Unpacking Trust, Fairness and Value in Pricing

Jean-Manuel Izaret: So, JMI is French, but JMI with an engineering background. But I came to the US and Silicon Valley in 1999, just before the crash. And I’ve been spending the last 25 years working in the technology space on revenues and growth and pricing topics. Over the years, I gained more experience both during pricing globally with more industries than just technologies. And so by now I’ve worked through almost every industry and every place in the world, including doing some work right now in India. So it’s fun to see how different markets operate. And I really like the discovery of so many different industries and so many different geographies and like to bring to each of these geographies the best practices that you can learn from other places and always a good way to learn as well.

Rohit Agarwal: Awesome. What led you to BCG? After engineering, I’m sure it wasn’t that you were prepping to go into consulting. That’s seldom a case that people have of you that, hey, I’m going to end up in consulting. What led you to join consulting, especially BCG?

Jean-Manuel Izaret: So I started as an engineer on a chemical plant. So not necessarily the direct route to finance or consulting. But very quickly, in an industry, the chemicals that was relatively commoditized and with a job that was very engineer-focused, where improving the yield by 0.5 % was a massive achievement after 30 years of improvement that had been done in that industry, for instance. I was longing for something where I could make a bigger difference. And I saw how much that the commoditized industry was focused on costs, and I really wanted to work on growth issues and upside. And so working to be a consultant and coming into the US and the Silicon Valley was a great way to make sure I was going to work on companies and problems that were all about new technologies. And of course, the 1990s with the advent of the internet in 1995 that became very broadly adopted was a really great way to focus on that. And for me, being a consultant was also a way to work on new problems all the time. And I like that.

Rohit Agarwal: What was the hardest part for you when you made the switch from engineering to consulting?

Jean-Manuel Izaret: To be honest, is I made the switch too late or I made the switch relatively late. So I worked five years. So I graduated in 1991 and I joined consulting in 97. So that’s six years later. And I learned a lot at Shell and then I started my own little company, did my PhD. I’d done a lot of stuff and starting into consulting, you know, you go back into square one, it builds your humility. But there were days where it’s like having people younger than me telling me that my slides, which was just for me, a cosmetic thing, were not as good as what they should be. It was just like, it was great. It was a great experience. There was a lot to learn. There’s always, you know, humility and being reminded about everything you can learn is always a good thing. That was that process.

Rohit Agarwal: And then what made your way into this area of sales marketing and pricing kind of broadly.

Jean-Manuel Izaret: I think there’s two things. One was what I mentioned earlier, which is my intent to really work on upsides and how things can change. There was also the fact that I did not have an MBA. I came to the US without a network. And as a French guy here, I looked at what is my differentiation. And with an engineering background, clearly being good with numbers was one of these differentiations. And so there was a lot of potential problems around pricing, sales, growth. And without any, I was weak on the relationships and long on the numbers. So I went for mastering the numbers.

Rohit Agarwal: Awesome. When you first joined BCG, was that already an established pricing practice or you kind of actually built it up?

Jean-Manuel Izaret: There was something called the pricing interest group, which is there was a number of people across the world, a few people, I remember in Toronto, there was another French guy in Paris, a friend in Munich, a few people in Atlanta that had done great pricing work. And as I started to do this when I was a project leader, and so I learned a lot from them and we’re all communicating and sharing ideas. Progressively, we sort of started this as a more formal practice. For many years, I co -led the practice with the French guy, the other French guy who was based in Paris, but working a lot very closely with also our fantastic team in Atlanta. And we all built the practice together. I ended up being the one who still does it like that. Sylvain Duranton, who is the French person I was mentioning, is the leader of all of AI for BCG. So this is a proof that there is a great career that comes from starting from pricing.

Rohit Agarwal: Awesome. I’m curious when are companies having the realization that, we have something to solve in pricing and thereby they are coming to you or you are approaching them and saying, hey, we think there is something wrong with your pricing or it can be evolved further and thereby, you know, XYZ can be done. How does it come about? Because it’s not a fully formed discipline as such, right? And so, yeah.

Jean-Manuel Izaret: It depends a little bit, which is arguably McKinsey, our competitor, and a few others published in the late 1990s, a set of really good pricing books that made people aware that there was something to be thought through about pricing, that it was a discipline that companies could master. And that thinking that market sets the price and therefore just follow the market. You’re gonna be fine was a bit too simplistic and there was more. That anchored better in industries where there was more differentiation than in other industries where you know, let’s say the commodities I was talking about for chemical products and steel and many other materials like this. So over time you find that some industries have really understood how important it is and they built entire pricing teams. The technology industry itself has seen a lot of emphasis on pricing and packaging and the role between, you know, the connection between defining the products and defining their prices as a discipline, which is sort of, that was easier for us to build on that acknowledgement from the industry and work very closely. companies like Salesforce.com or Uber made their entire business on a new pricing model. Pricing differently was the source of the innovation, essentially, with software as a service. Or buying a car by just buying a ride. Just change the pricing unit and your entire business comes out. But I could see still today, as I was in Japan just three weeks ago. And there, I went to Japan 15 years ago to talk about pricing. Nobody was interested. People were very polite. It was all so nice. I had a lovely time. But people were not really interested in talking about pricing or really understanding why it mattered and so on. There’s many other things that mattered for them. And of course, deflation for 30 years and stability of prices does that for you. You know, three weeks ago, there was tons more maturity about the pricing topic. The inflation during COVID and coming out of that period has awakened a lot of new ideas in Japanese businesses. And they’re asking questions that some of the European and Americans were asking 20 years ago.

Pricing as business-model innovation — writing Game Changer#

Rohit Agarwal: Very interesting. So what led you to write the book, Game Changer.

Jean-Manuel Izaret: I wrote the book because for a long time people were asking me, why don’t you write the book, JMI? You know, you spend all your time on pricing. And my answer for very long was, well, there’s some very good books. And it was not very nice to say publicly that McKinsey had written a very good book on pricing, but they did. And it was now almost 30 years ago, 25 years ago, but it’s a great book. Then as I did more and more work, I started to see some patterns in that many people underestimate the strategic side of pricing. And they all think about pricing as their discipline about prices, which is not wrong. But when you just think about what’s the number, you don’t think enough about the example I mentioned like Salesforce that changed the pricing units, right? Before Salesforce, you would buy a piece of software upfront, you would have the license forever, and you would buy millions of dollars of pricing of software in one go. And Salesforce comes and says, no, no, no, I’m gonna let it buy per person. And you could buy one person for one month. So they eventually got to, you have to buy at least five people and you have to buy at least a year and so on and commitments. But still, it was a very different way to price. And so that aspect about what are you charging for, what’s the unit by which you price, and all the pricing models questions is an issue that I thought was not covered as well. And we’ve seen how many industries price very differently, but the differences about pricing per industry was not covered very much. You had some… You know, many people in the pricing world say, well, you should not do cost plus pricing and you should do value pricing. We may talk about this in more details. Pricing to value is always really interesting, but there are many industries where it’s very hard. And then there are also industries where you need to know your cost and focus on cost plus pricing. If you’re in the construction business and you build houses, well, different houses have different costs. You need to price based on what it costs to build a house. Right. And so sure, understanding the value that customers have is important, but your costs are also really important. So the advice, don’t focus on your costs, focus on value, which can be caricatured as a simplistic advice that many people are giving or receiving. I thought it was too simplistic and I wanted to bring a bit of richness to that.

Rohit Agarwal: I love your analogy or example of Salesforce. So their pricing itself is a differentiator. It’s not putting a number on a differentiator. That’s pretty interesting. We’ll certainly unpack more of your concepts that you have in the book. But why don’t we start by understanding why is it so hard to get pricing right? What are the clear indicators that can say, hey, there is something to be solved here. It is not optimized, at least for the present conditions.

