How to Build a Better Pricing Strategy

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Welcome to HBR on Strategy. Case studies and conversations with the world's top business and management experts hand selected to help you unlock new ways of doing business. With rapidly changing markets and emerging technologies, how can you make sure you're setting your prices right? Today we bring you a conversation with pricing strategy consultant Rafi Mohamed. In this episode, you'll learn how pricing and demand interact and how dynamic pricing differs across a range of industries, from music and sports to airlines, hotels, and even online shopping. You'll also learn why your frontline workers can be a valuable source of market research to help you set the right price. This episode originally aired on HBR IdeaCast in July 2011. And just a note, we recorded this by phone. While the audio quality isn't great, the conversation is. I think you'll enjoy it. Here it is.

Welcome to the HBR IdeaCast from Harvard Business Review. I'm Sarah Greene. Today we're talking about something that affects every business pricing, but we're looking to the fringes of ticket scalping for some advice. I'm talking with Rafi Mohammad, who is a pricing strategy consultant and author of the one percent How Successful Companies Use Price to Profit and Grow. He also blogs for hbr.org and so I hear, gets a lot of great tickets on the secondary market. Rafi, thanks so much for joining us today.

Sarah, thank you. Always enjoyable to discuss pricing.

Yes, especially when it's something as much fun, I think, as either summer concerts or playoff tickets. But before we get into the ins and outs of that, I have to ask, why is there a scalping market at all? Shouldn't sports teams, musicians, shouldn't these people be charging more in the first place?

It's a great question. Why shouldn't the people who should be getting the revenue, why aren't they capturing it? And there's a couple of key reasons. And the first is there's just a great deal of uncertainty when a ticket price is set, whether it's for a baseball game, if the Red Sox are doing well or not, or even a rock concert. The Rolling Stones can be very hot in some cities and not so hot in other cities. And so one of the key reasons is due to this uncertainty, many sports teams and musicians tend to be conservative and set a low price. The second key reason is there's generally a hesitancy to set prices too high because there's a brand or goodwill associated with these entities and they don't want to set prices too high to damage that. And the third sort of interesting thing is that demand comes in waves. So not, you know, when tickets go on sale, there's a lot of demand initially, but there's also more demand over time. So, for instance, in the music market, the sort of rule of thumb is whatever you sell in the first five days, you double that, and that's going to be your total attendance. So there's this disconnect between selling and when the demand arrives. So a lot of times people just speculate and buy tickets, and they buy it up when tickets go on sale and later sell them to people who want tickets at a later date. And finally, it's important to remember that the scalping market, while generally people think of it as a way to capture higher prices, the scalping market also does set lower prices when demand is low. And that's a good way for ticket prices to be lowered. And generally speaking, teams and musicians are somewhat wary of lowering prices once they've set it. So for those four key reasons, that's why there's an existence of a scalping market today.

So that's interesting, and it's a good point that the prices can also be lower from a scalper sometimes. But isn't there a way for teams to sort of learn from the scalping market and to implement that kind of flexible strategy on their own?

Exactly. And this is the new wave of ticket pricing in the future. For instance, now the scalping market is about $3 billion a year. So if there's some way the teams and musicians can capture that, that's great extra revenue to make. The new way of thinking about pricing in these. For these events is dynamic pricing. So much like an airline or a hotel, you fluctuate price based on how demand is going. And so it makes intuitive sense. But I think what most people miss on this is demand is very different. So, for instance, demand for a flight from Boston to la, there's actually nine nonstops a day. And, you know, in fact, I looked for Thursday, the prices for These nonstops range from 369 to. To $2,278.

Wow.

So what happens is, if I'm an airline and I have low capacity, I can just lower my price and steal customers from other flights. Okay. And so that's how dynamic pricing typically works for sort of hotels and airlines. But you have to remember, for rock concerts or sports teams, you're not stealing demand from other places. So generally there's sort of a fixed demand. And what you try and do is get the right price. Given the current demand structure, you can't Steal customers from. It's rare to steal it from other events. So that's a key difference.

