Wholesome Marketing Ideas, Bite Size

Wholesome marketing ideas, bite size

Sunday, April 24, 2011

Cruising to profitability

You may have come across this recent WSJ article that puzzles over how "A growing number of cruise lines have built lavish—and separate—cocoons for their biggest spenders. It is a departure from the egalitarianism that had reigned on most ships for the last several decades when everyone from the humblest inside stateroom to the most luxurious suite would rub elbows in the same bars, dining rooms and pool decks."

No longer, it seems.

The well-heeled are shooed in, while the less so are booted down to a lower class of travel. 
Some airlines, too, have introduced entirely new seating classes. They have, for example, re-labeled what used to be their economy class to "Premium Economy," while introducing a knee-crushing, reduced leg space "economy" experience for passengers who have their dinner fed to them by the catapult effect created when the passenger in front of them decides to recline or redress their seat.

In fact, in almost every product category, from watches to wine, from cars to pens, there is now a very wide range of price levels, with the top prices often hundreds of times those for the least expensive products in the category. The class system is alive and well.

So why are class systems so popular? Because they are profitable.

A class system is a form of vertical segmentation, where the market is sliced into groups of customers willing (and, almost as importantly, able) to pay different amounts. The more slices you create, the more profitable the outcome. But with one big caveat, of course: the complexity and cost of making and selling so many differentiated offers should not exceed the extra revenue you can capture from those willing to pay more for frilly perks such as adequate leg room.

Let's consider a simple example to see exactly where the extra revenue comes from. Imagine you're a manufacturer of ball point pens searching for ways to increase revenue in a market that consists of two consumers.  

Consumer A, you find, is the pragmatic, down-to-earth, let's-get-it-done-at-low-cost type. She is indifferent to the characteristics of a pen, as long as it writes without smudging.  She wants to spend no more than one dollar on a pen.  

Consumer B on the other hand is fastidious about the design of her pen.  She prefers a futuristic design with a structured, anti-slip rubber grip. And she is willing to pony up two dollars, provided the pen meets her picky requirements.  

So now you, the pen manufacturer, have three strategic options: (1) you can make only the basic pen; (2) you can make only the fancy pen; or (3) you can segment the market and make both types of pen. 

If you decide to make only the basic pen, remember that neither consumer will pay more than one dollar for it.  Both may buy the product, especially if Consumer B does not find a fancier alternative. But even if both consumers decide to buy from you, your total revenues will be no more than two dollars.

If you choose to make only the fancy pen and price it at two dollars, Consumer B will buy it, but A will pass.  Total revenues again will be no more than two dollars.  

However, if you decide to make both types of pen, pricing the basic pen at one dollar and the elaborate one at two dollars, each consumer will select her preferred pen. You have a shot at magically increasing your total revenues to three dollars. In other words, a segmented strategy can yield 50% higher revenues than an unsegmented one.

In any market where consumer preferences vary (and they always do), segmentation is the more profitable strategy, provided the costs of producing multiple types, and tailoring communications and distribution for the different segments of consumers can be kept below the extra revenue earned.

That's the theory. Does it work in practice?

Does it ever. 

Look around, can you think of a product category where it's not being applied?

And in recent years vertical segmentation has truly taken off. Rapidly declining costs of ‘customization’ of products (think flexible manufacturing), communication (think targeted ads), and distribution (think online retail) have made segmentation strategies increasingly viable and commonplace.

At the same time, the economic downturn has made many (but, crucially, not all) consumers more price sensitive. Those that aren't are prized clientele -- they're the 20% who contribute the proverbial 80% of the profits. 

So cruise lines, airlines, and sellers in almost any industry you can think of, are figuring out a fine balancing act: trying to capture the additional profit from those willing to pay more, while retaining the volume that comes from serving the thrifty. 

And that means more and finer market slices.

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See also: Why we segment

Photo Credit segmented apple zirconicusso / FreeDigitalPhotos.net

Next week: guest post by Martin Roll, author, consultant, and brand expert.


Valentina Bardorf said...

