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Ed Kless: Ron do you want to buy my unicorn?

Ron Baker: Well, I have never bought one before so give me some context.

Ed Kless: Yeah exactly. There in a nutshell, sums up our point of today's second show or show in the series which is, "That all prices are contextual". Last week we talked about what we thought is the first law of marketing which is that, "All value is subjective" and we talked about a lot of dead wide economists and why we think that some are right, some are wrong and in this evolution of understanding what value is. One of the awesome things we said and we'll probably touch on it again today is that, "It's price that follows from value not from cost", and we gave you some examples and we've got a lot more examples this week on the show.

Really, this second law I think completes what we believed to be is our universal theory of everything in business and that is, is that "All value is subjective and all prices are contextual", and as you say it's even bigger than that, isn't it? It's all decisions are really contextual.

Ron Baker: Yeah, definitely. I mean, we always compare one thing to another. What I have to really like about these two laws of marketing at is when you combine them, it can help any business person, not only create more value but help them communicate more value and capture more of that value from their customers.

These two laws fit so well together and I'm glad we were able to devote a show to each one of them.

Ed Kless: Absolutely. I mean, is there anything you want to say by way of back track on last weeks show? Just to catch those up. I mean, first, if you haven't listened to last weeks show, you may want to do it, because ready for this, it will provide context for this week's show.

Ron Baker: Yes. I think you summed it up very nicely that it's really value that drives price and price that drives cost and folks we talk about a winery here in Napa called Far Niente and we told a couple of other stories that illustrated that and it does provide the background in the theory, also behind today's law as well.

Ed Kless: It's interesting because we were preparing for today's show and talking about it at this week and I got an email across my desk this morning that I think is an excellent example of this and that is, that Amazon today announced that it now has Kindle unlimited which allows people basically to read any Kindle but well, it's not easy as upon further review Ron, I did find out that Kindle unlimited is actually limited. There is some limitation.

Ron Baker: There you go.

Ed Kless: Long and short is that for 9.99 a month, Kindle will ... or Amazon will let you look at 600,000 titles, stream as well as audio books and it's 10 bucks a month. You're then having to fill in the context for that, right? You're trying to figure out, "Well, how many books do I buy a month? Will the books that I want be on the list?" All right, so, it's just an example of where all prices are contextual and then, if it were truly unlimited, it was really on any title that Amazon offered or was available, it might be even harder to put a price on it, wouldn't it?

Ron Baker: It does Ed. By saying unlimited, they're actually making it difficult for me to compare it to something else. If they were to put an artificial limit on it, say 500 books a month or 200 or whatever, that might be more understandable at least it would give me some context to make a comparison.

Ed Kless: Yeah, I mean, [inaudible 00:03:37] some absurd number like 500, no ones going to look at 500 books a month. I mean, not even Evelyn wood. It's going to get ... going to power through 500 books a month but it would put context around it, wouldn't it? You would go maybe, "Oh, okay, that's 20 cents a book", whatever I don't ... I'm not doing the math right but the context.

Ron Baker: Exactly, that the failure to be able to make a comparison could actually make this fail in terms of its message to customers. What's really interesting is by having an artificial, nobody's going to tell them in a focused group, "Oh, yeah we do this but you need to be stingy at first. Make it just 500 books a month or something", right? I mean it's not intuitive. It's not something that you pick up in marketing research. You have to understand how we humans make decisions and we do that in terms of context. We compare one thing to another.

Ed Kless: Yep, there you go, talking about you know those human beings again Ron. We just want numbers, facts and figures. It's all we want. It's business.

Ron Baker: Right, I know. There's no room for human emotion or bias or prejudice or whatever but, yeah. I guess, I kind of also, to sum up last week too, another very distinct thing is if you ask people, "Why are you in business?", I ask that question a lot and a lot of people say, "Well, to make a profit", but we really know that that's really not the purpose of a business.

The purpose of a business, Peter Drucker thought was to create a customer and we're saying it's to create value outside of our four walls. Peter Drucker also made another point that I think ties these two laws together very nicely, that the two functions that matter in any business are marketing and innovation.

It's only marketing and innovation that create results. All the rest are costs. The customer doesn't really care about the cost. It's something he called the marketing function and I loved it because it's simple but it's not simplistic.