That does seem sort of like a key point. Like for instance, if I'm a Red Sox fan, I wouldn't necessarily go to see the Yankees just because they were cheaper.

Exactly right, exactly. But if you're going to LA and there was a price difference between $369 to $2,278, if you're keeping your eye on your budget, you might, instead of going on your favorite flight, go on an earlier flight and save a lot of money.

How should people in the entertainment industry who are in this event driven business, how should they try to implement some of this knowledge on dynamic pricing?

That's a great question. First of all, obviously when demand is a little higher than what you expected, that's sort of the best case scenario. All of a sudden the Rolling Stones come to town and demand is much higher. Well, you can constantly over time play with prices to capture the highest amount of revenue. So in that case that's fine. But getting to your Yankees game analogy, when demand is low and it's lower than expected, what do you do? And there's two key things. The first is that you're getting people coming to your site, you know, the existing demand coming to your site. And if demand is low, intuitively people might think to lower the, you know, make all prices cheaper. But I think if people come to the site to buy a ticket, they're interested. And I would focus on trying to upsell them into higher priced seats so they're interested. They wouldn't normally sit in the best seats, but if you have an attractive price, you might be able to get more money out of people who have an interest, who have a demand. And the second thing that you have to do, and I haven't seen anyone discuss this, is that for low demand events you have to have a way to let consumers know that, gee, we've lowered our prices. So if I'm interested in going to a rock concert, I'm not going to go to the website 10 or 12 times to see what the price is. But if I know, much like on Broadway that the day of that they lower prices for some Broadway shows, there has to be an event that consumers will know, oh, maybe I should go back and check and see what the price is. So those are the two ways to think about dynamic pricing. When demand is high or demand is lower than expected.

Hmm, that's interesting. So I wonder if we can get into an example here of maybe A team or a musical act trying to implement this and see how well it's working. Is there anyone sort of on your radar screen who's either doing something that's working or maybe doing something that you'd want to avoid?

Right, sure. Well, a classic example is that the San Francisco Giants did a test market for dynamic pricing a couple of years ago. And what they did is in certain sections, they would lower and increase price. And what they found is that in these sections, their revenue increased by 20%. So that sounds like a really great figure, doesn't it? But here's where I think that they missed the boat on is this notion of cannibalization. It's not just for tickets. It can be for any product. People tend to say, oh, well, we lowered the price and we got more people to buy. But what you have to take into account is the fact that some people would have bought at the higher price. So let's go back to the San Francisco Giants. If they have an experimental section and they drop the price, why would I buy a ticket in the next section over that's at a much higher price? So if I were going to buy that ticket, I would say, well, gee, I could save $10 by going to the experimental section. Why not? So I think that my hunch is, is that there was a lot of cannibalization going on, and that 20% figure really didn't represent new revenue getting people price sensitive in the door. My hunch is that the majority of this increased 20% came from people who would have actually paid a higher price. That's a negative of dynamic pricing that I don't think has been satisfactorily accounted for.

So we've been talking about sort of dynamic pricing across a range of industries. Sports, music, you mentioned hotels, you mentioned airlines. And I think it sort of has seeped even further, even more than we know, into other industries. Especially since online shopping makes it pretty easy for online retailers to figure out what kind of a shopper you are and what you might be willing to pay. Is there any industry that you think is safe from dynamic pricing, or are we just going to be all getting different prices all the time in the future?

Well, Amazon, in my experience with Amazon, they do change prices. So by the day, for instance, you know, I see that my book price goes from 18 to $20. And so they definitely changed the prices. Several years ago, they did get caught up in a pricing scandal where sort of they were offering different prices to different consumers at the same time. Okay, so people are like, gee, I just bought this DVD and I paid this. And someone else will say, I bought it at the same time and I paid a very different price. And so after that there was a lot of discussion about this. Amazon came out and said that we aren't going to offer different prices to different customers at the same time. So what they didn't say is that we're not going to vary prices over time. They just said they were going to stop that practice. So what you're seeing on the web is that since it's a great experimental venue and you can see how people react, you are going to see on the web more price experimentation by all types of retailers to try and figure out what is exactly the right price.

