Archive for October, 2006

“Perceived Cost Plus” as a New Pricing Mechanism

Thursday, October 19th, 2006

“Cost Plus” is one of the most basic pricing mechanisms for goods and services. Under this mechanism, the manufacturer calculates the Total Direct Cost of an item by adding its direct material, direct labor and direct overhead costs. To this, they add the sales, general and administrative overhead costs to arrive at the Total Cost. By loading a markup / margin to this Total Cost figure, they arrive at the Selling Price.

Many people I know tend to have an opinion of what an item should cost i.e. what it should cost for the manufacturer to produce the item. Let me call this “Perceived Cost”. For example, if they’re about to buy a writing pad, they’d quickly break it up into paper, cover page, stapling and binding and assign a cost to each of these “sub-items”. By adding up these costs, they’d arrive at the Perceived Cost. They’d then add a markup, which could range from 5% to 25% or even higher – depending upon their views on “profit motive” – and arrive at what they’d consider a fair price. If the actual selling price is close to this ‘fair price’, they’d conclude that the item is priced “reasonably”. If the actual selling price is way above (or way below) this figure, they’d tend to question the price or the genuineness of the product and put their purchase decision on hold.

Based on this sort of empirically observed consumer behavior, I am putting forth a new pricing mechanism in which a company arrives at the selling price by adding a certain markup to the ‘perceived cost’ (instead of the ‘actual cost’ as is the case in the traditional “Cost Plus” mechanism). Let me call this the “Perceived Cost Plus” pricing mechanism.

Will perceived cost equal the actual cost? Probably not.

In the following situations, perceived cost tends to be higher than the actual cost.

  1. Whenever a middleman is involved. Most buyers tend to conclude that a middleman introduces a layer that adds to the total cost.
  2. Buyers, especially in the lower economic strata or in developing economies, tend to think that things sold in an organized retail environment — such as a plush, air conditioned supermarket, with superior ambience — would cost more.
  3. Whenever goods have to be transported, especially across a country’s borders, buyers tend to ascribe a higher perceived cost.

However, buyers’ perceptions of higher costs is not always right. That is, actual costs in these situations could be lower than the perceived costs. Let’s look at a couple of examples.

Wal-Mart is perhaps the world’s largest middleman, buying from the manufacturer and selling to the consumer. Its plush stores offer better ambience compared to a typical mom-and-pop store (aka ‘kirana’ shops in India). Still, prices in Wal-Mart are lower than almost anywhere else.

Despite doomsday predictions made about the future of middlemen (distributors, dealers and retailers) at the height of the dot-com era of the late nineties, the fact is that most successful dot coms of today are not original manufacturers or service providers but middlemen like Amazon, Expedia, Travelocity, and so on. Web 2.0 leaders like Digg, Flickr, Jigsaw and YouTube offer virtually no content of their own. Instead, as middlemen, they provide the platform on to which users post and share content with one another.

All these middlemen have demonstrated a consistent track record of delivering lower prices — which is clearly contradictory to the widespread belief that costs would be high if a middleman is involved.

What gives?

Many middlemen are able to deliver lower prices due to economies of scale, trade promotion policies, lower overheads, and so on.

The pricing power wielded by middlemen is very well illustrated in the hotel industry where leading chains have been making announcements that they offer the lowest tariffs for rooms booked directly on their own (i.e. the hotel chain’s) websites rather than on the websites of middlemen. Some go a step further: for example, Hilton guarantees that if you do find a lower rate on some other booking channel, they’ll match that rate PLUS offer a $50 gift cheque for your trouble!

Click here to view Hilton’s guarantee.

Supermarkets that have opened up in India in the last one year provide another excellent example of offering products at lower prices than the ‘kirana’ stores. Despite being plush and air conditioned, these supermarkets were the first to actually sell products at ‘below MRP’. (As per government regulation, all packaged goods in India must display a so-called Maximum Retail Price or MRP, which is the highest price at which the item can be sold — by anyone, anywhere in the country. Until recently, nobody expected to buy a product lower than the MRP either. The recent spate of supermarkets have changed that).

