The man who believed in "price-driven costing" might well have had a lot to say about how the pop band is selling its new album
Peter Drucker loved music—Haydn and Beethoven, Mozart and Mahler. Were the late management philosopher around these days, however, he would undoubtedly be grabbed by the newest offering from an altogether different sort of act: the British rock band Radiohead.
Not its synthesizer-driven sound. Drucker, rather, would be struck by Radiohead's bold focus (BusinessWeek.com, 10/09/07) on something that far too many businesses overlook: pricing. If effectively tied to an overall marketing strategy, it can be a powerful tool in helping an enterprise seize opportunities.
Last week, Radiohead began to distribute its latest album, In Rainbows. Consumers can download it off the Internet and—here’s the twist—pay whatever they think it’s worth: $2, $10, or nothing at all.
"It's up to you," the band tells visitors to its Web site. "No, really. It's up to you."
The Complexities of Pricing
Properly pricing a product is no easy exercise. It involves a complex bit of calculus that must take into account not only a business’ up-front investment but also the ongoing costs it expects to incur (as it moves down the learning curve and, presumably, becomes more efficient); the position of its competitors; and the crucial interplay between price and volume.
It also requires a degree of self-restraint. "The first and easily the most common sin" among businesses, Drucker wrote in a 1993 article, "is the worship of high profit margins and of 'premium pricing.'"
Historically, many companies ignored these factors. They set the price of something simply by adding up all their expenses and then slathering on top as much profit as they thought the market would bear.
As Drucker pointed out, such "cost-driven pricing" was backward. In the end, he concluded, "the only thing that works is price-driven costing"—that is, figuring out what customers believe a product or service is worth and then designing the item accordingly (with a sufficient profit built in to support sustainability and growth, which does not necessarily equate to the highest price that could be obtained).
Trusting the Customer
"Cost-driven pricing is the reason there is no American consumer-electronics industry," Drucker asserted in the 1993 article. "It had the technology and the products. But it operated on cost-led pricing—and the Japanese practiced price-led costing."
What Radiohead has done is take things to an even more sophisticated level. In effect, the band has embraced to the extreme the idea of "value-based pricing": charging customers what you believe they're willing to pay, given the benefits provided them. In the business-to-business market, in particular, this means establishing different prices for different consumers for the very same product, based on its value to each.
Since word of Radiohead’s pricing plan broke earlier this month, reactions have ranged from nonplussed to nearly apoplectic, with some predicting that the band's take-it-to-the-people approach will help hasten the demise of the big record labels. (Radiohead recently ended its relationship with giant EMI Group.)
I’m far from convinced that the release of this one album, in and of itself, will prove ruinous for the industry. But I would bet on this: It’s bound to help the band enhance its own bottom line.
A Concert Draw
Thomas Nagle, co-author of the classic The Strategy and Tactics of Pricing, is also impressed by Radiohead’s savvy. Twenty years ago, when the first edition of his book was published, he cited the wisdom of musicians who charged relatively little for their concerts because these live performances were what drove record sales—then the most lucrative part of the business.
Now, he says, "the world has flipped." By pricing In Rainbows so flexibly—including presenting the option of paying the ultimate bargain-basement price: nada—Radiohead may well attract new fans that will fill its concerts, which are the real money machines of music today.
Beyond that, Radiohead is selling a souped-up version of In Rainbows (featuring a pair of vinyl LPs, a CD with extra songs, and photos) for around $80. Some observers have suggested that the digital download may thus act as a kind of "loss leader," hooking in folks who'll then be inclined to fork over a mint for the more expansive package.
But here's the funny thing: The In Rainbows download could well turn out to be a leader at no loss.
Nagle notes that consumers are often willing to pay for something, even if they can get it for free, as long as they perceive that it's a fair deal. And sure enough, a poll conducted by the music magazine NME indicates that Radiohead fans are, on average, plunking down $10 for their digital copy of In Rainbows—right in line with what Apple's iTunes charges for most albums.
All of which, of course, validates a page right out of the Drucker songbook: "What the customer sees, thinks, believes, and wants, at any given time, must be accepted by management as an objective fact and must be taken as seriously as the reports of the salesperson, the tests of the engineer, or the figures of the accountant."