For products as companies like that start experimenting. I think part of the reason it's useful, for instance, to talk about ticket scalping is that it becomes obvious when you're leaving money on the table because either people are willing to pay more or they're not. As you mentioned at the beginning, they'll pay less. So it's sort of easy to see how close you are to the mark by how close you are to that secondary market. But if you are in a business where your product or service doesn't get quote, unquote scalped, how do you know if you've got it right?

I always ask people on the front line, you know, because they deal with customers. And oftentimes people on the front line can tell you, you know, a lot of people would have paid a lot more, or we're getting a lot of people who are very interested. They take the product off the shelf, they're interested, but once they say the price, they sort of put the product back. So sort of the two ways of doing it is one, sort of a market research type which we discuss on the Amazon by varying prices, or second, I feel that the frontline really has a lot of intuition on what customers are willing to pay. And that frontline has a lot of market research that they can share with people who set prices to help set the right price.

That's interesting. It's always interesting to know how much of this always comes back to those people on the front line. Okay, so I can't let you go without going back to ticket scalping and just asking the question that I know is on everyone's minds. How do I get the best deal on tickets that I want?

Well, you know, we can't tell all the secrets, but I'm happy to share, share some of the key secrets and it really comes down to uncertainty and how you deal with uncertainty. And it's been my experience that the closer you get to an event, whether it's a rock concert or sporting event, you see prices go down. And so obviously, if you're taking a significant other or celebrating a very important event or going out with clients, you really don't want to be sweating it out until the last second and hoping that prices are going to go down. Okay, so that goes back to the notion of value. So I value the certainty of having great tickets to the Rolling Stones or the Red Sox versus the Yankees. So I'm willing to pay a premium just to get that certainty. But much like what you see in life and, you know, in pricing in general, if you're willing to wait it out and deal with the uncertainty, you can get the best tickets at face value, if not lower, if you wait until the very last minute.

So just a little negotiating ploy there.

Not only negotiating, but it's sort of as events get near. I have this theory that people often buy tickets for their friends. And I think the older that you get, the more of life's obstacles that you face. And at the end, oftentimes, friends can't make it. And so I often see when I'm going to a show or a sporting event, people are like, oh, my friends were supposed to come, but now we have two extras. And since there's so many people in that situation, the market has set a lower price. So that's really the key to getting the best tickets at the lowest price. And what's always surprising to me when I go to these events or I'm looking for tickets at the last minute is how good of a seat comes up. It's shocking that, generally speaking, the day of or two days before you'll see on Craigslist or ebay, tickets in the first 10 rows that you can get at face value. If not, and, you know, if you bargain a bit, even lower.

Well, it's excellent, excellent advice. Raffi, thanks so much for talking with us today.

Thanks so much, Sarah. I appreciate it.

That was pricing strategist Rafi Mohamed in conversation with Sarah Greene Carmichael, former host of the HBR IdeaCast. If you like this episode, check out HBR IdeaCast on Apple Podcasts, Spotify, or wherever you get your podcasts. They release new episodes every week. HBR OnStrategy will be back next Wednesday with another handpicked conversation about business strategy from the Harvard Business Review. And in the meantime, we have another curated feed you should check out HBR on leadership and visit us anytime@hbr.org where you can subscribe to Harvard Business Review and explore articles, videos, case studies, books and, of course, podcasts that will help you manage yourself, your teams and your career. This episode of HBR on Strategy was produced by Ann Sany and me, Hannah Bates. The show was created by Anne Sanney, Ian Fox and me. Special thanks to Maureen Hoke, Adi Ignatius, Karen Player, Anne Bartholomew and you, our listener. See you next week.