Jean-Manuel Izaret: Think about the ideal pricing situation, which is that of a market. You have a set of farmers that sell tomatoes. And you have all the farmers side by side. They’re selling tomatoes and salads and cucumbers. And all the customers pass by and they pick. And sometimes they come to the same farmer because they like their tomatoes better. This is an ideal situation of the market the way many economists thought about the markets in the 19th century. But they have very specific characteristics that make it different from many other markets. So first, all the farmers are side by side. They can see each other’s tomatoes. And some are more green and ripe than others and so on. But you’re going to tend to have a conversion to the same price for the same kind of tomatoes. And there’s a little bit of variation that some farmers have that can have the tomatoes maybe one week earlier, they’re going to charge a little more. But the market is right there for everybody to observe. And in many markets, you don’t have just three farmers. You have 20, 50 farmers in the big markets and more. Now think about the situation where we are where you buy a software product. It’s a, we’re talking about Salesforce. It’s a digital product, it’s virtual. You don’t see it. So there’s a lot of work to even discover what the product looks like. Then to discover that for different vendors, of course, every vendor will not tell the price they will give to each customer. So you have both the customers don’t know if they’re paying the right price because what is the right price? They don’t know what others are paying. It’s an opaque market. And then simultaneously, every vendor, if the customer comes back and say, I can have the same thing from that other vendor for a less price, they don’t know if it’s true. So you don’t have a reference, a market price that you can anchor that everybody can observe. And that creates uncertainty on both sides. So then that forces both sides to really think about, what am I willing to pay? What should I charge the other side? And many markets are actually market now where on top of that you have few than 50 potential solutions. You have three to five solutions that are viable solutions because it takes a lot of investments and research to have new technologies. And so when you don’t have that many alternatives, you always have the game theory aspects of pricing, which is if I lower my price, my competitor might lower their price and we’ll have the same share. And then everybody lowers their price and we have price wars. And so it’s not just, it’s a one -time pricing, but it’s a repeat pricing. And my pricing strategy depends on what my competitor does. And so you have all these twists about if they do this, but I do this and then, well, I will do that. And then they will do this. It’s just like, where does it go? That makes it pretty complicated. So you have essentially three aspects. I should price based on my own economics. So I need to understand my costs. That’s aspect one. I should price based on what the customers value. What are they willing to pay? And I should price based on competitors and what they are charging. There are three things and you could price based on all of these three and the combination thereof. And it gets complicated pretty fast if you don’t see everything that’s happening in the market.

Who owns pricing in an organization#

Rohit Agarwal: Why do you think companies are not having in -house experts to be able to navigate with such a complex maze of information that is constantly coming in and needs to be evolved? Especially if we talk about technology companies, every single day new features are being released, every single day new competitors are cropping up, and the value that the customers are seeking are also evolving.

Jean-Manuel Izaret: So that’s an excellent question. Many times, companies have people inside that are in charge of pricing. And you find two extremes. Sometimes you ask the newest analyst to do some pricing analysis. And somehow, you have people that have been in charge of pricing and are basically encyclopedias of pricing in that particular industry and you have everything in between. But very often, these people in the pricing world in a particular company develop an expertise for that particular industry. And sometimes analogies and differences in markets that come one way to the other, makes it harder for them to relate to other things and other markets. So very often, you’d have some of these gurus of pricing on one particular product. that is the main product that that company has, that person has more knowledge than almost anybody in the industry. There’s three competitors and there’s three people in each competitor that know everything. And imagine there’s a new space that evolves from that market, which starts to sell software or some digital products. And maybe these people that were selling boxes have no expertise in how to sell software. And they need to seek that expertise. They need to hire people that have sold software and know how to price software, which is quite complicated. Licensing models. When you sell the box, it’s just a box. I have my product in my box. What’s the cost of the product? And then I price that box. And I see how other people have done this. Software, I can have different packages, different licensing. Do I upfront? Ongoing, all sorts of complications that come up.

Rohit Agarwal: Got it. In your view, organizationally, who owns pricing? If there is not a particular person designated to really own that area, who is generally owning it?

Jean-Manuel Izaret: Who should own it is a very common question. The answer for me, and that’s sort of why we wrote this book Game Changer and we define different games, is depending on the game you’re playing, depending on the type of pricing you have, you should have different people owning pricing. And so if you are in a very mature industry, where the margins are very thin, you need to be really close to the finances in order to price right. But imagine you are in the luxury business, you are Hermes, you know, LVMH, and the pricing is all determined by how you anchor people in imagining new things, you know, new sense, the world is different and that’s the price of a perfume. And on that side, marketing should probably own pricing. And you contrast that with some of the software companies we’re talking about, the B2B sales, where you have a lot of intense discussions between buyers and sellers and negotiations. Sales is really close to understanding what each customer is willing to pay. And so sales should also play a key role. And in most companies, you’re going to have some rotating responsibility that will need to combine finance, marketing, or product management, if you wish, and then the sales team. All of them needs to work together, which is in that sense that pricing is a cross-functional discipline that needs to, and very often companies have put in place pricing committees that bring different people from different functions to the table in order to define good pricing strategies.

Transparency, fairness, and custom pricing#

Rohit Agarwal: What is your take on custom pricing? If a company puts out a price, that makes it very easy for all customers to actually appreciate and budget what it’s going to cost for them to really buy a certain software. Shouldn’t that actually drive much more trust and enable the customer to buy with a lot of confidence rather than figuring out what should I really pay? And am I paying the right price or not, or am I just getting short-changed?

Jean-Manuel Izaret: So you use the word trust, and it’s a very important word in pricing. Essentially, prices are the way to trust that the money you spend or the money you get when you sell something is a good money, is the right amount. And why? Basically because you find something to compare. And so when I sell an amount of tomatoes or anything like, well, what’s the price per tomato? Well, is it per tomato or is it per kilo or per pounds? And then you find a way, you find a price and you’re like, okay, it’s like we all roughly get the same price. It’s a way for me to trust that I’m spending my money in the right way. Now, why is it that we have markets that are opaque? and where you don’t know exactly what the price should be and you have haggle and negotiations. Well, sometimes what everybody’s selling is so different than what everybody else has that it’s hard to make any comparison. And companies find that there is different willingness to pay for different customers. And so some customers will have enormous value in a particular product and others will have less value. If providing that product has no marginal cost, which is the case in software, you have, if you were to price everybody low, you won’t make that much money. And so you want to be able to differentiate the prices. But if you tell people, hey, you get a lot of value from that software, so I’m charging you more than the other, then suddenly, you know, people are not going to be happy. Right? So you need to find ways to do that without upsetting people. Let me give you a funny example. One piece of software is Excel. We all have used Excel, it’s fantastic, you can do a lot of things. But there are people who use Excel, like students, to do some calculations in science and their papers in high school. How much money are they willing to pay? Well, for a little science project in high school, it’s just like, you know, that you want this to be available to everybody, right, in a very free way. But imagine an Excel model that is developed by a risk actuary that is working for a hedge fund that will allow to really understand risk for billions of dollars of risk. The value of Excel in of that model. So it’s not just Excel, but the fact that you could do this and this model is really enormous. So the problem that Microsoft selling Excel has is how do I make it available for all the high school students to do the little table, but also for all the risk managers and to be priced differently. So Excel is now very well known, commoditized. Google has come up with Google Sheets. But think about pricing Excel in the 1990s at the beginning. You had that tension. And that tension I just described tends to be present in every software company with different values for different customers that then gives an incentive that if you price to the high school price for everybody and give that same price, you do not have any incentives to develop new features. For instance, more complicated functions and tables and pivot tables in Excel. You would never do that because that’s just the simple sheet. Put your numbers in there and do add additions and subtractions.

Rohit Agarwal: Make sense. So there is no fairness necessarily from a customer standpoint in pricing. It’s more either is it for me or not, right?

Jean-Manuel Izaret: So there’s a long history about what fairness and trust means in pricing. Aristotle started and the view, you know, like he thought about almost everything. So he thought about pricing as well. And his view was pricing needs to be the intrinsic view of pricing and pricing differentially for different people was unfair and was not right. And indeed, for a long time, it was pretty clear that treating people differently, is the definition of unfairness. And so giving people different prices. But as economics and markets has developed, I think we have understood also that the dilemma we’re talking about, which is, and you can have it for drugs, for instance. You want to give drugs to everybody. But if companies don’t make any money selling drugs, you will not have any new drugs developed. So on the one hand, you have some markets where people are willing, where essentially the willingness to pay for drugs and life -saving drugs is much higher than some others because people earn more money in these markets. Let’s say the US is famously charging more for drugs, but the Europeans also then… Let’s say countries in Developing countries in Africa and other places you want these drugs to be available everywhere. If you had the same price for everybody You would never have enough research money to pay for research and development to develop new drugs So you need some price differential in order to develop that now how much price differential is a debate? I don’t want to go into right now at that moment, right? But but some differential is needed. And therefore, it’s better for everybody to have slightly different prices for everybody. We take another fun example. You know that in Switzerland, the fine you pay for a speeding ticket is different depending on your income? and you’re like, first the reaction is like, why? Like it should be the same fine for everybody. Well, think more. If you pay the same fine for everybody, the people that are really with high income and will not care about the fine, and they will drive fast and so on, like you want to regulate everybody, right? So having some differential prices is actually fair for society, for fines, right?