Ed Kless: Right, well the marketing concept, right?

Ron Baker: Right, marketing concept, sorry.

Ed Kless: Is that the five piece too? Or four piece?

Ron Baker: Well, Peter Drucker didn't come up with those. Some other, I think a marketing professor did, I forget his name.

I loved the idea that marketing and innovation are what create results outside of an organization. All the other function, finance and HR and all, they're all internal and the customer doesn't really care about any of that. It's kind of what we were illustrating last week as well when we talked about the difference between seeing the baby and hearing about the labor pains. Right? The customer is interested in the baby.

Ed Kless: Very true. I mean this whole idea of positioning too. I mean, we have a colleague at [various H Tim Williams 00:06:25] who has done extensive work on this concept of positioning and how professional organizations but it doesn't ... Tim isn't working in this arena of professional organizations but really it's anyone.

There's a great example of a Rory Sutherland who talks about ... Oh, by the way, folks, we're going to have Rory on in a couple of weeks, I'm really excited about that.

Ron Baker: Yes, absolutely.

Ed Kless: Shows a great video about Shreddies, the Canadian cereal that had ... I don't know, it's like a 400% increase in sales where they put the Shreddy 45 degrees and call that diamond Shreddies.

Ron Baker: Rather than square.

Ed Kless: Rather than square, right? I mean, and a huge increase in sales.

What is great about that is that it was an innovation but it was ... almost combining these two functions together. It was a marketing innovation. They did not change the product in the slightest but they had an increase to sales. I'm using literally correctly here, they literally changed the position, right?

Firms and organizations can change their position in the market place and the perception that outsiders have of them through their marketing message and thereby create value for the customer just in how they position themselves. This is a really hard thing for a lot of people to get their minds around because it's not ... Well, you don’t see it on an income statement or balance sheet anywhere.

Ron Baker: Exactly Ed and I think, we always talked about the category mistakes that so many business people make about assuming that value only lies in producing tangible things. Things that you can drop on your foot that can hurt you and they down play or discount the value that happens from marketing, from innovation or even some of the more intangible ways that businesses create value. Certainly a brand, is very intangible.

Ed Kless: Right, tell us a little bit more about this because I know you are in my world, that one of the foremost authorities on Peter Drucker, I think you have read everything Drucker has ever written.

Ron Baker: No, I doubt that.

Ed Kless: Well, all these books for sure and many many of the scholarly articles but talk a little bit more about this marketing concepts and results on the outside. How did he come to that?

Ron Baker: Yeah, this was something he wrote about in the 60s in one of his books and it always just stuck with me because it's so simple but at the same time it's not simplistic. In way, I always talk about genius being at the other side of simple, right? What he said was, "All organizations, not just businesses, all organizations exist to create results outside of themselves".

The result of a school is an educated child. The result of a hospital is a cured patient. The result of a church, let's say, a soul. Well, what is the result of a business? Hopefully, to satisfy delighted customer who comes back, maybe spends more, buys more from you, refers other people to you.

Well, all of those results exist on the outside and it was actually Peter Drucker, Ed, who coined the term profit center. I believe it was in his first book, A Study of General Motors in 1947 and he wrote about this idea of a profit center which was a term which was a term that was not well used but certainly became part of [inaudible 00:09:57] businesses and in 1997 in a Harvard business interview, he renounced that and said that, "That was one of the biggest mistakes he made in his life", which I found interesting. He said, "Because there's no such thing as a profit list, generally in a business. The only profit center a business has is a customers check, that doesn't bounce".

Ed Kless: Yeah, then that's so entirely profound to me. I guess, last week we talked about John Mackey and profits being the life blood of ... or being compared to blood but he says, "Purpose is really outside the organization", right? There's really corporate existentialism in a way. The why of the business, the why of the individuals that make up that business.

Just by way of a quick example of this and I think this is an interesting story, I did some work back in the mid 90s for a company called amfAR, the American foundation for AIDS research. Talking about somebody that really understood their customers, I mean, this is an organization founded by Elizabeth Taylor in the 1980s to combat AIDs and you can imagine that the people who were working there were not doing so for the bucks right? They have had a friend, loved one, significant other spouse that had died of these dreaded disease and we're doing this mundane accounting implementation, right? New accounting system for this organization.

