Liar, Liar… “Average” Liar

The “Average” or “Arithmetic Mean” is one of the most common statistical formulas applied in business performance analysis.

Almost everyone knows how to calculate it… it is just the sum of a list of values divided by the number of occurrences.

However, for some business questions the “Average” can deliver deceiving answers and lead to wrong decisions.

Example: A company has 2 branches and they are facing some customer satisfaction issues because of the queue time that their customers endure.

After a customer survey where almost all mentioned that they accept to wait up to 5 minutes, but if they had to wait in queue for more than 5 minutes, they would be extremely unsatisfied. So, the company decided to evaluate their branches and deliver regular incentives to the best performer.

Branch A had 10 customers and the queue time of each one was:

4 min, 3 min, 5 min, 4 min, 4 min, 20 min, 7 min, 4 min, 4 min and 5 min.

Average queue time = 6 min



Branch B had also 10 customers and queue time of each one was:

1 min, 7 min, 6 min, 4 min, 7 min, 2 min, 8 min, 1 min, 7 min and 7 min.

Average queue time = 5 min

So, the Branch B had the best performance… or maybe not.

Remember that the customer survey told us that if the customers had to wait more than 5 minutes they would be extremely unsatisfied.

From the count of impacted customers perspective:

Branch A: 80% of customers satisfied vs. 20% of customers extremely unsatisfied.

Branch B: 40% of customers satisfied vs. 60% of customers extremely unsatisfied.

So, the Branch A was able to deliver the expected service level to 80% of the customers and the Branch B only delivered it to 40%, therefore impacting negatively much more customers than Branch A.

This is a just a simplified example that shows how the “Average” can “lie” when measuring business performance and that is even more risky in business scenarios where outliers can occur as this one.

The “Average” is very useful in business analysis, but be careful when interpreting it, because it also can “lie” to you.

Always keep in mind that sometimes there are other formulas to measure that are more suitable to answer your business question.

Pricing Wars – Rational Explanation of an Irrational Behavior

Pricing wars are frequent in almost all industries and if you ask business directors about it, 99% of them agree that it hurts their business and they only did it because their competitor started it.

So, if Pricing Wars are a race to the bottom, why are those so frequent?

To understand that behavior in the market, the best approach is looking at “the prisoner's dilemma” from game theory that shows why two completely "rational" individuals might not cooperate, even if it appears that it is in their best interest to do so.

(This model was originally developed by Merrill Flood and Melvin Dresher in 1950)

Below you will find an example of the model adjusted to a Pricing War between two companies:

To understand this dynamic you need to keep in mind that business managers from different companies cannot speak with each other about their pricing policies (mandatory by law in many countries), therefore they are unable to meet or speak to align their pricing strategies.

This lack of communication between companies, which is imposed by most governments to promote competition, triggers a huge fear within the companies.

Business Managers feel fear? Why? 

Because, if the other company drops their prices suddenly and your company doesn´t, there is a huge risk of losing market share, therefore losing revenues to the competitor. On the other hand, your competitor feels the same fear towards your company.

So, if the companies are unable to communicate, both feel a huge risk in case the other company strikes first and that builds a great pressure on managers.

This fear automatically drives pricing aggressiveness and that pressure tends to bring prices down on both sides and by keeping almost the same market share in the end, both companies’ loose revenues after a Pricing War.

So, since both companies probably will end much worse than before, Pricing Wars are irrational, although there is a rational explanation for it.

Unexpected Strategy – “I want buses”

World War II was a humanitarian disaster, but although it was a sad episode in history, there were lessons learned at Strategy level.

World War II showed that speed, agility and mobility are far more efficient then strength, trenches and strongholds strategies that dominated World War I.

After German blitzkrieg in France which led to a desperate evacuation of the Allied forces in Dunkirk, it became clear that England invasion by Germany was imminent.

One of the most notable English generals, Bernard Montgomery, was appointed by the Prime Minister to prepare England defenses of the imminent invasion in 1940.

Winston Churchill was surprised by his General demands.

Instead of requesting the construction of heavily protected bunkers and strongholds, “Monty” requested buses, many buses.

Why?

“Monty” immediately understood and adapted to the new dominating strategy of the war that he witnessed in France a few months earlier.

Strongholds can be avoided by the opponent and when the generals perceive the move of their opponents their stronghold was already surrounded and sieged without access to supplies which leads them to surrender.

For that reason, the British general requested buses, many buses, because he wanted to be 100% mobile, agile and fast by delivering to his main force the ability to move around the country with buses to face the opponent wherever they landed, or in the coast or inland through German paratroopers.

From the General perspective, the coastal defenses should be light and with the only purpose of get some extra time until the main force could move towards the opponent and deliver a decisive blow.