Rohit Agarwal: That’s surprising. Yeah.

Jean-Manuel Izaret: So, and of course, almost every country has implemented a tax system where people who make more money have slightly higher marginal tax rates. Right? So, you’re right there. You have this balance between different considerations when you think about prices. And while if you ask people about what’s a fair price, everybody will say a fair price is the price my neighbor has paid. I don’t want him to have a lower price than me. If you ask do you think senior people should have discounts? It was like, of course everybody senior should have discounts, you know, that’s so So, you know on the one hand everybody is in favor of the fair prices for everybody the same But actually grandma should have you know should pay it a little less like let’s give her

The three pricing approaches: cost, value, competition#

Rohit Agarwal: yeah, interesting. Once you start peeling the onion, it becomes quite interesting to think through these nuances. Very cool. Let’s dig deeper into the strategic relevance of pricing. In your book, Game Changer, you discuss the transformational role of pricing beyond mere transactional exchanges, right? So beyond kind of the pricing model innovation that we talked about with an example of Salesforce, or let’s say it incentivizes… research and development. Are there other kind of core drivers in business model innovation or any kind of other strategic value that pricing can bring to a company?

Jean-Manuel Izaret: Yes, so many different, and I’m going to give a few examples and we’ll discover more. But think about the early 1900s and there’s a new technology. It’s not the internet, it’s cars. It’s the internal combustion engine. And you have something like, in each market, more than 100 small companies, startups that are trying to… to sell cars and build cars and so on. Half of them break down every 10 miles. And if you go to any meetings with people that are rebuilding old cars, you’re going to see that there’s always something not working and so on in the early cars. And by the 1920s, cars are a bit more reliable and so on with less manufacturers, but still many more. Who was the most successful car manufacturer between 1910 and 1925.

Rohit Agarwal: Ford.

Jean-Manuel Izaret: Ford, right? Why were they so successful? Well, people say, well Ford was successful because they invented the production line. And with the production line, they could have cars that were less expensive and therefore they produced the most successful Model T Ford cars that until I think the Volkswagen Beetle, there was no car that sold as many cars of the same model. Let’s peel the onion. What was Ford really trying to do? He was really trying to make the car affordable for everybody, including his own workers. And I would say that his strategy was fundamentally a pricing strategy. That… Producing cars in production lines with applying the theory of Taylor was a way to get the lowest cost possible and in order to do that he did a lot of things that others didn’t do at the time which is Make the car the simplest possible so it could be assembled in a simple way. The the car model didn’t change only once a year. Ford was famous by saying you could have any color you want as long as it’s black. If that’s not a pricing strategy, you have not thought about enough about what his strategy was. He was basically saying, look, I want to keep my cost and my prices as low as possible. Therefore, I’m going to keep my cost as low as possible. I’m going to make my product as consistent and similar as possible so it’s as reliable as possible. Every car is going to be the same. And this way, I’m going to be able to give a car to everybody. And that was his source of differentiation. And he gained market share, and he invented the car industry at the time. And so you’ve had since then, in the 1950s, one of the inventions from BCG was the scale curve. And one of the concepts, the scale curve is basically saying that as you accumulate scale, as you double the amount that you produce, your costs are going down. One of the immediate consequences from that is you can price down the scale curve. You could give prices to the market that corresponds not to your scale today, but to the scale that you will get once you will price lower. And so this way you can price under everybody. You will get the share. The scale will show up. You will have lower costs than everybody. And you will have built a scale and price advantage. So that’s really the side of pricing not based on a new pricing model, but just based on a price point that is a good understanding of your own economics. And it’s the cost side, the economic side of pricing that really matters the most. But at the same time, in early 20th century, after Torsten Weblen writes the theory of Leisure class. And it’s a book about the British high society. And he talks about the he invents the word conspicuous consumption is people consuming not for the value they get from the product, but just to show off to their neighbor. I’m exaggerating and simplifying. But it’s basically that in the 50s. This is in the US people buy a car to show they have a car or fridge or something is like they’re really proud of having like all that pride about the differentiations about what I can buy. When you are selling a product like this, you can find places where you have these inverted demand curves, which is the higher the price, the higher the demand, which is just the opposite we were talking about with Ford, right? And with pricing to scale. So you have another side of pricing, which is if you could build enough demand for your product, make it really unique at one time, you could create an inelastic segment that will pay anything there is. And you saw that with sneakers and with cryptocurrencies like this, you know, the Dutch had tulips, you know, 300 years ago and that continues to happen, right? So there’s another side of pricing, which is make something very unique, advertise it, create a hype around what you do and you could have this inverted demand curve, where the higher price is gonna actually signal the goodness of your product and you’re gonna sell even more at a higher price point. That’s two completely opposite views that we can get to.

Rohit Agarwal: Yeah. Certainly, I think scarcity demand is something that a lot of companies are using to their advantage in a very interesting way. When you were talking about the examples, it kind of felt to me that from a startup perspective, perhaps pricing then becomes the first point to think about in the business strategy, right? And arguably, people then should build their business strategies or business plans around the pricing model or what are they going to price a customer, how much the customer is willing to pay. That all seems to be like the number one input that should go in the plan.

Jean-Manuel Izaret: That’s right. So I have a joke that I work for, you know, the strategy consulting firm. And so everybody thinks strategy is paramount. And the joke is that strategy is just a branch of pricing. That in order to have a good strategy, you need to first have good pricing. But being a bit more serious and thorough about your question, as we saw, good pricing is understanding really your economics. understanding what your customers value and understanding what your competitors are doing. That trifecta that we talked about. If you think about what strategy is, it’s also about understanding how can I produce something? What’s my business model? What can I produce? What’s the value that I’m adding for customers? And what are my competitors doing and the competitive forces that can come from new entrants or from my current competitors? All the five forces is all about these three things from Michael Porter. And so the way I’m thinking about this is pricing and strategy are the same thing. If you think about your pricing, you can think about your strategy. And therefore it’s not like you need to start with pricing. You need to start with what value am I adding to whom? How am I going to produce that value? And who else is doing something similar? That’s your strategy that also gives you your answer to pricing simultaneously.

Why capturing all the value is the wrong goal#

Rohit Agarwal: Makes sense. Let’s talk about value creation a little more. One of the key themes in your book is the alignment of pricing with value creation and then capturing that value. How should companies approach measuring the value to ensure that then thereby their pricing strategies are enhancing both customer satisfaction and the profitability for the business?

