You Get What You Pay For
Since some customers require more service than others do, why charge them all the same?
Customers are the most important part of our business. Yeah, yeah, sure. Fine. But they sure can be a pain in the neck. And it's the same everywhere. Some customers are total sweethearts. Others require a tremendous amount of hand-holding, follow-up service, and support.
Yet you charge both your good customers and the ones who are . . . uh, challenging the same price, don't you?
That doesn't make a lot of sense to David and Linda "Charlie" West. They say folks should get what they pay for. And that is exactly how they set prices at the San Luis Sourdough Co.
The Wests, who run the $3-million company in San Luis Obispo, Calif., halfway between San Francisco and Los Angeles, price their products according to how much service their customers -- area supermarkets and small specialty-food stores -- require.
A look at the way the company prices its one-pound loaf gives you an idea of how that marketing strategy works.
If a supermarket is happy to have the bread dropped off at the back door -- known as Level 1 service -- the wholesale price is 97¢. If the store also wants to be able to return day-old bread for full credit (Level 2), the cost is $1.02 a loaf. And if the store wants the company to put the bread on the shelf, price it by sticking a bar-code label on each bag and another on the shelf, and accept returns (Level 3), the price climbs to $1.05.
Those prices aren't arbitrary; they're designed to cover the cost of the service. For example, an average supermarket order calls for 100 loaves; on average, 3 don't sell. The 5¢-per-loaf premium the Wests charge for returns covers the cost of the bread and the handling of returns.
The same holds true for the 8¢-per-loaf charge for stocking, pricing, and accepting returns. The Wests figure it takes one of their drivers about 30 minutes to stock a shelf. Since the drivers are paid $6.50 an hour, the $8 premium -- the 8¢ times the 100 loaves of bread -- San Luis charges to stock and price covers the drivers' time, plus benefits and the cost of the returns.
"We don't care which pricing option you choose; they're all the same to us," says Dave. About 60% of the company's customers opt for Level 2. The others are evenly divided between Levels 1 and 3.
Why not charge $1.05 across the board? That way the company wouldn't need a three-tiered pricing structure, with the attendant bookkeeping complexity, and could even make a profit on its service, since only one in five customers pick the stocking-and-return option. "Our bread costs more to begin with," explains Charlie, "and we don't want to be accused of gouging."
Besides, you can argue that by its very existence the pricing policy produces profits. The Wests are passing the cost of service on to their customers. Instead of eating the 5¢ or 8¢ a loaf it would cost to give additional service, they're making their customers pay for it. Accounting 101 says that if you can reduce your costs, you boost your profits. Pretax margins at San Luis top 10%.
How can the Wests get away with it? After all, the company's customers -- which include huge supermarket chains -- require other bread companies to charge one price no matter what the level of service is. Why does San Luis Sourdough get a special deal?
There's a three-part answer: the superiority of the Wests' product, clever marketing, and altruism.
Let's take altruism first. Believe it or not, big companies occasionally will give the little guy a break. Recognizing that they're dealing with a small company -- and it wasn't that long ago that Charlie worked by herself all day baking bread, with Dave taking care of the equipment at night, after running his salvage yard during the day -- the stores are willing to bend their rules a bit.
But altruism stretches only so far. The Wests also bake a better bread. It's hard to find good sourdough bread outside San Francisco, and customers -- buyers for supermarkets -- are more flexible about pricing if you have something they want that's hard to find. That's especially true when the seller isn't sure it wants to do business with you.
The Wests never intended to market to supermarkets. Their initial plan was to serve local restaurants and have a retail outlet or two of their own. (There is a small store inside their bakery.) Since the supermarkets courted the Wests, they're able to exploit their position; that's where the clever marketing comes in. "What we've told all our customers -- and it's true -- is that we just don't have the resources of a huge bread company," says Charlie. "We have to compete on the quality of our product, not our level of service."
So far, her customers have bought the argument. For example, Costco Wholesale Inc., a national supermarket chain that prides itself on always having the lowest prices, doesn't have a problem paying an 8¢-a-loaf premium to have San Luis Sourdough provide Level 3 (the most complete) service. "To be honest with you, I'm happy as hell," says Randy Cochrane, perishables buyer for Costco. "We don't have the manpower here to stock the shelves, price, and handle returns. As long as I'm still able to offer the lowest price on their bread, it's a very workable arrangement."
That underscores an important point about the Wests' pricing strategy. All customers are treated equally. You want service, you pay for it -- no matter who you are. "If we started providing Level 3 service to one company for the price of Level 2 or even Level 1, pretty soon we'd have to do it for everybody," says Dave. "By handling every customer the same way, we don't run the risk of alienating anyone."
Or increasing their costs.
Rules for making clients pay
Here are Charlie and David West's rules for making customers pay for extra service:
* Don't gouge. The Wests charge customers exactly what the service costs them. They don't add a surcharge, figuring rightly that it would alienate customers.
* Don't play favorites. If customers require extra service, they pay for it. If you absorb the service cost for one, word will get around, and eventually you'll have to do it for everyone.
* Give them a reason to go along. If your product is the same as everyone else's, there's no reason for people to pay a premium for service, especially service they may feel they're entitled to. You'll have to make your product unique.
* Let them establish the level of service they want. If you let customers tell you exactly what they want, you may find they require even less service than you think, and you'll both be better off.
San Luis Sourdough Co.'s three-tier approach to pricing is a twist on traditional cost-plus pricing. For a refresher on basic pricing strategies, turn to the guys who wrote the books on marketing -- textbooks, that is. All marketing textbooks cover the same basic turf, so consider either of these clearly written tomes:
Marketing: Concepts and Strategies (sixth edition) by William M. Pride and O. C. Ferrell (Houghton Mifflin Co., 1989).
Principles of Marketing (fourth edition) by Philip Kotler (Prentice-Hall, 1989).
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