The above examples clearly show that actual costs and selling prices are not necessarily higher when middlemen are involved. Let’s now take another example which, while illustrating the same thing, sounds a warning bell to marketers to take the concept of perceived cost seriously while formulating pricing policies or risk losing customers.

A couple of years ago, an emerging financial institution (FI) in India ordered a PC from its original manufacturer, which happened to be a large and reputed IT company. The FI never received the PC within the promised delivery period of four weeks. They got tired waiting for another two weeks and decided to buy another PC from the market. When they looked around, they found that they could buy the same model of the PC off-the-shelf from one of the dealers of the same IT company — and at a slightly lower price!. In other words, the middleman was able to supply the same item readily and at a lower price than the original manufacturer. You can imagine the shock of this FI when this happened.

What appears to be puzzling to a customer or the common man has a perfectly valid explanation: It has to do with pricing and dealer management policies like ‘First Dollar Rebates’, ‘Target Achievement Bonuses’ and ‘Over Target Achievement Bonuses’. FDR is the margin received by the Dealer on each unit starting from the first unit. If the Dealer achieves the quota, they get a TAB. If the Dealer exceeds the quota by a certain percentage, they earn an OTAB. In the computer hardware industry, FDR is typically 20%, TAB is 5% and OTAB is 2%. The important point to note is that TAB and OTAB are applicable on all sales during the quota period – not just on sales exceeding the quota. Therefore, it was possible for a Dealer to make money by selling the PC at a lower price to this FI than the original company’s discounting policy would have allowed it to sell to a new customer.

It’s obvious that the Dealer had the PC in stock and stood to earn TAB / OTAB by selling it to this FI at a higher discount than the discount to a new customer by the original company’s discounting policy.

However, the FI didn’t need to know all this. Because they felt very strongly that prices should be higher when a middleman is involved, they thought the IT company was fooling around with them. They got so pissed off that they blacklisted the company for all their future hardware purchases … a fate that the IT company could have avoided had their marketing professionals adequately heeded customer perceptions regarding costs while formulating their pricing and dealer management policies.

In this article, I have introduced the concept of “Perceived Cost Plus” as a new pricing mechanism. In a future article, I will discuss its applications for a few specific products and services. Stay tuned.

Save Whiteboard Drawings Using Your Camera Phone

Wednesday, October 11th, 2006

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When was the last time you attended a meeting where the speaker wiped the whiteboard clean before you could copy it down? Not so long ago, I can bet.

With scanR.com, you can save whiteboard content without having to copy it down by hand. Simply click the whiteboard using your camera phone or a digital camera and ‘send’ it to the email address wb@scanR.com. In a few minutes, after a very simple registration process, you can collect a PDF file of the whiteboard from your email Inbox!

How do you ‘send’ the photo to scanR.com? There are many ways of doing this.

  1. Directly by using the MMS / email feature of your mobile phone (if supported by your phone and offered by your network provider).
  2. Upload the photo from your mobile phone to your PC (via cable, infrared or bluetooth) and then use email.
  3. Upload the photo from your digital camera to your PC (via cable) and then use email.

You need minimum 1 megapixel resolution camera for this to work.

However, one thing that struck me was,

If I anyway have to email the whiteboard photo from my camera phone to wb@scanR.com, why can’t I simply email it to my own email address instead? Either in this manner, or by using my camera phone’s infrared / bluetooth / cable connections, I can get the photo of the whiteboard as a JPG image into my PC. (If I am particular about PDF, I can easily convert the JPG file into PDF format using any of the several freeware PDF print drivers available for a Windows XP based PC.)

So, what’s the difference between this JPG image and the PDF file I’m getting from scanR.com? Does scanR give a better quality?

I actually tried this out using a half-sized white board (a cafeteria menu board!) and a 2 megapixel camera phone.

See the comparison below.

On the upper half is the original picture I had clicked on my camera phone and uploaded to my PC as a JPG file. The lower picture is a screenshot of the PDF file I got back from scanR.com. Sure, the scanR picture seems brighter because it seems to have removed all the grayness in the background. However, the original picture shows the frame of the whiteboard clearly, which helps you remember later that you are looking at a whiteboard. Whereas, in the scanR picture, the frame is hardly visible.