Jean-Manuel Izaret: So there’s different types of value that you can find. And the value always is about comparing to what is the alternative. And so if I come up with, say, a new robot, and that robot can allow to produce, say, cars or any manufactured product much faster. And nobody has a robot that is as smart and can produce as much. I could say my value is I’m going to allow you to sell many more widgets and to produce many more widgets faster. And so that value is in the amount of widgets. It could also be that my new robot is just a little bit newer than the olders, but there’s a lot of robots that roughly do the same thing. And so I’m comparing myself to the other robots. And my robot is a little bit faster. And so it produces a little more. So now the value is the comparison between the number of products produced by one versus the other. It’s not necessarily the additional revenues you’re going to get. You’re going to get the same, right? The same amount of things. And so depending on what you compare yourself to, you’re going to have different sources of value. If you are very unique, and you’re driving your customer’s revenue up, it’s a really big upside. The value tends to be really high. If I’m comparing to something that is very much the same, that my value is much lower and the differentiation is much lower because I can be replaced by almost anything. So then you have, of course, the question of, well, differentiate yourself as much as possible because you’re going to add as much value as possible. But essentially, that’s the way it works. finding yourself to compare, how to compare yourself, and what is the differential value, that essentially where the source is, and you try to quantify that. Now, once you have quantified that, you need to say, do I deserve all of the value that I create? And here, there’s a theory in pricing that says, well, you need to capture all of the value. Let me highlight that if you capture all of the value, then your customer has no interest into getting you with versus the other thing, right? Because you captured all the value. Okay, so let’s say, you know, I, in my robot, my robot is better and goes faster. And I determine that per robot, this is one, the robots cost 10,000 and the value is 1000 additional. If I sell you my robot for 11,000, you’re going to say, well, my economics are the same. I buy you, I buy your robot for $11,000. I buy the other robots for $10,000. But this additional $1,000, I will get into savings. So I will make it up. but I have no interest, well, I’m indifferent between the two robots. Now, if I charge you 10 ,500, then you’re going to make $500 more. So sharing value is giving you an incentive for you to buy my product. So first, capturing all the value is usually not the right thing. And so you could, well, why don’t you give, why don’t you capture $10,999? And then there’s $1 in value. Well, then, you know, like, does the customer really care about $1? Are they going to have to switch between your word and the other robots? And so you have all sorts of things that come up. But, but essentially if you capture all of the value, usually you make your customers indifferent between you and the others. And that may not be what you want to do. Now, you have the specific situation where you have a monopoly. I’m doing something that nobody else wants to do. And now I’m capturing all the value. The extreme example of that is there is a hurricane, you’re on an island, and you have run out of water. I come up with a boat and I have a lot of water for you. And I’m saying, for that water, you’re gonna pay me your entire life savings, otherwise you’re gonna die on that island because nobody’s gonna come and save you. That is gonna be perceived as unfair by everybody. Should I pay you more than the cost of the bottles of water that you got on the land? And do I pay for your gas and your pain? Should I pay you more than the usual price of water? Yes. Should I give you all my life saving because I’m gonna survive because of that? No, I shouldn’t. Right? So even in more circumstances, when someone tries to extract all of the value of a product that they have monopoly, you tend to create really bad feelings from your customers. So you have the situation of, I’m a scammer. I’m going to take the money and run, and I don’t care about any relationships. And so, yeah, sure, that could seem to be the economic optimum. But most businesses are in business to help their customers on an ongoing basis, and they want a relationship. Therefore, you need to share the value. One of the upsets for many pharmaceutical companies is that people perceive they’re trying to extract the maximum value all the time. So therefore, in my view, and that’s one of the things we’re pushing in the book, and we have actually demonstrated that if you charge for all of the value all of the time, you actually will get less volume that you would have. And the optimum share of the value even for unique products is between 50 and 60 % share. It’s a little bit like the famous example, you walk down the street with your friends and you are the one spotting the $100 bill on the sidewalk. And if, you know, like you’re not going to take it all for yourself, you know, you’re going to share the, you know, it’s random, you know, you deserve to have the one because you spotted it first. If you want a good relationship with your friends, you’re going to share the 50 bucks, the 100 bucks and just have 50.

Rohit Agarwal: Make sense. I think there is a little bit of that fairness element that comes into it after all, where you are saying, hey, I’m not, I am going to be fair to you to be able to share a little value that I’ve created and incentivize you to buy my product by sharing that.

Jean-Manuel Izaret: That’s right. And societies for a long time, humans work together. And there’s a sense about, I do something for you, you do something for me, we are all better off. You and I are better off when I sell you something. That’s really fundamental principle of society. You apply that to business. When you go too much to, in my view, the greedy side of the business, we’re like, I can take all the value, why? You know, just like that. I did it for you, you couldn’t have any other solutions, so let me take 99 and you get $1. You should be happy with $1. Yeah, in that particular transaction, $1 is enough to incentivize you to do that, but in the long term, you don’t like the person who did that.

Rohit Agarwal: Makes sense. In that parlance, do you think pricing is more science versus art? Where are you on that pendulum?

Jean-Manuel Izaret: I’m in both sides of the thing. I mean the yes answer. It’s yes to both. In that, when you have a lot of products and a lot of customers and a lot of different situations, think you’re a retailer and you have 2 million SKUs and you need to price all of them and you have… you know, different areas in town and different people value different things. And you have different competitors in different places and so on. Like, dude, you need some science in there. Otherwise you’re going to make really wrong. Right. But you need to help the science with, and you have this with many retailers, what am I trying to accomplish? And many retailers, you know, have the mantra about we’re going to try to, we’re going to work hard in order to give you the lowest price for all the products we can get here. In other words, they’re trying to give back value to you. They negotiate, and they’re trying to give back value for you to have lower prices. So there’s both science and there’s a sense about, well, what’s that give back? And do they give everything back? Do they have really no margin whatsoever? Well, no. Many of them have some margin here and there, and there’s different ways to have that margin and so on. But that’s… So even for retailers which has have a very complicated pricing problem You need to be guided by some sense about what’s the right value to share? What are we trying to accomplish? And different retailers can then take different stances and so grocery retail tends to focus on I’m gonna give you these products at the lowest cost possible But then you have some specialty shops that are not saying it’s all about costs. I’ll give you access to some unique dresses that you can find anywhere and you have them in this shop for the first time. And there’s no other shop in town that can sell you this.

Dynamic pricing and the Uber surge problem#

Rohit Agarwal: Makes sense. Let’s talk about dynamic pricing a little more. You referred to it earlier. You advocate for dynamic pricing strategies in general. What are some of the more compelling outcomes that you have observed that have successfully, from companies that have successfully implemented these dynamic pricing strategies?

Jean-Manuel Izaret: So there’s clearly a tension between dynamic and fairness. Dynamic pricing gives different prices at different times to different people. When you come back home and you paid what you thought was a good price for a ticket concert, Taylor Swift, let’s say, and you find your neighbor paid half of what you paid, you pissed, okay? So there’s some legit things about this and it’s so unique. It’s in my, in the example of the high value monopoly situation. There’s only one Taylor Swift. There’s only one concert in town, let’s say. And you know, that’s sort of that situation. Taylor Swift needs to be careful and she’s trying to be… to not have prices be too high, otherwise, her image can be affected by this. And even Congress can get it. So that highlights the difficulties of dynamic pricing. And we have many examples of companies trying and not communicating well around what they do, not necessarily setting the prices right and trying to capture too much of the value. And that gives a bad rap to dynamic pricing. Now think about airlines. They implemented dynamic pricing 30 years ago in the 1990s. At the beginning, people were really upset that everybody was paying less. But early on, people figured out that if you sold some tickets for 50 bucks, you can have students just show up at the airport and go for a weekend in some island somewhere. And that allows to fill the plane. And at the same time you had the business people that are willing to pay more and could want to get the ticket to the last minute and so on and you have some tourists families that are planning the year ahead about where to go there and They also have a different the different prices when you combine these three prices. You can have full airplanes And you can have more people go to see that island. Okay. We figured out that’s a society that that’s actually a good thing. And let me say this is before, you know, we figured out that putting, you know, CO2 in the atmosphere was pretty bad. So we can get back to that later. But it’s a better way, like allowing people to travel, to discover other societies, to go on vacation, and at different prices, depending on who they are, we figured out this is a good way to organize air travel. Otherwise, we would have air travel to just be what it was in the 50s with super rich people that can only pay a lot and blah blah blah blah. It’s been a force for democratization and indeed there’s different prices for different people but we as a society think that it’s a good thing and for many years the dynamic pricing enables airlines to make outsized profits. They have very think margins. And so everybody understood, well, you have more people traveling, airlines are not making that much money. And we find different people to be willing to pay different things. They decide whether they want to and they can all stop flying if they don’t want to if things are too expensive. So you have the market forces that play out and that’s a decent outcome. So what’s the difference between my Taylor Swift concert and my airlines? Well, there’s more competition with airlines. There’s less competition with Taylor Swift. Taylor Swift actually in the US you have a monopoly of the distributing company that does that. So therefore they can behave like the guy on the island trying to sell you the water for all their life savings. When you behave that way, that’s not the fact that it’s dynamic that is wrong. It’s the fact that you’re trying to extract all the value and you upset people. So dynamic is not the root cause. It’s what goes with it and what’s the was enabled by the fact that you had no competition. So dynamic pricing, when you have competition, is actually less problematic. And you have many prices on the internet vary dynamically, and retailers price dynamically, and Amazon does that. And out of all the flaws that people complain about Amazon, it’s not necessarily that they price too high. right, if anything. So therefore, I think you were going to, what’s the lesson for companies who want to implement dynamic pricing? Well, the first lesson is you are going against the situations where you’re going to get different people pay different prices. You absolutely need to have a really strong story for why you think it’s fair. Treating people differently inherently will trigger people to think that something is unfair. So if you can’t explain why it’s fair, why it’s fair for everybody, why it’s better for society that everybody pays this way, then you’re going to be thrown out of business. If you say, no, no, I think it’s fair because I will make more money. They’re like, are you kidding? That’s not the reason it’s fair. Fairness has to be something about it’s fair for everybody. So if you can’t make the case that it’s fair, then don’t do it. Now, if you can make the case for it’s fair, then explain what you’re doing. And one of the rules about doing it in a way that we were more likely to be perceived as fair is have a good case for why you’re sharing value and not extracting all the value. And then, you know, there’s all sorts of math that you can get into for how to do that well, but that’s the main principles.

