HBR published a fascinating article about Kellogg’s Purple Pricing strategy. This is a brilliant model for businesses seeking to determine the best price they can charge for a limited product that will maximize revenues. Here’s how it works:
- Start: Purple Pricing follows a Dutch auction model. You start with a high price, and then discount the price until the item is sold. Once sold, it’s gone. The theory is that the threat of competition from other bidders will encourage people to bid the highest price they are willing to pay.
- Guarantee: A challenge businesses face is the issue of customer satisfaction. For example, if you charge $200 for a concert ticket one week, and then discount it to $100 the following week, your customers will be extremely frustrated if they purchased at the $200 mark. To get around this, and to build customer loyalty, you guarantee a refund if you reduce the price of the product.
- Execute: Managing this model becomes simple: In the prior example, you could start the bidding at $250. If you sell 50 of 5000 tickets, you try decreasing the price to $200. You have to refund $50 to each of the first 50 people ($2500 loss) but you sell an additional 2500 tickets ($12500 win) – well worth the trade-off. You could then consider selling at $175. By going to $175 you’d have to take a $63750 loss, so you have to sell at least 365 additional tickets to make up for it – you sell 1000. With each discount, you approach a point where the incremental losses outweigh the incremental gains. This is the optimal point for your business.