I had an interview with the CFO and when I asked, and I said so, "Whats the purpose of your business?" He told me, "It was to go out of business."

Ron Baker: Right.

Ed Kless: How absolutely profound that was. Yes, it really mocked up my next question which was, "How can I help you do that?", right? But the reality was that, is that we were helping him do that in a way because in putting in this mundane accounting system, we were going to be taking hundreds of thousands of dollars out of the administrative budget and where was it going to go? Well, it's going to go to AIDS research, right?

This whole idea of ... it kind of jailed on me at that moment until I met you then, years later when I said, "Oh, this also works in profit organizations as well", right? It's not just the not for profits where this exist. It's also in profit organizations that the results are outside the organization.

Ron Baker: Right, exactly. I just want to be clear that we're not arguing against profit. I mean, I understand the importance of profit.

Ed Kless: Go profit.

Ron Baker: I think we have maybe a little bit different definition. I think that profit the way Drucker does is the price that we pay for tomorrow and George Gilder says, "It's a measure of ... it's an index of altruism, right? Which is an interesting to look out as well. No doubt about it, profit is important but it can't be the major focus of your business. Maybe when we come back, I'll give you another definition that I really loved from the person that I believe is the true father of the customer service movement. Somebody who knew everything about customer services, some 60 or 70 years ago.

Let me just say something very briefly if I can about Stanley Marcus, who my brother, Ken Baker discovered long before I did. He was reading the sky in the 70s and I started reading and I believed in the 90s and I just realized what a profound thinker this gentleman was. He was one of the sons of one of the founders of Neiman Marcus which opened in [inaudible 00:13:41] there in Dallas and Stanley Marcus ran the store. It never lost money during his year and he ran through the great depression.

I think he took over sometime in the 30, so even Marcus sells a lot of high end things, he was also quite innovative. He talked about marketing and innovation to being the main functions of the business. He was very innovative. He did the Christmas catalog, he did the his and her gifts. He invented the fashion show, all of these different and this is what he said about profit, the way I've ever heard it described. He said, "You're not in business to make a profit but to provide a service so good, people willingly pay you a profit in recognition of what you're doing for them", and the store which I think is simply the best business book on customer service, ever written. It's called Minding the Store by Stanley Marcus and I just loved how ... oh, that makes so much sense.

Ed Kless: Yeah, I know, it's great stuff and I think, just [a leverage off 00:14:43] for that, I've just recently become a huge fan of Mr Selfridge and Ron, we talked about this really, you haven't seen it but you got to take a look at it. Same kind of deal about Harry Gordon Selfridge, in fact, he was the one who invented the phrase, "Only x shopping days until Christmas". Believe it or not. That's one of his claims to fame in marketing.

Again, this whole idea of value really coming from innovation and innovative marketing and marketing innovation, right? Those two words keep coming back to us, over and over again that it's marketing and innovation. We have a little model that we've used Ron, right? The five Cs of value to try to talk about this and they stand for, it's just for for Comprehend, Create, Communicate, Convince and Capture.

Really, last week what we were talking about under the first law of marketing was this idea of comprehending and creating value. We want to focus the rest of that today on ... is this idea of communicating, convincing and then even capturing that value through your price. Why don't you tell us a little bit about the email that you received from one of our listeners about something that he had an experience, that he had with this.

Ron Baker: Right. Yeah, this is was an email I got email yesterday [from Brice 00:16:04] and I believed he runs an advertising agency Ed and he said, "While justifying price, we quoted yesterday based on the value of [we take to bring 00:16:15] to his company" this is a conversation that he's having with ...

Ed Kless: Yeah, we're definitely losing Ron here. I appreciate ... I'm just going to pick up on this at this point. It's an email we got where this guy said to Ron that he wanted to share something humorous that happened in a conversation with Ron.

This guy said, "While justifying a price we quoted yesterday based on the value that we take to bring to his company", so, a lot of the things that we were talking about last week, that value is subjective. He said, "Value should have nothing to do with the price that he's willing to pay", but instead, he didn't want to talk about value, right?

He didn't want to talk about this idea of value because what would happen? Well, the price would go up. What Brice was talking about that is really interesting was the fact that he himself was the one who had effectively trained or educated this customer to think like this, right? Because, as we mentioned last week in trying to justify one's costs all the time. You really make this mistake of saying that your price is somehow based on your cost. Pretty bizarre that this would happen.