Rohit Agarwal: That makes a lot of sense. I still remember one of the nights when I was still in San Francisco and there was some storm situation and apparently Uber just jacked up their prices like five, six, 10 times. And on top of that, there were just no cabs available. And so the ride that should cost like 10, 15 bucks was costing like 70, 80, a hundred bucks. And just like everyone was just like so mad. Totally, totally makes sense.

Jean-Manuel Izaret: Yes. That’s right. And you’re mad partially because your sense is that actually, sure, there’s a logic that we will get more drivers to you. But if you scratch a little bit, actually, the drivers are not going to make that much more money on that ride. They’re not going to make 5x, 10x. They’re going to make, let’s say, 2x or 3x. And you’re like, aha! So you took advantage of that situation. It’s the storm, it’s the hurricane situation that you find. And you don’t have to go for the life savings. A price varying at 10x what you’ve been paying. And people like, you know, if you ever was able to say, no, look, we couldn’t find any driver. We found one that came all the way from San Jose to get your, you back into, and otherwise you would have to walk, you know, 10 miles and see me three hours in the rain and that guy is the only guy who wanted to come and you have to pay him. Maybe you wouldn’t have felt so bad about it, right? But in reality, the money didn’t go to all the drivers.

Rohit Agarwal: And that’s why they were grumpy as well.

Jean-Manuel Izaret: That’s right. And everybody’s grumpy, right? It’s just like, someone is taking advantage. So, yeah.

Game theory pricing and global market differences#

Rohit Agarwal: All right, makes sense. Let’s talk about the game theory pricing approach a little more. This seems to have evolved than the other approaches. Can we discuss when does this approach makes most sense and how to execute this effectively?

Jean-Manuel Izaret: So. I talked a little bit about the game theory, and let me summarize and then go to more complicated situations. So game theory is the fact that when you have very few competitors, looking at where everybody is pricing can really determine the prices much more than the demand. And so if I have only two suppliers and I can make them negotiate against each other and tell one, well, the other one is doing less, and then you it says, okay, so I lower my price and then the over lowers our price and so on. You can find out that you can get a price war that works your way as a buyer and you can try to engineer that. I was part of an experiment that some of the PC OEMs, the manufacturers, so think about HP, Compaq, Apple, in the early 2000s did. When they were purchasing a number of technology components like hard disk drives and memories and so on, they tried to do what’s called reverse auctions, which is basically on a public space, ask everybody to bid down on how much they wanted in order to sell 1 million hard disk drives that size. At the first one or two auctions, they get lower prices than they had with different negotiations, opaque negotiations one-on-one. But very quickly, the sellers saw what each other’s were doing, and they figured out that they could go down, and there’s no limit to how far they were going down. They could go down all the way to the marginal cost in order to get there. What was more is when you had… There’s four or five and then quickly you have some that don’t have exactly the same products and you have three that are competing and then the when the third one stopped bidding down the number one the number two immediately stopped. Because they were sure to to sort of be in the two winners and the usually a the PC OEM wouldn’t want to have only one supplier because what if there is one flood somewhere in you know, that wipes out one plant, you want to still be having, they will have some drive from some other places. And so, you know, you tend to give, let’s say 60, 70 % share to your number one and 40, 30 % share to the number two. And so there’s not that much difference between the two, you are a winner, it’s much more than, 40 % is much better than zero. So as soon as the number three stopped bidding down, the number one and number two stopped bidding down. So you have this interesting game theoretic outcome where the prices are determined by the supplier that will get no volume on the deal. Right? But then if the top two always try to win against the number three, the number three will at some point stop stopping. He will keep pricing down because at some point he needs to win some lots, some of these sales. He can’t not sell anything. And so you have this clarity that comes out because they can observe it of the number one and number two needs to lose space for number three to win once in a while. Otherwise, number three is going to destroy the prices for everybody. And so you have several game theoretic lessons from this. First, in a very counterintuitive way, the seller determining the prices is number three, not the number one and number two. If you told the number three that he had any pricing power, he says, I have no pricing power. Well, in reality, they do have pricing power. They determine the price of everybody else. Then the second lesson is number one and number two need to leave some space for number three. And therefore, their strategy has to be to sort of, there’s an equilibrium that rotates between, you know, in some customers and some types of lots, you’re going to have the number three and number two winning, some other times number one and number two winning, sometimes number one and number three, and sometimes number four. And so you find these, there’s an equilibrium that sort of shows up. That equilibrium is really unstable, which is the essence of markets is why you need to be careful with pricing. But that equilibrium shows up and it’s all about what will my competitor do that determines the price? You saw in these negotiations, the outcome was not determined at all with what the buyer was willing to pay. The buyer was accepting the outcome of what the suppliers was bidding against each other. So after, I think, three quarters, most of the PC OEM stopped doing auctions, and they went back to trying to, you know have a discussion about where are your drives better? How do they align with my needs? I already have the necessary software that makes it more plug -in and play to have one versus the other. And it’s a complex supply chain. And since then, I think, now it’s solid state drives, but they’re all still negotiated and not done by auction.

Rohit Agarwal: Very interesting example. It seems like kind of reverse auction as a procurement tactic still exists, but more from your commoditized items.

Jean-Manuel Izaret: That’s right. So when you have 20 potential suppliers, you have a commoditized product, and you have no difference between each other and so on, like all these aspects you tend to have. So when you’re in a commoditized market, that’s what we call either the cost plus market or the elasticity markets, the uniform prices, you tend to have everybody paying the same price. And that’s a situation where you have lots of suppliers, lots of buyers. That’s essentially the oil markets or markets for securities, you know, stocks, who cares who’s buying and selling, even there’s variations of prices, but at any point in time, everybody, the price to converge to one same price for everybody.

Rohit Agarwal: That’s interesting. What have you seen in terms of differences or nuances in different global markets around pricing? Do they work in a certain way? Do culture play a role in how people perceive price? Or how could you adopt a certain pricing strategy in certain geographies?

Jean-Manuel Izaret: So there is no doubt that different markets have evolved differently. The concept of fairness that we were talking about is interpreted differently in different places. Let’s take the US versus Europe versus China and India that have some similarities. We found when we did surveys and looked at the practices, that in developing markets, developing from a maturity standpoint in terms of the economics and so on, you find a lot of tolerance in India and China and Vietnam for price differentials. The same differentials would be completely unacceptable by people in, say, the Netherlands or Germany or France. OK? In the US, the US is the middle between the tolerance for price differences. So that’s one of the differences. Another difference that is really that we found really interesting is not in what people think is fair, but what sellers think they should do. You find in China that people think like producers of almost anything think there is one market price. They adopt the single market pricing theory of economics where everything converges and they sell to everybody at the same price. Even for B2B companies, small and medium businesses, you find that in China, there’s a very, what I call a slow, a flat slope, which is large customers, small customers, everybody pays roughly the same. You go into the U.S., you tend to have big slopes, which is, largest customers have lower prices if you’re a smaller guy. sorry, you’re gonna pay higher prices, right? And the Europeans tend to be in the B2B in that space. Notice that there is, in theory, when I said in China, people tolerate, customers tolerate more paying different prices, but then that’s the buyer side, but the sellers all charge the same for everybody. You could say, how is that compatible? This goes against each other, right? And I think, one of the reasons why people tolerate that the customers tolerate different prices is because they know that most of the suppliers are trying to be fair in that with a definition of fairness, which is charging everybody the same. So they tend to trust the suppliers, the suppliers don’t take advantage too much. And the suppliers themselves have a self-discipline to not discriminate so much. When you go to Europe, they know, you know, a bunch of Europeans know that companies will charge whatever they can. And they’re very suspicious of that. So whenever they see it happening, they’re like, something’s, you know, right, must be happening. And then you have, so the differences, I talked about the fact that everybody thinks grandma should get a discount. That’s for most products, but there’s some products that are so commoditized that people don’t think grandma should get discounts on her groceries. and should get discounts to go to the movies. Everybody wants grandma to go to the movies, even though there’s not that many movies for grandma, but we want her to get out of the house and have fun. But people don’t think, in general, grandma should get discounts on gasoline. For gasoline, it’s like no gasoline is gasoline. Like, you know, you have this, you find this thing. This is like no, no, no discounts for gasoline. When you push, you find that in the US and in India, there is, everybody thinks, you know, grandpa and grandma should have big discounts and students should also have some discounts, roughly half of the discounts that grandma should have. Okay. In France, people think that students and grandma should have exactly the same discount. But for gasoline, the French think that it’s OK to have some discounts for the students more than for grandma. And so where does that come from? Well, that comes from structural societies. And you find French and the Japanese are really similar. So it’s not just Asian versus Europe. You have all sorts of the complexities about societies are built. Japan and France have good retirement systems. And so while we love grandpa and grandma, like, let’s not push it and have them have discounts on everything all the time. It’s just like, okay, that’s not right. In the US, we have a really very unequal retirement system, to not say really bad retirement system. Everybody tends to favor older people, right? As far as students, you tend to, who wants to give discounts to students? Well, usually young people. because they’re more likely to be students like, yeah, yeah, students should have discounts. So that’s the normal thing. But you tend to have in the US in particular, people that are conservative, the older they go, the older they are, sorry, the more they think that students should not get discounts. But if you’re a liberal, if you’re a Democrat, you tend to think even when you were in your 50s and you’re 16 and you’re 70s, that, you know, students should get discounts. So you get that all the way to the presidential election and the way it plays out. And Biden with his idea of forgiveness for student loans, that plays to democratic audiences very well. But all the conservatives are like, this is a scandal. Why do we do this? This is not right. We have all sorts of reasons. So these are all examples about different markets that see fairness in a different way. And imagine a global company trying to sell their products everywhere. They need to think about and understand these idiosyncrasies, these differences country by country, market by market, because otherwise they will make mistakes trying to give discounts to people that in that country, should not be in discounts or something.

