If auto insurance were truly a commodity, insurance companies would have no control over price. In order to gain pricing power, a firm would first need to differentiate itself from its competitors. Fortunately for auto insurers, their offerings aren’t identical. The challenge is making customers aware of the quality differences among insurers in terms of, for example, customer service and claims handling. However, with slogans like, “15 minutes could save you 15%,” “Drivers who switched saved an average of $396,” and, “Discounts up to 40%,” auto insurers draw the customer’s attention to price rather than to the desirable attributes of their products that might otherwise differentiate themselves.

Even if the commoditization of the auto industry is inevitable, there are ways that firms could add to their bottom lines through innovative pricing strategies or by bundling value-added products with the main auto or home insurance policy. As Mr. Lucker reasoned, “It’s a lot cheaper and easier to sell more to customers you already have than to get new customers.”

One interesting avenue for profit growth could be through offering warranties on consumer goods as add-ons to existing home or auto insurance policies. Retailers of electronics and home appliances in particular offer warranties at the point of sale that yield notoriously high margins. Insurance companies might be able to offer a similar product to existing policyholders. For example, a customer would have the option to add a warranty for a computer, a television, a cell phone, or an e-book reader to their home or auto insurance policy.

It’s not immediately obvious what pricing strategy would be appropriate for the insurer in this case. Apple, for example, might be able to demand a premium for its Apple Care warranty because of the technical support they can provide the customer. Retailers might have a competitive advantage in customer acquisition since they interact with the customer at the point of sale. An insurance company, however, might offer a greater value proposition by consolidating all a customer’s policies into one bundled policy. A definitive answer is beyond the scope of this article; however, if done correctly, warranties represent an opportunity to better price discriminate by allowing a customer to purchase a basic policy and then add whatever they feel is necessary.

Another interesting and potentially lucrative avenue for profit growth would be to offer expedited claims and VIP repairs service for a higher price, either on a recurring basis, or as a one-time extra charge at the time a claim is made.

An existing example of creative pricing in the insurance industry is a little used auto insurance product called PAYD (pay as you drive). This strategy is used by Texas insurer MileMeter and was once used by Norwich Union in the UK (Norwich Union has since discontinued PAYD partly due to privacy concerns).  The idea of PAYD is self-explanatory; a customer is charged based on how many miles he drives. In the case of Norwich Union, a GPS was installed in the consumer’s vehicle to monitor where, when, and how he drove. Per-mile insurance rates varied based on vehicle speed and on the time of day (young adults, for example, were charged a higher rate between the hours of 11pm and 6am because the probability of a collision was higher during this time).

MileMeter’s method of tracking the amount of miles a consumer drives is a little less formal. When a driver buys an insurance plan they submit a digital photo of their odometer. Each six-month policy covers multiples of 1,000 miles with a 1,000-mile minimum. Once the six-month policy is up, the driver sends another digital shot of the odometer and they are charged for going over the mileage they purchased or credited the dollar value of the miles they did not use, with the exception of the first 1,000 miles. This strategy is similar to a two-part tariff. The purchase of the first 1,000 miles is basically the entrance charge and additional miles carry an incremental cost to the driver.

Although PAYD is creative, Mr Lucker suggests that it might actually hurt an insurance company. A per-mile charge could encourage drivers to use their cars less, thereby lowering revenue and profit. However, the incremental cost is probably small enough, particularly compared to the cost of gas and wear-and-tear, to be largely irrelevant when deciding whether to drive or use alternative transportation for a particular trip.

Finding innovative ways to price discriminate based on value is critical to remaining profitable in a market that is undergoing commoditization. The ideas discussed above illustrate the need for the insurance industry to find creative ways to price and package their services to avoid price wars and the resulting commoditization of their products.

- Jared Mulholland, M.B.A., Class of 2010

Ms Frazier notes that retailers often use PL product pricing to, “drive price perception with the customer and offer a lower opening price point.” The challenge for retailers is often to price low enough to attract price sensitive customers, induce trial, or to support an overall store image of good value, while still maintaining the perception of adequate quality relative to the nationally branded product. If a PL product were priced too far below the price of the branded product, consumers might avoid the PL product because of the negative quality signal of an extremely low price.