I enjoyed reading this post and have noticed this happening everywhere recently. I travel frequently and have personally viewed and experienced the different seats now made available - it almost seems as if it the airlines are downgrading the norm, and upping the norm ever so slightly so as if to make travelers feel as if they are getting a premium, more luscious travel experience - whereas they really are only getting a little more than they would have normally, but because in comparison to the now downgraded regular economy, they feel like kings and queens. In addition, its for these smaller price increases that this can be attained, and thus travelers are more willing to take that one splurge or that one flight in more comfort because its not the jump from economy to first class - its just a couple hundred more for a step above the bottom. I think this plays into our minds and what people want to feel like in relation to others, because, who doesn't like to know they aren't at the bottom? I realize sometimes I see, for example, canned tomatoes for either $1.00, $1.09, or $1.45. Now the lowest is the private store label, the middle a regular brand, and the higher a 'so called' premium tomato can. Now normally im a no name kinda girl, but when you put a difference of only 9 cents in between the no name and the supposed one-up tomato can - a girl is gunna feel drawn to just spend that extra 9 cents and get a little something better (even if it may just be the same). This is because a jump of 9 cents really isn't much compared to 45 cents - so in the grand scheme of things, it seems like a cheaper way to get something better. If this kind of an outlook is taken on everything - prices scaled larger and what not - then who knows how much more one may be willing to spend to not be at the bottom. If the top is so preposterously higher, but a middle level clearly attainable - then the normal jane like me may be willing to say okay and go in for the higher from the lowest price thing to feel like a queen.

Ryan Klein said...

I find this very interesting.

I wonder if the desire for greater profitability will ever come to point where everything is segmented in such a manner.

I challenge anyone to try and find a market whereby this type of "slicing" does not occur......

Canadian Health Care comes to mind, however with increased privatization, their is higher WTP for things such as MRI, which has caused an increase in private MRI clinics, where the waiting time is significantly less.

Wendy Yang said...

I think the concept of segmentation is also tied to your more recent article post by Dan Ariely. Ariely makes a bold claim in that marketing is good for society, that it motivates people to be more productive in order to be financially able to afford desirable products.

Segmenting defines social tiers, wherein those on the bottom fight to rise above while those on top guard their positions warily knowing that utopian societies cannot exist into the foreseeable future. Therefore, segmentation, besides more accurately targeting varying consumers, also drives productivity as consumers constantly strive to improve their positions.

In class we talked about luxury cars advertising in spaces that reach lower segments who aren't able to afford the cars. Yet it is creating that longing -- that aspiration to belong in higher segments -- that allows luxury car manufacturers to achieve higher WTP.

It's a bit unsettling to say, but segmentation as a mirror of existing social tiers are the reason for luxury brands' profitability. Marketing capitalizes on this human desire for social mobility to succeed. Without it, marketers would be out of jobs.

Breanne McMurray said...

I find it interesting that no one has mentioned the idea that with segmentation you are deterring away from your core values of your company. For example, a pen manufacturer who has only produced blue pens thus far realizes a potential profitable opportunity through producing in the premium, trendy pens market. Initially this will be a profitable option for the manufacturer; if the fixed costs do not increase substantially. However, because this manufacturer is not experienced in this new product development there is a large likelihood that the product will fail. Therefore if a manufacturer decides to segment they must set strict policies and guidelines to ensure that their quality and reputation is maintained. On top of this if they segment with the same brand, the company must be extremely careful not to decrease the brands equity by lacking focus and having a disconnect between the two products and the value proposition.

Danica Chan said...

Segmentation and flexible pricing based on consumer willingness to pay are concepts that are indeed popping up in every industry. I recently read about Ticketmaster's announcement to partner with MarketShare to introduce a dynamic pricing policy. The company realized the potential of adjusting prices according to demand as "one of the most important and untapped opportunities to unlock value".

I agree; With their plethora of consumer data, Ticketmaster should easily be able to thinly segment their consumers according to willingness to pay and maximize revenues.

In such an industry of dedicated fans and extreme variances in willingness to pay, it is imperative that they segment consumers as much as possible. Sold out in minutes, hockey fans are willing to pay in the thousands for premium seats in the "100 section" while many concert seats perpetually go unfilled.

Also, seeing a decline in ticket sales and an increase of scalpers and online discounters, this competitive business must learn to use data analysis and technology to extract more value from consumers.

Looking at the company's previous year's loss of nearly 230 million, I am very interested to see if greater segmentation through flexible pricing will truly make a company most profitable.

pattaya apartments said...

This practice only make sense. You would want your services to satisfy as many customers as possible and with the highest profitability possible. It is up to the customers if they want to buy a higher level of satisfaction.