Rohit Agarwal: Quite interesting. It just reminds me of a meeting I had yesterday with a relative. He was talking about a handbag, a laptop bag that he has brought a few years back and that it costed him, let’s say 8,000 bucks, right? And Indian rupees, so not that much, relatively speaking. And he was saying, you know,

Jean-Manuel Izaret: okay. Okay, yeah.

Rohit Agarwal: Today, like after a bunch of years, he knows that the quality of that product or that brand is still good, but he doesn’t want to pay like 3X the money that he paid eight years ago, right? Because his anchor of that brand is still back there at that 8,000 Indian rupees.

Jean-Manuel Izaret: Yes. Yes.

Rohit Agarwal: and not at whatever 25,000 that they are charging today, even if the quality is good or even have gone better. So he would switch to a different brand, which may or may not have better quality, similar quality, and maybe pay 10K extra for an aspirational brand rather than sticking to the same brand and get that drill quality product, but then pay more.

Jean-Manuel Izaret: So yeah, there is a sense of what’s fair over time and the consistency of your positioning. So what should that brand do? Well, that brand needs to justify the price increase to him. It needs to explain to him why it is that the price is now three times what it was 20 years ago. And you can have many logics. One of them is look at inflation. And so inflation, we just followed inflation, is just at the inflation. Some people may be convinced by that. I suspect your friend might not be. And so it’s like, well, look at what it costs us today. This is the margin we had at the time. This is the margin we have today. It’s the same margin. And so therefore, we’re not more unfair than it was. It’s just like it costs more and cost certification are usually really well accepted by people. But it’s not the only one. They could go to your friend and say, look at all what we did for this bag. It’s such a better bag than the bag it used to. When we started to build these bags, we had, you know, we were learning, we had been in business for five years. Now we’ve been 35 years and our manufacturing is better, our, you know, blah, blah, blah, blah, blah. And that bag, sure, you could be upset at us and buy the other bag that you think is better, but actually compare the two bags. All bags are better. And so therefore, this is what you should do, which highlights that for many of these products and our situations, will this computer bag company have the opportunity to talk to your friends? And probably not to make the case I just made, right? He just has his opinion and that’s what he thinks, let’s go to the store. And if your bag breaks, you’re gonna buy another bag. Which is an illustration of communicating around prices, communicating about why you do the connections between prices and your offers and all the time and having some good value communication is really fundamental. And you could lose customers for just having not explained with enough communication over the past 20 years, why the back’s prices went up.

Inflation, AI pricing, and complexity#

Rohit Agarwal: Make sense. You raise the point around inflation. Should companies be able to raise prices equal to inflation every single year?

Jean-Manuel Izaret: So I am a big fan of a few principles in pricing. First, always customize to your situation. Second, you have no inherent right to do something. You don’t have the right to extract all the value. You don’t have the right to inflation just because it is inflation and so on. What happens? It might be that your costs inflated more than the inflation. You need to still be in this and make money. You should raise your price probably more than the cost of inflation. And I hate companies that say, well, all prices are going up. And I can, you know, like I have the right to. Well, is it the right thing for you to do? Is it in line with your strategy? Are your customers going to understand that or not? Right. There is no doubt. So, so therefore the big principle is always understand your situation, your strategy, customize your pricing. And even I, my advice for most companies is, If you have 1,000 products and inflation is 2%, don’t raise your prices by 2% on all 1 ,000 products. Most likely, some of them give more value to your customers. Some of them have less competitors. Some of them, the competitor dropped because he couldn’t sustain it and you were pricing too low anyways for the beginning. You should price up. Some of them, it’s very competitive. You don’t have that much differentiation and 2% may be too much. So which is it? Understand your market, understand your situation, price accordingly. Now, let’s go a little more in inflation. I suspect there’s a lot of questions people have about inflation. Inflation in theory is just created by money supply. The macroeconomic view is money supply, there’s too much money around, and so the prices float up and so on. Okay, so from a… Micro perspective, this is sort of very different from what a company should do. And I argued in my first answer to anchor yourself into what’s happening to your company and do what’s right for you first. And then you will worry about that, about what happens for the economy later. Now, you know, if you are, I can understand situations where, let’s say you were a restaurant and you saw your costs go up. And you’ve seen in the neighborhoods, you have, you know, in the town, you have 50 to 100 restaurants that are not so far from where you are in the big city. You saw all of them raising their prices. Well, the, you know, raising the price roughly the same as everybody else’s is probably a good way to be, you know, with you don’t have a pricing analyst for every restaurants that go into as much details as being able to hire BCG to do that. So the simplicity of what’s the inflation in a market with a lot of competition, what other people have raised their prices by is probably a good gauge about what you should do. But that’s because your situation is you have a similar business than many others, and you can anchor on all the other situations, all of the other competitors. Now, Let’s talk about why there has been so much inflation over the past three years, much more than economists expected. Most central bankers and most economics were surprised by the birth of inflation. Not that there was some inflation, but how far up it went and how it was resilient. I was not surprised. I wasn’t surprised because over the past 10 to 15 years, I have seen companies raise prices less than they should. In many companies that we work for, on average, three quarters of our recommendations would have been to raise prices versus lower prices. In other words, most companies tend to overestimate elasticity. In another way to translate that, they would think they’d lose more volume than they would actually if they were to raise prices. They were afraid to lose share. They preferred to have share versus higher margins. You correlate that over many, many years, and you tend to have prices that are lower than what the customers are willing to accept, structurally. And then you have this moment when you know you need to raise your prices because your costs went up. There was a real supply shock. Costs went up. It costs more to do stuff, to ship it, and so on. All of these costs went up. That was a true fact. Now, how much your costs went up? You think your costs might go up again in the next quarter. The cost went up by 15%. Do you push your prices by, say, 15% or by 20% just in case? It’s going to keep going up after that. If you see your competitors raising also their prices and so on, that gives you a right to raise prices. You know customers won’t remember exactly where the prices are because now all prices are 15%, 20%, 30% above where they used to be. The pandemic wrecks havoc into the price comparison that people have. Therefore, suddenly, you can raise prices more than you would. And the underlying demand is willing to pay that because there’s now 15 to 20 years where you didn’t raise your prices as much as you should have. And so we had, I believe, in these last three years, a catch-up on inflation that we should have had before. And that catch up is why the inflation was slightly higher than it would have been otherwise and surprise people. So that’s the assumption of someone who has been working with hundreds of companies, helping them set prices and see their reactions and how in 2015, 17, they were all afraid of losing share and suddenly they forgot that they were afraid in 2021. And I was the same one advising them to do something and so on, but I could see the behaviors in the day -to -day pricers change. And that’s my interpretation. Do I have a sample the size of the economy to prove my point? I don’t, right? I just have my own sample. It’s pretty broad, but people are free to disagree. But that’s my interpretation about what has happened.

Rohit Agarwal: No, quite interesting. I’ve experienced when I visited San Francisco, after the pandemic, I was shocked by the restaurant prices. They were up at least 35, 40 % at a minimum to even like 60%. And to kind of corroborate with that, literally every single restaurant was packed. So yeah, price elasticity was just not there and people were ready to spend. 40, 50, 60 % more than they were used to pre-pandemic. Quite interesting.