From my experience, I would say that the jury is still out on this question of whether scanR renders better picture quality compared to my original JPG picture. Don’t forget that that the camera phone I used had a resolution of 2 megapixel, better than the 1 megapixel stipulated by scanR. And, I’m not even talking about the cost of MMS / email from your mobile phone to scanR’s email address. Depending upon where you live and your service provider, this could range from 25 cents to a dollar.  

Am I missing something here? I thought "maybe yes" when I read a May post of the CNET Alpha Blog yesterday, according to which scanR does an OCR (optical character recognition) of the whiteboard picture you send it, so that the PDF you get back is indexable in your PC by your desktop search engine. Surely, this is great help when you do a search through these PDF files later.

However, I was not able to do any desktop indexing on my PC with the PDF I got from scanR.com. Besides, Windows XP’s ‘Search’ command failed to recognize any words inside the PDF. Neither could I find any mention of OCR when I  checked the scanR.com website today.

I wonder if this feature has been removed since the time of the CNET Alpha blog post of May.

I decided to turn my attention to the Business Card scanning feature offered by scanR.com. Basically, you click a business card and send it to bc@scanR.com, and you get back a VCF file. Since it’s always painful to have to type in contacts from a business card into your PDA or Outlook, getting a readymade VCF sounded great because I could simply upload the contacts directly into my Palm or Outlook without manually typing them.  However, when I tried this out using a stipulated 2 megapixel camera, I got back a highly garbled VCF file — so badly garbled that I’m not even bothering to show a comparison of the original and the processed pictures. There was no question of uploading this VCF file to my Palm. Maybe this feature, having been launched only recently, is in beta and will deliver better results in the future.

Apart from this, one very useful thing scanR claims to do is to upload the contact details from the scanned business cards directly to leading business contact marketplaces like Jigsaw and Salesforce.com. I intend to try this out in the coming days and will keep you posted on this blog. Watch this space!

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Nifty Web 2.0 Toolbar

Monday, October 9th, 2006

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The last couple of months, I’ve been blogging about Web 2.0 applications and their power to raise the bar on customer communications and to generate explosive growths in innovative business models like person-to-person lending, group action, and so on. During this period, I have come across many lists of Web 2.0 sites, some good, and others not so good.

Personally, I’m very excited about web toolbars. So, you can imagine my glee when I came across a very nifty Web 2.0 toolbar that lists several Web 2.0 sites right in your browser! To quote its publisher www.web20toolbar.com,

"The Free Web 2.0 Toolbar aggregates the best of Social Search, Social Bookmarking, Social Pics, Social Video and Social News websites."

The Web 2.0 toolbar supports Power Search, Power Submit and Power Alert to help you search keywords across multiple Web 2.0 websites from Digg to YouTube, submit posts to several social networking sites right from your toolbar, and keep you notified of the freshest content on over 40 top Web 2.0 sites.

Click the image below to visit www.web20toolbar.com and download the Web 2.0 Toolbar and install it into your PC. It’s absolutely free!

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Web 2.0 & Financial Applications — A Few Are Already Operational

Sunday, October 1st, 2006

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In a previous blog post titled "Web 2.0 and BFSI Applications", published on 16 August 2006, I had described several Web 2.0 applications that the BFSI (Banking, Financial Services & Insurance) sector could initiate in order to provide more personalized service to their customers. At the time, I had also noted that, barring a couple of examples of financial institutions like UBS and Dresdner Kleinwort who have used RSS technologies to distribute research to clients, Web 2.0 technologies have so far not made too many inroads into business applications, whether in BFSI or elsewhere. Subsequently, I also came across some AJAX platform vendors proposing Web 2.0 BFSI applications in the areas of Financial trading and settlement, Account provisioning and enrollment, Call center and CRM, Order processing, Field sales and service, Software as a service, Product quotation and configuration, and so on.

I recently came across a recent research paper from Deutsche Bank Research titled "Financial services 2.0: How social computing and P2P activity are changing financial research and lending". DB Research notes that close to 40% of US internet users read blogs on a variety of topics, which "illustrates how easy it is for consumers to follow the experiences of many other users (accurately presented or not) before taking decisions".