Later in WWII, these speed, agile and mobile strategies were mastered and applied with great efficiency by the U.S. General George S. Patton that it is still today the most famous United States General and Strategist.

Military Strategy overlaps with Business Strategy and we can see today that companies that are more agile and faster to adapt to the market by changing their ways of working and engaging with their customers, tend to be more successful and last longer than companies that stick to their old ways just because it worked in the past. 

Sales Incentives Can Backfire

Sales Incentives and Commissions are common in many industries as a tool to improve sales performance internally or through Indirect Channels as Telesales or Retail Agents.

Usually, companies design their commissions’ models around a percentage (%) of the billed revenue because automatically rewards performance growth (5% of 10,000 is always more than 5% of 7,000).

So… where is the flaw of the revenue approach?

Most of the companies´ have more than one product on their portfolio, since they are aiming to extract the maximum value from each customer by upselling, so to better understand the issue, please check below.

Consider an Insurance Company that has two Life Insurance products in their portfolio, the Insurance Basic which has a price of $500 a year and another called Insurance Premium that costs $1000. 

In this example the sales strategy is pushed through one telesales partner, by rewarding the partner with 5% of the first year bill of the acquired customer, which means that the Insurance company will be paying $25 for each customer that buys Insurance Basic and $50 for each customer that buys Insurance Premium.

So, at a first glance it looks like there is an automatic incentive to the Telesales partner to push Insurance Premium first, since the partner will make double the commission per each sale on the Premium product.

Well… that is the flaw. Most of the commissions’ schemes don´t incorporate a key variable which is time. 

The sales pitch effort that can be measured by the average time per sale of each insurance product.

The insurance company must also understand his telesales partner perspective, since the time spent and effectiveness per each phone call is critical to the telesales partner business model.

If in this example the Insurance Premium product takes 4x more time to sell than the Insurance Basic product, the telesales partner will be only focused on the cheapest product (Basic) regardless of the briefing provided by the Insurance company, because per each Insurance Premium product sold ($50 commission) the partner expects to sell 4 Insurance Basic products, therefore he can extract more value in the same time ($25 x 4= $100 commission) by pushing solely the Basic product and...

... this brings a huge opportunity cost to the Insurance Company since they will have many customers that would have bought the Premium product, but instead were only exposed to the cheapest one.

To address this revenue model flaw there are basically 2 solutions:

• Develop a commission scheme that also incorporates the sales pitch time/effort per product/segment, so you may get the expected focus from the telesales partner.
• Or hire 2 different partners and each one will be solely focused in one of the segments/products.

Smart Pricing – The Next Generation

Smart Pricing is a Pricing Strategy that can be implemented in many different industries and combines the following:

• Profitability - Design an offer/promotion/service/product which is profitable. 
• Relevancy - Identify the customer’s profile that may consider the offer relevant. 
• Segmentation – Push the proposition only to the customer’s segment that the offer will be relevant and profitable.
• Timing – Identify the trigger event that has associated a higher probability of the offer adoption and push/promote the offer at that moment.

“Smart Pricing" sounds only as another marketing buzzword… not true.

So, it is easier to visualize the Smart Pricing concept through an example:

"Imagine a coffee shop that through a loyalty card tracks the orders of their customers.

From that, the coffee shop knows that a specific regular customer always order one medium size coffee and never orders any food.

Additionally, in this example there are the assumptions that the difference between a medium and a large coffee is only $1 and the coffee margin is high, and without a sale cannibalization, a discount of 75% on the coffee upgrade it still be profitable.

So, next time that specific customer checks in with the loyalty card, the shop assistant would be notified in the machine that the customer is eligible for a special promotion that day – he can upgrade is coffee to large only for 25 cents, instead of paying the normal price of $1.

If the customer doesn´t adopt the promotion, the shop probably still gets the usual medium size coffee sale… but if the customer bites it, there is a short term positive revenue and margin impact and from the product seeding there is a relevant probability of behavior change on the customer, if he starts ordering in the future a large coffee instead of a medium, even without a discount."

The Smart Pricing drivers on this example were:

• Profitability – The discount on the coffee upgrade is still profitable.
• Relevancy – The targeted customer already orders regularly a coffee, so the promotion is on top of what the customer is looking for. 
• Segmentation – Only customers that regularly order a medium coffee would be eligible and would be presented with this promotion.
• Timing – By proposing this deal when the customer is already buying one coffee in the shop increases the probability of the customer taking up the promotion, instead of sending him this promotion through a newsletter by email.

The Smart Pricing strategy is an effective way to increase revenues, profits and also customer satisfaction, engagement and loyalty.