Just being considered “as good as” the name brand alternative, however, isn’t good enough for some PLs. Mr Goodin points out that in the grocery space there are now premium PL products with prices to match that are higher than the name brands. Trader Joes, for example, has many premium store branded items, “and the customer views its private label products as high quality and good value.” Rochester-based supermarket chain Wegmans has several lines of store branded products, from its bargain-priced pastas, to its super-premium basting oils. The fact that consumers are sometimes willing to pay more for a PL product than the name branded product is evidence of a major shift in consumer perception of PL products.

The rise of PL products has in some instances created tension between retailers and name brand manufacturers. A retailer’s decision to introduce or expand its PL product offerings has the potential to encroach on both the shelf space and the market share of the incumbent brand names. Mr Goodin notes that retailers generally do not have to spend much on advertising for their own PL products, particularly since they, “don’t have to pay to create awareness about the goods they carry.”

So with all this pressure from PL products, what are nationally branded products to do? Marketing development funds and promotions by name brand producers, “are still very big,” for retailers, and represent one lever that national brands can use to combat the encroachment of PL products. Mr Goodin also sees national branded products continuing to use their advertising and promotion spending to stimulate demand for their products. Ms Frazier has seen the name brands responding to the competitive threat of PL products and macroeconomic environment by issuing more coupons for their products. Additional coupons might allow the name brands to maintain their price and margins on high willingness-to-pay customers, while simultaneously competing more aggressively with PL products for price sensitive customers who are willing to clip coupons.

The relationship between PL-product-producing retailers and name brand suppliers doesn’t always have to be hostile, however. One strategy that has been employed by supermarkets is the bundling of a name brand product with a PL complement. For example, Ms Frazier has observed a, “grilled cheese meal deal assortment,” that pairs Kraft cheese singles with PL bread.

Name brand producers might be encouraged by Mr Goodin’s observation that up until this point for PL products, “the overall penetration is low.” Until economic conditions improve substantially, however, it is highly likely that we’ll see even more families making the switch from the branded products to PL products. As more customers try and are satisfied with the quality of PL products, their prevalence is likely to increase. As long as name brand producers recognize how to use their larger marketing budgets to their advantage and avoid knee-jerk, widespread price reductions, however, the damage to their profits from the rise of PL products should be able to be contained.

- Sean Senhouse, M.B.A. Candidate, Class of 2010

An interesting feature of the all-you-can-eat ticket is that the fan chooses, perhaps weeks or months in advance, whether or not to purchase the admission ticket by itself, or the admission-food bundle. Before the game starts, any given fan might not know exactly how much food or drink he’ll want to consume. If the fan is very hungry and thirsty come game time, he’ll have to pay the notoriously high concessions prices if he didn’t buy the all-you-can-eat ticket. On the other hand, that same fan’s appetite might be lower on game day for any number of reasons. Offering advance sales of the admission-food bundle might allow baseball franchises to profit from the fan’s uncertainty about game-time appetite.

Mr. Friedman observed that bundling is nothing new in sports. For years, teams have been using pure bundling for some seats in terms of season tickets.  Instead of allowing you to choose tickets a la carte to only those games that you would like to attend teams across all sports often only offer their premium seats in a pure bundle: season tickets.  Seats at football games that are in the closest section to the field on the 50-yard line are usually exclusively reserved for season ticket sales.  The only other way to sit in the premium sections is to purchase a ticket in the secondary market, often from a season ticket holder who is in effect unbundling the season ticket bundle.

Tickets in the secondary market regularly sell for many times their face value, which begets the question, are baseball teams leaving money on the table? A recent article in the Hardball Times looked at the difference between the prices listed on team websites and the prices found on Stub Hub, a secondary market website, for the same ticket.  By comparing the difference in the Stub Hub price, a proxy for customer’s willingness to pay and the initial ticket price, Major League Baseball may be foregoing approximately $300-$500 million in revenue across all teams. This kind of under-pricing is not unique to sports, either. Concert tickets, for example, often sell for much higher prices in the secondary market.

