Academic journal article The McKinsey Quarterly

Getting Prices Right on the Web

Academic journal article The McKinsey Quarterly

Getting Prices Right on the Web

Article excerpt

Two widely disparate approaches to pricing have dominated the sale of goods and services on the Internet.

In the rush to capture first-mover advantage, many start-ups have offered untenably low prices. Because the Internet, the reasoning goes, is the most transparent and efficient of markets, low prices--for both consumers and businesses--outweigh such factors as product benefits, quality, and service.

Many incumbents, by contrast, have largely neglected on-line pricing and simply transferred their off-line prices to the Internet. They may have done so in the belief that their brand strength inoculates them against the threat posed by their new competitors. More likely, they felt pressure to establish an on-line presence before they had a chance to weigh the complexities of multichannel pricing.

But on-line customers are neither slaves to prices nor clones of traditional shoppers. Instead, they base their buying decisions on a wide range of factors. Far from being a price destroyer, the Internet can bring new detail to pricing strategy, creating enormous value. But companies must act quickly and rethink their on-line policies before habit and customer expectations make change difficult if not disastrous.

The reality of e-pricing

Low-price strategies aren't without foundation. Indeed, of the various reasons to shop on-line, consumers cite price most frequently. [1] But an analysis of consumer click-through behavior reveals that most buyers do very little cross-shopping (Exhibit 1). A separate study of on-line shoppers in North America reveals that only 8 percent of Internet users are aggressive bargain hunters. [2] Most of the remainder keep returning to the same sites.

Now, the primary goal of businesses that buy on-line is cutting the total cost of ownership. On its face, this might suggest that they are more likely than retail consumers to shop for the best price. But in on-line business-to-business (B2B) markets too, factors other than price are driving most buyers' choices.

In a recent McKinsey study, only 30 percent of purchasing managers identified lower prices as the key benefit of buying on-line. B2B purchasing managers said that they expected the primary benefits to be lower transaction and search costs--for example, less time required for paperwork-and automated purchasing information that permits them to track their purchases and to make better purchasing decisions. When asked to identify the source of these cost savings, only 14 percent said that they would come from the suppliers' lower profit margins, so buyers clearly recognize the benefit, to both themselves and suppliers, of reduced transaction costs.

Business behavior confirms such findings. Half of the companies buying through reverse auctions don't choose the cheapest supplier. [3] Also, 87 percent of the buyers that didn't choose the cheapest supplier stayed with their current ones, even at a higher price. Overall, only 15 percent of companies that make purchases over the Internet have even tried reverse auctions. Only 3 percent intend to continue using them in 2001.

Three ways to profit from the flexibility of e-pricing

Neither business-to-consumer (B2C) price insensitivity nor B2B purchasing behavior means that on-line suppliers can raise prices indiscriminately. While price may not be the most important factor, it is one of several that consumers weigh before making on-line purchasing decisions. It is critical that prices, both on- and off-line, be competitive so customers can meet strategic volume and profit objectives. Price changes that appear capricious or, worse, deceptive can cause long-term damage to a company's price proposition.

The Internet gives companies that respect such constraints better information about who their customers are. It also gives these companies the flexibility to set the maximum price customers would be willing to pay and to adjust that price instantly as circumstances change. …

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