Jean-Manuel Izaret: That’s right. And that’s one of the conundrums that the Biden administration has in that they are trying that the economy objectively, many economists would say is not that bad. But the prices are still high and people remember and they were stable enough for 20 years that people sort of remember the price of milk or the price of restaurants and so on. But at the same time, there was an article I read this weekend that was saying, why, you know, if Americans are so unhappy about the economy, why are they spending so much? Right? And so in practice, people are spending life is not that bad, but the indicators of prices that you see every day are higher than you. It’s like, I’m unhappy. It’s like, yes, you are. But it’s like collectively, the reason why prices have stayed up is also because collectively people are willing to pay many of the prices that are out there.

Rohit Agarwal: Yeah, yeah, it is again. And when you look at again, the Bay Area specifically, we had a lot of tech companies are in there laying off, you know, a bunch of employees. And then on the other side, you see the same, you know, again, those restaurants are packed. You’re like, okay, where are these people who are getting laid off? Right.

Jean-Manuel Izaret: Yes. Yeah, there’s something. So I’ve seen three crises in the Silicon Valley. After 1999, so there’s a 2001 crisis, there’s a 2007 -2008 crisis, and now the one where we are. You could tell the intensity of the crisis based on how long it takes you to drive from San Francisco to Santa Clara in the morning at seven. If you want to be at 8 a or 8 .30, let’s say, at a meeting, if it takes you two hours, there’s no prices. People have been laid out, they find other jobs, everybody’s on the road, it’s all good. And you still, if I go from my home now to San Jose, which is on the East Bay side, still quite a bit of traffic in the morning, less than they used to be at the heydays and so on. So yeah, a bit of… But we not at the in 2002, I remember you could drive in basically 40 minutes, half an hour down the entire valley, which is just like, you know, 75 miles an hour or 70, right? And otherwise your average is sort of 35 or 40. So.

Rohit Agarwal: Very cool. Let’s talk about AI. You said you have an answer to “Is AI gonna take our jobs?” and that is related to pricing. Can you elaborate on that?

Jean-Manuel Izaret: Mm -hmm. yes. Yes. That’s a fun fact. So everybody’s concerned, and I think there’s some legit concerns to be had, about AI is replacing us. It’s not completely yet, but it’s there partially. They can do many things that we could do before. But one fundamental question about that way to see whether we’re going to be replaced in the economics environment. So like, are you going to be replaced two years from now, five years from now? Who knows? New technologies, they all smarter. The chat GPT 4 .0 came out and now you can talk to you and me just like, and have different voices. Okay, we’ll see where that goes. But today, how are AI products priced? There’s two main pricing models. One of them is per token, right, which is a chat GPT model. And the other one is per user like the copilot. When pricing, AI’s models are priced per user, they are here to help the user. They’re not here to replace the user. If they were here to replace the user, and then you would have less and less users, then your revenues go down. If you’re an AI company, you don’t price per user if you want to replace users. Right? So as long as our AI models are priced per user, they’re here to help us. When they will be priced per task or per outcome. That’s when they’re gonna be here to go for our jobs. Okay, so.

Rohit Agarwal: Makes sense. So you’re replacing a human partially or fully, whatever task a human is doing, and then you’re charging for that full efficiency, not just an incremental productivity on top of. Yeah.

Jean-Manuel Izaret: just an incremental. So when I completely replace and the humans aren’t necessary. So I use this analogy or this image as a way to sort of help people think through the importance of pricing units. I am well aware that even price per human, there’s some tasks that are replaced and there’s some efficiencies that are seeked by companies that will look for… you know, savings and getting less people in the workforce and so on. But the big picture is because they are priced per user, I think we’re not there on being ready to replace humans in so many places today. And I believe you will see a change in the pricing model when that time comes.

Rohit Agarwal: Got it. What’s your take on simplicity versus complexity of pricing? I’m trying to refer to, let’s say, something like payments companies. They thrive on the complexity of their pricing. How do you think about that?

Jean-Manuel Izaret: So there is a cycle in every market. And when you establish the market, you can price in a lot of different ways. There’s a few players, and they try to have simplicity in the pricing model. That’s the Ford example at the beginning. You price per car, and that’s simple. Then over time, as the differentiation is not in the product anymore, the differentiation could start to be in making things a little more complex in the way you sell and the pricing models and you tweak, you add a fee here, you add a fee there. Now you bought your car, but your car now has a destination charge. What? Yeah, of course. Like the price of the car is different because it takes different, you’re a different distance from the factory. You’re like, but in the US, you know, there’s all these cars are produced in, you know, overseas, and then we come on boats. Like why, you know, they arrive in LA, why do I have a destination charge in LA, which is higher than a destination charge somewhere in the middle of the country? Well, because people are willing to pay more in LA than in the middle of the country, let’s say Kansas or other places. And so this destination charge is an example of increased complexity with an additional fee that was set up. And most customers go negotiate with their dealers, they negotiate really hard on the price of the car. They don’t negotiate on the destination charge. They don’t even see, they don’t even know there is. And on the bill at the time, there’s $1,000. They already spent three hours negotiating to buy a $25,000 car that it went down from 28,000 to 25,000. And now they find they need to pay the taxes. They need to pay, there’s this line item, destination charge. How many of them says, no, no, we’re going to renegotiate for another three hours again? It’s like, no, I need to come back home. I need to cook for the kids. I’m done negotiating. And therefore, you have less sensitivity to the additional fee than to the main price of the car. And therefore, you could have more willingness to pay for the fee. And then you can hide some margin in the fee. And the destination charge, which initially was introduced in order to take into account how much does it cost to get the car from the factory to the place, now is mostly something which is adapting to the market forces in different regions, different geographies. So I took the example of the car. You have in many other services, like financial services, and payments is an example of that. You have an ability to add fees that is unbelievable. Like you could be creative with fees, right? And so banks have gone for a while into, well, let’s add a fee here, a fee there. And this is like the fees for depositing your checks on Saturday. Like same work, okay. I’ve seen the company that had a fee for sending you the bill with an envelope that had Merry Christmas on it during Christmas, there was a fee because we had to pay for different things. There was some margin hidden in that fee. And so you were paying for the Merry Christmas you were wished by the company and there was a fee for that. And if you asked, they would take out the fees. Like, okay, we won’t tell you Merry Christmas on the envelope. Okay, all right. So it could go pretty far and be pretty ridiculous. The… The cycle of markets that we were talking about earlier is that usually when you go too far, there’s a player that comes out and says, no fees. No fees is the way I’m gonna advertise. And every one of my competitors have put so many fees for so long, that then the no fees is a real differentiator. If you had said no fees 20 years earlier, it was just a few fees, it was not that big of a deal. It was just one bucks for the bank once every year and so on. It’s like no big deal. Now you have fees everywhere and now no fees can be a differentiator. And then, you know, so then every bank smashes that because they lose their customers, right? Or if they do, right? So there’s a balance that comes out and then everybody restarts with less fees and advertises no fees. And then you go for another 20 years of adding fees. So big picture. There is no doubt that adding complexity into pricing model very often could be to the advantage of the seller. To my point about fairness and value sharing, I think companies should be careful about this. Pushing it too far will create your competitors that are going to come and say no fees, or say we don’t trick you, or say all things like this, or we don’t nickel and dime you. You can trust us, blah, blah, all of this. So I think there is enough in market forces to sort of balance these things. We need to be careful with situations where customers don’t have as many choices and they discover things too late. And that’s where I think regulation is OK. If the market structure is such that it enables a few companies to really take advantage, let’s go back to our Taylor Swift example concert with one monopoly that distributes these tickets and can add you know I don’t know many more fees like no you shouldn’t like that’s right monopolies are not good for business they’re not really well with good way to balance it’s good for a company to make a lot of money but it’s not good overall for the economy and when you have the situations I’m okay with regulations. But I am more in favor of having more competition that will, by the competitive forces, bring things down. And there’s a cycle to all of these things, and it’s okay.

The Microsoft Money story and the future of pricing#

Rohit Agarwal: Makes a ton of sense. Reflecting on your extensive experience, what was maybe one of the most challenging projects related to strategic pricing that you did and any key lessons learned from that?