Ron are you back now? You are on the phone with us?

Ron Baker: I am Ed. Sorry about that. I don't know what happened, I'm having technical difficulties here.

Ed Kless: Well, I just finished talking through the Brice story so why don't you give us your thoughts on that email that you got from Brice.

Ron Baker: Yeah, I think what this illustrates Ed is that, it's so important how we communicate value to our customers and in this particular instance, since it's an advertising agency, a professional firm, their frame of value is hourly, right? What is your hourly rate? So, it kind of goes back to the labor pains, right? Focusing in the labor pains, the inside of the business rather than outside of the business where all the value is created and this is the way this industry has educated its customers. It's what I call ballistic podiatry, right?

I mean, this is a clear example of shooting ourselves in the foot. I mean, we've met the enemy and he is us. Right? I told Brice, I said, "You're going to have to do some work on re-framing your value with your customers", and luckily, that's what this show is talking about.

Ed Kless: Let's go back. We've talked about Brice now, but let's go back to this idea of communicating, convincing and capturing value. Let's take them in order. Let's talk about this idea of communicating value.

Ron Baker: Right, I think one of the most effective ways to communicate value because if you think about it, it's the one area that both parties have aligned interests, right? We have an interests to businesses, to maximize the value that we're providing to our customers and may have an interest to get maximum value. Of course they wanted it the cheapest price, we wanted a higher price.

Talking about price, is not where our interests are aligned. We talk about value, it's where our interests are aligned because we both want to maximize it and that's much better framing in terms of having a discussion or doing marketing or advertising or branding, it should all be around value because that's what everybody is trying to maximize.

Ed Kless: Right, and as we've talked about last week. They don't care about your cost, they always are going to want your price to be lower. Value is the only place where we agree.

Ron Baker: Right, that's part of communicating the value and then convincing the customer that they must pay for that value.

I think Ed, one of the best ways to do this is to offer options to your customers. We always use the American express example, the gold card, and the green card and the platinum card. Giving the customer a range of choices, basically, different price value points and they get to decide for themselves what price value trade off they would like to make. That's one of the best ways to convince the customer that they must pay for their value.

Ed Kless: Well, and not only that but in a sense, what it does is it also creates context by offering ... Well, we know ... Again, these options, what I prefer are the language choices. You're creating your own context and we're going to talk more about that later with the different affects that we see in that but in a way as one person who came to one of our seminars talking about that, he says, "Well, it forces me to compete with myself", which I think is a brilliant way to think about it, right?

It's that they got to compete with themselves. This is an interesting story we had. I had someone who about two years ago went through a program I did, where we were talking about offering choice and he send me an email, the couple of weeks after, he said, " I just want to thank you for this idea of offering choices to my customers". Different option on almost the same basic product but then creating choices around it because, and this was what the guy said, he said, "When I sent it to this one customer, the guy said to me, "Thank you so much for giving me these three different choices, my boss wanted me to get three choices and now that you've given me three, I don't have to go elsewhere".

Ron Baker: That's one of my favorite stories whether it would talk about an unintended consequence-

Ed Kless: Right.

Ron Baker: of offering choices.

Ed Kless: Just so huge, right? I mean, now, looked, that's an out-liar. I get it, that's not going to happen on a regular basis, right?

Ron Baker: Right.

Ed Kless: It's not going to always happen but the point is that, as human beings, there we go again, talking about human beings and not facts and figures or numbers. We want context, we want choice, it helps us make a better decision even if that sometimes better decision is to spend more money than we had anticipated in the first place.

Ron Baker: Right. That old Wendy's commercial. I don’t know if you remember that Ed from the old cold war days of nobody likes no choices and it's the soviet unions-

Ed Kless: Oh, right.

Ron Baker: back and show. I think that's one of the best commercials ever made.

Yeah, life would be dull without choices. When we fly, we get to decide whether or not we're going to sit in first class or business class or coach or what kind of room we're going to get in a hotel or rental care.

I mean, what this also does, is it prove that there's not one optimal price for our product or service. There's a range of optimal prices and good pricers need to sort that range and that's also another important component to capturing the value that you're creating for your customer which is the last of the five Cs.