Although it would appear that baseball teams and concert promoters are leaving piles of money on the table, there might be a good reason why teams may not want to fully extract all consumer surplus, even if they could.  In some respects a sporting event is an experience good and the value one fan gets from the game is dependent on the atmosphere and the other fans around them.  If a stadium were filled with only customers who were wealthy enough to afford high ticket prices, or who only wanted to attend due to the presence of a bundled product of the ticket and food, you may get a scenario where the hardcore fans are priced out of the game. Teams have a vested interest in accommodating their hardcore fans because they help to cement a home-field advantage and to improve the atmosphere for other fans attending the game. To the extent that hardcore fans increase the willingness to pay of other fans and the team’s attractiveness to stadium sponsors and TV broadcasters, it could well be optimal for a baseball team to ensure that enough “under-priced” tickets go to hardcore fans.

Baseball is big business and it would appear that many teams stand to reap large rewards for taking a more strategic approach to pricing. When there is asymmetry in the willingness to pay of different customer types, businesses can potentially increase profits substantially by bundling. Do not be surprised if you see teams across all sports moving to more sophisticated pricing models in the near future.

-Zachary Freed, M.B.A. Class of 2010

But should recession-induced changes in consumer behavior permanently alter a company’s pricing strategy? That depends in part on how much of this shift in consumer behavior is permanent. Some believe that shifts in demand will persist due to the “schizophrenic consumer,” the consumer that radically changes his or her spending habits. Mr. Singh disagrees. “Personally I don’t believe that. I think that this will last for a certain time. People have very short memories and Americans are apt to save their money for some period of time and then go right back to their spending ways.”

The expectation of an eventual rebound in consumer spending might suggest that a sound recession pricing strategy would be to lower prices temporarily while demand is weak, and then raise prices as American consumerism returns. But how much should a company reduce price in the short run? And how successful are companies likely to be at convincing customers to pay higher prices once their appetite for spending returns?

Mr. Singh advises that it is important for businesses to stay out of the “discounting trap.” The fact that a recession is taking place should not mean automatic price breaks for customers. Knowing the customer and the end consumer is critical when determining how and how much, if anything, a firm should cede on price.

One of the main challenges when it comes to pricing in tough economic times is that companies want to avoid overreacting and lowering prices too much. “All the companies want to be responsive without being overly responsive. The biggest fear that companies have is: ‘I am willing to make a decision on price where it will help me maintain a good customer or capture initial market share.’ However their fear is that they are going to lower price in a place where they didn’t have to do that for either of those two means: where they already were the preferred place to go for the customer or were charging the right price. “

While companies that have lowered prices during a recession might like to raise prices once economic conditions improve, this is much easier said than done. Especially in manufacturing sectors; a lower price is close to a permanent move. Gas stations are somewhat of an anomaly in that “they seem to be able to easily raise and lower prices as they see fit.” For most companies, the reality is that customers come to expect lower prices as the new norm. As Mr. Singh explains, companies need to understand that “if [they] ever put out a price that’s down there, [they’re] going to be expected to live with that price in the future.”

So why would Starbucks want to both raise and lower prices at the same time? At the low-end, Mr. Singh believes the price decrease reflects Starbucks’ desire “to fight over price buyers” that might defect to competitors like McDonald’s or Dunkin Donuts. Reducing prices also helps to counter the perception that Starbucks is expensive. Drinking a coffee at Starbucks, however, with its baristas, cushy couches and armchairs, “is just a different experience” compared to a McDonald’s.

Raising prices on high-end products may reflect an attempt to maintain the overall margins needed to support this experience. Of course, the higher prices on premium products could instead reflect underlying cost increases that Starbucks was able to pass on to its least price sensitive consumers. Alternatively, the new prices could be related to the introduction of Starbuck’s new line of instant coffees, which was launched widely in September. Revisiting the pricing of all existing products is advisable when making product line changes. See this article for another take on the price changes.

Unfortunately there is no simple answer to the question of how a company should change pricing strategy in the face of a recession. Pricing is difficult enough in a growing economy but there are additional complexities when consumers aren’t spending as heavily. Opportunities to profit and gain market share while competitors are obsessed with cost reductions abound, but finding and capitalizing on those opportunities require bold and brave thinking. Mr. Singh mentioned an interesting article from NPR about finding market share opportunities in a recession. A business that pays close attention to consumers, however, and is strategic about setting their prices can find those opportunities and be more successful for it.

- Adam Crossman, M.B.A. Candidate, Class of 2010