Subsequently, I did some looking around and found a few fully operational Web 2.0 based applications that are financial in nature, even if they might not necessarily be deployed by conventional banks or financial institutions. By definition, all of them employ user-generated content or user-generated action, and deploy elements of Web 2.0 technologies like RSS. Many of them are in the area of collective financial action. For example, PROSPER is a leading online person-to-person (P2P) lending exchange, CIRCLELENDING supports the cumbersome administration and documentation processes involved in P2P loans between friends and family members, whereas FUNDABLE covers group financial fundraising action.

In PROSPER, borrowers specify the amount of loan they want and the maximum interest they are willing to pay. Lenders place bids for this amount with progressively reducing interest rates in an eBay-style auction. At the end of the auction, the borrower gets the loan at the lowest possible interest rate. Borrowers are urged to form groups. Because a single borrower’s default can tarnish the entire group’s reputation, the emerging group dynamics is likely to put pressure on the individual borrower not to commit a default.  

Because person-to-person lending  excludes banks, one would imagine that it would entail negligible amount of procedure and documentation.

Looks like that’s not true … according to CIRCLELENDING, many traditional P2P loans between friends and family members end up straining personal relations, presumably because they lack clarity on important points like interest rates and repayment schedules. CircleLending, which  bills itself as the "smart way to manage loans between relatives and friends", offers services like contract negotiations, repayment scheduling, fund transfers and statementing, in order to protect the financial and emotional interests of all parties concerned in such transactions.

The third and last Web 2.0 financial application I will be covering today is FUNDABLE.

Fundable lets groups of people pool money for fundraising and group purchases. In the last few months that I have been following it, one popular group purchase on Fundable is a group subscription for Browsercam, a website that offers screen capture and remote access services for a wide variety of browsers. A year-long subscription costs close to 1,000 USD for 25 user licenses. Now, a private individual or a small-and-medium enterprise may find the thousand dollar tab a bit steep and would probably not need more than a couple of user licenses anyway. Fundable allows such a person or firm to create a posting (called "Fundable Page" in Fundable lingo) for collecting 40$ apiece from 25 people. If this page signs the required number of people, the fundraiser gets the required 1,000 dollars, purchases the Browsercam subscription, and gives out one user license to each of the participant of the Fundable group action. Pretty neat concept, isn’t it?

As I’d said earlier, these applications are financial in nature, though they need not necessarily be deployed by BFSI companies. If any of you has come across any BFSI deployments, I’d appreciate if you could write back to me on sketharaman@sketharaman.com.

At this stage, readers may have a few nagging questions about how these applications protect the interests of all participants involved in a financial transaction. For example, beyond the pressure against defaulting that PROSPER’s community action seems to place on an individual borrower, do lenders have any other repayment guarantees? Once the successful fundraiser collects the 1,000 dollars at the end of a group action on Fundable, who ensures that she buys and distributes the Browsercam subscription to the others who have paid up 40$ each? Who takes the responsibility to certify that Browsercam permits resale of its license? As many readers familiar with software product licensing would be aware, many software companies have stringent conditions on their licensing agreements that prevent reselling by anyone other than their appointed Value Added Resellers (VARs).

Most of these questions are valid for Web 2.0 in general.

Largely, many questions are addressed by the excellent self-regulating framework that most Web 2.0 companies have already put in place. For example, eBay’s rating systems provides quantitative benchmarks for establishing credentials of buyers and sellers wishing to enter into transactions with each other. Likewise, the "Challenge" facility available in Jigsaw, (a business contact marketplace), whereby any registered user can challenge an existing contact and be rewarded if the challenge is proven correct, is a step in the right direction for progressively improving the accuracy of contact information stored in Jigsaw.

However, I am sure there are still a few questions that CEOs of Web 2.0 companies think over and try to answer everyday, going by the comments I received from the CEO of a leading Web 2.0 firm that I had profiled earlier.

To the extent that Web 2.0 financial applications deal directly in money rather than photos, videos or general knowledge, how well such issues are addressed will determine their basic survival and future growth.

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