Ed Kless: Right and we recognized and understand that the people who are listening to the show are different industry segments and in some cases like in professorial organizations, they will have a chance to have a value conversation with each and every customer.

In other industries, you're not going to potentially have that chance to have a one on one individual conversation with a perspective customer. What you have to do is you still have to search those things out and what I find fascinating around this in talking with this to all kinds of people across all different sectors is that the life of goes on often times within and they even ... When they start to say to me, "Oh, I see where my dry cleaners doing this to me. I see where the car wash is doing this to me and Starbucks with tall, grande, venti", and they get really fired up about it because it's true. It's absolutely everywhere once you start to take a look around. It's absolutely everywhere.

Well, last week on the show as you've mentioned we talked a lot about some dead economists and even some living ones and the subject that we are always hearing about when we talked about value is okay but what about supply and demand, what about supply and demand? How does that factor in? Because everybody remembers their Econ 201 course where they drew those neat little curves, we have supply and demand and we had a little x somewhere like and it's like the optimal price and everybody was happy about it. We cheered and said, "Ah, this was so easy, because we can just break it down to math".

Ron Baker: One economist said we could basically just train a parrot to say supply and demand and you have an economist.

Ed Kless: There you go.

Ron Baker: I mean, supply and demand is a great theory. No doubt at it and there's no doubt that part of the context that customers are going to compare your offerings too are your competitors and that's where supply and demand enters best.

It's probably a good thing that we're not paying the full price for products and services based on how much we value them. I probably value my eyeglasses more than I paid for them. We value a lot of things much much much more and competition is what drives the prices down, or has a tendency to, but that said Ed, what I think there's the missing gap when most people say supply and demand as a way to drive prices down. They don't realize that that is just a tendency, it's not an iron law, and the other component to supply and demand is this thing called price discrimination.

Ed Kless: Wooh wooh, discrimination. We can't have that Ron.

Ron Baker: Yes I know. I need to qualify this by saying, it's obviously not discrimination based on race, sex, religion, ethnicity. This was the term that was first used I believed in 1920s, so this term has been around for a long time. It's called various other things today like yield management, dynamic pricing, revenue management, you call it what you want but I still think of it as price discrimination because that's how I was taught from all these different economists but the point is Ed, that this is the holy grail for most businesses when it comes to their pricing function.

One of my favorite examples of this, is book publishers. The cost say between producing a hard cover versus a paper back book. We know the price difference is pretty big. Like say, 30 bucks for a hard cover when it first comes out, say, Harry Potter novel or John Grisham or whatever. Then when it comes out paper back it might be $8 or $9, right? But what's the cost difference to the publisher of producing a hard cover versus the paper back? Well, it's zero. There's no cost difference.

See, you kind of have to scratch your head and go, what's going on here? Well, what's going in is that they realized the different types of book customers exist and what they want to do is get more profit from the people that have to own the book right when it comes out, the Harry Potter lovers, the people that queue up at stores or whatever and they charged them a higher price.

They still want the business of the people who buy it in paper back a year and a half or a year later but they charged them a lesser price because they know they're more price sensitive and it's those type of strategies that you can deploy. Almost any business can deploy these types of strategies and as you said, they do, if you start looking around. Even Starbucks is price discriminating. Look at their menu.

Ed Kless: Right, no absolutely. The way their menu is, the way it's laid out. The way ... and they are particular in niche, they always put the lowest price first and work their way up. There's ... in a sense a secret menu which I order, I happened to be a fan of the cappuccino short because it's a properly made cappuccino and not enough that I can bathe in.

When I order a cappuccino at Starbucks it's always the short, it's funny and I've sort of tested this. I've got this theory that they really don't want the rest of the world to know about the short, so you know how they call out your drink? [No wep foam for Ed 00:28:47], right? When they call it up.

When I ordered the cappuccino short it's always like cappuccino short for Ed. I mean there's ... I know. We're not yelling about it because it's not even on the menu, right? Again, it's a discrimination function. It's price discrimination that hard books but my question to you Ron on this, this relates back to one of the things we open the show with. What about the Kindle, right? What about the Kindle, what do you think is going to happen from the pricing perspective on that?

