Sellers Change Pricing Strategies, Not Buyers

May 2

The history of commerce teaches us that almost every single innovative pricing change has been done by sellers, not buyers. This is because most pricing strategies are often changes in business models—that is, how companies monetize the value they create.Yet, across the professional knowledge sector we hear endlessly how firms and their customers are going to have to jointly get rid of the billable hour. This is nonsense.Professional firms will have to eliminate the billable hour by changing their business model, from one of "we sell time," to "we sell intellectual capital." Companies that sell intellectual capital don't price by the hour, or maintain timesheets.I have compiled example upon example of business model and pricing innovations throughout history, all of which were developed by the seller. Here are just a few examples, among many:

During 1815-1835, England's postal revenue was flat, even though the economy grew considerably during this period. The average price of mailing a letter was 12 cents, and it was priced according to weight, enclosures, origin, and destination, with each letter requiring individual inspection. Paradoxically, payment was due at time of receipt from the addressee, not origin from the addresser, and if the letter was rejected no payment was earned.In 1840, Rowland Hill, an unknown British schoolmaster in England, proposed a radical idea to change the way letters were priced. He suggested a price of one penny for a half-ounce letter, along with a prepayment system utilizing an adhesive postage stamp, to be paid by the addresser. This suggestion was met with virulent opposition from the Postal authorities, who claimed it was "preposterous," and a "wild and visionary scheme." It took several years for the idea to be tested before its merits were convincing. From 1838 to 1863 the annual mail volume in England increased from 76 million to 642 million letters, and the revolutionary pricing method spread to other countries.
Remember Disneyland's A-E ticket pricing scheme (E stood for Excitement)? This was classic price discrimination, a method of charging those customers who valued the more exciting rides more money for the extra value. It worked quite well from 1955 to 1981, until Disney changed to a one-price admission in response to the competition, mostly from Six Flags. An example of a competing seller changing the business/pricing model. Disney and Six Flags never asked the customers, they just did it and the let the market figure it out.
Xerox failed to capitalize on the computer technology it developed because its business model was to be paid by the page. In the electronic office of the future, there was no page counter, so how would you get paid? This pennies-per-page model was so endemic in Xerox it blinded them to the opportunity of other pricing strategies. Steve Jobs and Apple were the ultimate beneficiaries of Xerox's myopia.
Knowing what, exactly, your customers are paying you for is extremely important. Does anyone think customers pay professional firms for time? When General Electric asked this question they discovered the customer was not merely purchasing its airplane engines, but also the ability to keep them continuously in service, as downtime is costly for airlines. As a result, General Electric innovated the "Power by the Hour" program for its aircraft engines, whereby it would be responsible for maintaining the engines and price for the serviceable usage the airline received. The customers didn't ask for this, General Electric figured it out.
AOL switched from charging for Internet access by the hour to a monthly fixed-rate price, which was so popular it shut down their operations as it didn't have the capacity to keep pace with the demand.
If you have ever been bribed off an oversold airplane—with a free flight voucher, upgrade, or airline money equivalent—you have the late economist Julian Simon to thank. Until 1978, travelers were bumped off overbooked planes rather capriciously—the airlines preferred to bump old people and military personnel on the theory they would be least likely to complain, causing enormous amounts of customer complaints and ill-will. Worse yet, the problem fed upon itself, because passengers began to expect being bumped and so would book several flights under various names to insure a seat on at least one; this caused the airlines to increase bookings even more in order to insure decent load factors.One day while shaving, it occurred to Mr. Simon that "there must be a better way; indeed, an auction market could solve the problem by finding those people who least mind waiting for the next flight. The practical details fell into place before the shave was complete." Once the airlines tested this pricing procedure and learned it worked, it spread rapidly throughout the industry.
Netflix founder and CEO Reed Hastings tells this story in the April 2008 issue of Wired magazine:
I had a big late fee for Apollo 13. It was six weeks late, and I owed the video store $40. I had misplaced the cassette. It was all my fault. I didn't want to tell my wife about it. And I said to myself, "I'm going to compromise the integrity of my marriage over a late fee"...I started thinking, "How come movie rentals don't work like a health club, where, whether you use it a lot or a little, you get the same charge?"

Hence, a new business model, and pricing strategy, was born with Netflix. Customers had nothing to do with it, except to vote with their dollars their approval.
An excellent article in the May 2008 SmartMoney magazine profiles how price optimization—sometimes referred to as yield management, or price discrimination as economists call it—is being adopted by banks, apartment managers, retailers, live entertainment (such as sports teams, symphony orchestras, ballets, etc.), car rental companies. I encourage you to read this entire article and see for yourself if customers had anything to do with these changes.
In that same article, on the third page, they profile Bob Cross of Revenue Analytics. I've had the great pleasure of meeting Mr. Cross, and he is a giant among pricers. He brought Yield Management to Delta Airlines in the mid-1980s, wrote a fantastic book about it (Revenue Management), and then founded a software company that installed price optimization software to hundreds of companies (read: sellers).

You can probably think of numerous examples on your own. There are many more.I don't know how much proof has to be assembled before leaders of professional knowledge firms realize that they are in control of their pricing strategies, not their customers. For more reasons, see this post.If you innovate a new business model, the pricing strategy will change as well. Customers don't have anything to do with it, except to validate it by voting with their pocketbooks. Customers hate the billable hour, but they aren't going to have an alternative until more firms offer a different pricing paradigm.Customers don't run your business, nor do they spend their waking hours dreaming about how you should monetize the value you create.It's truly tiring to listen to professionals repeat how the customer has to be involved in developing an alternative to the billable hour. It's an abdication of their responsibility. How can you change something if you don't take responsibility for it?Just offer your customers fixed prices, based on value. Like the above examples prove beyond doubt, you have the potential to change an entire industry, or at least your part of it.