Jean-Manuel Izaret: we talked about a few. There’s one we talk in the book that was really formative for me and is a good illustration about what good leaders can do in a company. Many times people ask, JMI, what is the right price? And just give us the price and then that’s it. And so we do our best to answer that question. And the dialogue is always useful. Let me illustrate one situation. We were working for Intuit, which is a company selling QuickBooks, so an accounting software for small businesses. The leader in the space, and at the time, Microsoft had an alternative Accounting software. As we were doing a long-term pricing strategy for Intuit, thinking about what’s the right way to price the products they have and to think about new products, the news comes up just before we launched the survey that Microsoft had come up with making their Office Accounting Express product free. So for everybody into it and Microsoft had different product packages, the prices were roughly, to make it simple, between $100 and $250, $300 for different types of packages. And here was Microsoft coming out with one product for free. And it was the online version of the product. And they figured there’s no distribution, there’s no physical product, there’s no CDs that you need to send. we can go straight and offer that for free. The dialogue with the people at Intuit and particularly with Brad Smith was very enlightening. We were so very quickly, we all agreed we need to test free as part of our analysis and to see whether or not. But Brad came in the room the next Monday with clear view and he said a few things. One, guys, this is potentially existential. Make no mistake. If they go free on this, maybe they go free on other things. We can’t survive with only free. I’m not against free, but we need to know that to acknowledge that this is potentially a really big issue. I want to take this very seriously. You know, point number one. Point number two, that means if you think we should go free for something, that’s perfectly fine. Just tell us. Go for that. Think about where to go free and why and what’s the logic. But I give you the entire freedom to think creatively about how to answer. Because it’s a big threat, don’t hesitate to look at any other solution there is. And I’m ready to do things that are really unconventional. I know that if we go free on any of our products, and especially the products that is the equivalent product that we have. We’ll lose, which is the number two product, most expensive product. So if that product go free and all the other products go free, suddenly that was almost 50% of the revenue is down. Like as a CEO, getting 50% of your business down is just like not nice. Okay. Like you have any problems, but he was saying like, look, I’m willing to consider anything. Go do the analysis and look at what happens. And, and as he was leaving, he said, is it past one one super smart question and says, by the way, maybe we should think about who would buy an accounting software for free. Look at that sentence, right? Who would buy something for free? Right? It’s not get, right? It’s who would buy. And so that forced us to think about like, even free is a purchasing decision. And you, and then when you unpeel that, that, that, that question, you’re like, is we’re talking about restaurants earlier, is a restaurant owner who’s been owning her restaurants started 10 years ago. She has a good stable business. What is she worrying about? Is she worrying about inflations, her employees, the cost of some food items that are on her menu make her have the cost in relation to prices? She has a lot of issues that are about her business. Is she concerned about saving $200 on an accounting software, especially when she has an accountant that works with QuickBooks? Is she going to try to save $200 and try to explain to her accountants who will then say, no, but I work with everybody on QuickBooks. It’s much easier. You send me the data on QuickBooks and so on. It’s like, OK. So she’s not going to switch. Now think about another potential customer, small business. Think about a few guys in a garage that are just starting up a company. They have no revenues whatsoever. They don’t know if they were going to be in business six months from now. They’re coding their stuff. They have a website app, but the app is not working very well, and so on. What is their accounting system? Excel spreadsheet. It’s free. So if you tell them, well, you can have a true accounting software where you just enter the numbers in a few places, then you don’t have to embed it yourself with an Excel spreadsheet. They might go for that. If their startup is successful, then they will switch to another more professional accounting software. OK, so they are the targets for Microsoft. Do I want these customers if I’m Intuit? Well, some of them are not going to stay in business, right? Most startups fail. OK. And so I don’t charge them anything. And I don’t lose any potential revenues from down the road because they don’t exist. No big deal. There is no marginal cost to my software. I give it to them. That’s OK. There’s nothing wrong. If they become successful, they will want to choose software. They will upgrade. Do I want them to upgrade on Microsoft platform or on my platform? I want them to upgrade on my platform. Therefore, the answer was you need to offer something for free to the customers that are these startups and these small businesses that are just starting. Now, once you looked at the Intuit product lineup, so the different products that they had, there was one that was really targeting to that particular audience. It was called Simple Starts. In the name of the product was the target. And that product was priced around 100 bucks. Was less than the online version. So we went free. We recommended to go free for that product. We answered the questions, yes, who is the segments who wants to go for that, blah, blah, blah. And we did all the work in order to make it for free. It was sold in retail. There’s lots of complications about how to make that work in practical terms. But we made that work. And eventually, three years later, Microsoft decided that it couldn’t be successful in that market. And they stopped doing small business again. So from it was the right move, but there’s two lessons I’m going to simplify and sorry if the story is a bit long. There’s two lessons. One, Brad Smith was very open, very clear-eyed on the potential consequences and the gravity of the situation and ready to make very radical decisions if needed. But also willing, asking excellent question, but willing to accept the answer from his team and the work we’re all going to do together with his team. And then the second lesson is the answer to a pricing problem was not to think about the elasticity and matching the features of Microsoft. It was asking the questions that are more fundamental about what are the products, what are the customers that are targeting these products? So start with the customers. What are the customer segments that are really targeted by that offer? Answer the problem for that segment, not for the product. So, and again, many people would say, that’s just the usual answer about be customer centric. Yes, it is. Start with the customers, always. But it’s so easy to go, Microsoft went down with their online product. We need to do something for our online product, which would have been absolutely wrong answer.

Rohit Agarwal: Awesome, awesome story. Well, all right. And no doubt Microsoft then have tried to buy Intuit and others over time to get into that market, but with not much success. Interesting.

Jean-Manuel Izaret: Yes, that’s right. So Microsoft had, I think, twice tried to buy into it. So there was some history there.

Rohit Agarwal: Cool. Let’s talk about future of pricing. Do you have any opinions in terms of where pricing is heading?

Jean-Manuel Izaret: I think we are heading in general to several trends. I think we’re going to continue to see a lot of innovation in the digital space with no marginal costs. And so whenever you have prices with no marginal costs, you tend to need price differential. And so people should continue to expect price differentiation and not everybody paying the same price. An extreme version of that would be dynamic pricing. And I think dynamic pricing, pricing that is more dynamic and change more regularly can be seen in many more markets than it is today. I think retailers are going to probably continue to implement and generalize having the price tags to be digital so that you could change the prices more dynamically on the shelves. And so that’s coming in the future. And AI models are going to continue to be more and more sophisticated and allow companies to manage more complexity. I don’t believe that that means all prices are going to move all the time everywhere and so on. Like, there will be a lot of businesses where the costs are the same, the demand is the same, having stability of prices is going to be there and it’s going to be a good thing. But in general, I think it’s good education to let our kids observe pricing, learn how prices work, and learn how to both buy well as customers and consumers, and eventually they go into business, understand how they should price for the success of their business. Because as we said earlier, pricing right can really determine the outcome of your business.

Rohit Agarwal: makes a ton of sense. Are there any resources, anything that you would recommend to young professionals who want to aspire to be leaders in this profession?

Jean-Manuel Izaret: so I’m a bit biased. I wrote this book for young people. I also wrote it, of course, for business people and all this, but, but essentially one of the key audience I had in mind was the people that are coming out of college, or into grad schools, in, in business and, and starting business. It was an attempt to help them go beyond what they taught in Econ classes that talk about supply and demand, that tends to be idealistic economic situations, that when you are in the reality of businesses, you have a lot of different things. And the book here is describing the different games as a way to describe different situations and have different mental map for how you price if I am in a concentrated market, if I have a unique product. If I have a few competitors and we bid, then there’s complete opacity in how the markets are. Or you have all these different situations that we explain in the book. I hope the book is a really good resource for thinking strategically and understanding the different situations. One, two, and one particular situation, there’s all sorts of books that are really more specialized on one specific pricing problem or the other. The great books on game theory, great books on elasticity. get books on value pricing. So, and they’re not hard to find. So I won’t necessarily give names, but there’s a lot of really great books. Ours is really geared to helping people in young professional understand the complexity and get a sense. And hopefully, I’m not advising everybody to read this book page to page, from front to back. It’s a book that understanding the main ideas will… should give you pretty far and you should have a good sense reading the intros in the first chapters about where this is going. And then pick different parts of the book that are really specific to your business that should give you ideas about how to push forward in the specific business you’re in.

Rohit Agarwal: I also like the interactive charts and kind of various informational stuff that you have on the website. That was quite unique to put out all the frameworks in that interactive manner.

Jean-Manuel Izaret: Yes. I’m glad you discovered that. Yes, we made the book with a set of a lot of visuals in color. I tested that you can understand a lot of the book by just looking at the images, like a children’s book. It’s an economics book, so there’s a lot of really complicated game theory stuff, but just look at the images and you will understand a lot. And you can access more details on these images and how they come to life in our website.