guffawed, pointing out to my obvious hick nature that everyone was paying rack rate plus a “weather premium”, unless they had US military clearance.  Having none, I squeaked my willingness to fork over about three times what I had paid for the same room just five months ago.  As they say at Texas rodeos, “Some times you make 8, sometimes you hit dirt.”

Perceived Value

This one is my favorite and a clever, effective reflection of human nature.  Here, the product is so good, has such great rewards, that you don’t even ask the price.  The one word, quintessential example of all time is Viagra.  Who knows the price, and who cares?

Perceived value has applications beyond pharmaceuticals today.  The telecommunications world has many fine examples in the wireless phone and internet connection services.  Here is how it originated.

In the mid 70’s, Tagamet was the leading ulcer medication.  Tagamet’s success attracted competitors.  Soon after, Zantac appeared on the market.  Both products served the same purpose and appealed to the same customer base.  The table below summarizes the performance of the competing drugs in terms of cost.

This is an interesting pricing strategy for a buyer.  Zantac had to find a way to knock off the king of the hill, Tagamet.  The advantage of better quality and lower production costs suggested adoption of the time tested better mouse trap theory.  That is, introduce the Zantac at a lower price in order to capture market share.

That is not what some very clever execs did however.  Instead, Zantac chose to trumpet its ‘Perceived Value” of less drug interactions, fewer side affects and better dosage schedule.  Even though both drugs accomplished the same job, the greater perceived value, reinforced through advertising, of Zantac could be translated to increased price.  That is exactly what happened as Zantac was brought market at a price premium over Tagamet.  Within about two years, Zantac was the best selling drug of all on the planet.

Frequently, new product rollouts or high tech services come to market on this pricing strategy.  Voice mail provided by telephone companies are an example of a high price but low cost service justified by perceived value.  This is not to say that the product or service does not have actual value.  On the contrary, we want to establish a basis for negotiation.  We are interested at least as much at a product’s cost as we are in its price. 

Optimization

This is a relatively new method and is in favored by big retailers with many SKUs.  A software program analyzes an array of variables such as sale history, competitor’s process, even time of day and week to produce a mathematical model that estimates the greatest yield of sales and profit.  Airlines are now getting into the act using it to vary pricing many times per day for the same flight. There are applications for markdown of merchandise.  Further, the software is industry and sector sensitive; within the food industry, sales of generic or store brands of pasta and cereal do not follow the same patterns.

Here are three of the many suppliers of price optimization software

DemandTec

SAP

Oracle