Ron Baker: Well, it's really interesting because as I try and decide whether or not to sign up for that unlimited Kindle, I'm certainly comparing it to how many kindle books I buy in a given month and is this a good deal or well I just continue to do what I'm doing, and I think by not being able to make a comparison isn't this what Spotify did Ed when Spotify came up and they say, unlimited music for 9.99 a month.

Ed Kless: Still do.

Ron Baker: They still do, yeah. I think that's a mistake. I really do. I think you're right. I think they need to put some type of artificial limit in there but maybe they're just trying to get that same appeal to people that you know how free, is very appealing to us as humans.

 Anything free, we'll grab. Maybe, that's their logic.

Ed Kless: Let's talk about this, how this might relate to other businesses. We talked about, maybe professional companies or anyone who manufacture, who has some kind of a service component. It may affect you if you say that we have unlimited whatever, unlimited service calls, unlimited conversations, unlimited this ... There might be a challenge with that.

We're not saying that we actually want you to put a type limitation on things like, "Oh, you can only call us once a month or something like that". I think that ... what we're suggesting here is create an artificial limit that's so high that no one would ever actually get to it but what it does it allows you to provide context.

Ron Baker: Right. This is an insight from behavioral economics so I think it's pretty interesting and obviously a lot of the companies now were testing it and I think that's what part of Amazon is doing. They may be very well testing this concept of unlimited versus some type of artificial limit.

Ed Kless: Yeah. It's going to be interesting to see how this plays out and of course as I mentioned, as I dug into some of the fine printed, unlimited doesn't doesn't zero our limits. Including your books Ron. I'm not on the Kindle unlimited list. You got to work with your publisher on that.

Ron Baker: Exactly. Ed, probably the ... I know people don't like to talk about this but the airlines are fantastic at this yield management if you will because what are the odds that you've paid the same airfare as the person sitting next to you on any flight today?

The odds are pretty low, right? It's because they're not pricing the seats. They're pricing the customer or at least they're trying to, right? I mean I know you fly with American, I fly with United. They don't come out and interview us every time we buy a ticket. "So, Ed why are you flying to California? Is it business or are you going to Disneyland?" I mean, they have to devise all these little rules but they're still price discriminating and you know where I find interesting about it is they educated the country. They have educated their customer that this is normal, this is good and this is a good thing and it's worked very well for them.

Ed Kless: Absolutely. I can't tell you how many conversations I have had with people who are concerned that, well what if my customers talk and I offer two different prices. Like I sit next to people all the time when I'm flying. I don't walk down the aisle and say, "Would you pay? Would you pay? Would you pay? All right, lets storm the counter. Let's do it over here, who paid 59 bucks for the sit. We want a refund", right?

I mean I'm flying in this tube with them for two and a half hours or whatever and we don't think ... We're not going to compare prices but I think in my opinion the reason why that works is because they set the price upfront and I decide yes or no and I'm making a decision, ahead one, I'm also spending other people's money on expense to carry to but that's another factor that we'll get into another time, but yes I'm always ... when I'm concerned about that, flying personally, I'm making a decision to accept it and I've accepted it.

There's no reason for me to then go through that and have that conversation with the guy who sit next to me, "Hey, what did you pay?"

Ron Baker: Right. If you think about it, after they're deregulated in the 70s, if you bought a ticket say in early 1980 and you figure it up the person next to you paid 10%, you would probably be upset with the airlines. Today, who would you be upset with?

Ed Kless: Myself. Right?

Ron Baker: Not barking it sooner. [crosstalk 00:33:43]

Ed Kless: I should have bought it sooner. I should have waited. I should bought sooner or maybe I should not use miles for this ticket, yeah.

Ron Baker: They've done a very good job educating their customer. It just kind of illustrate a point that pricing changes are part of the innovation and the innovation comes from the supply side. It comes from the businesses, not the customers.

I never got a letter from my airline asking me if they could go to yield management type pricing, right? They just did it because it was an innovation on their side.

That leads to, I think an interesting thing about behavioral economics and how we humans actually make decisions. Goldilocks pricing offering three options. Three seems to be the optimal number doesn't it? For offering choices, because so many businesses do it, small, medium, large. Starbucks, outside of your example that's not on the menu, is three choices. Most company give at least three choices, it's called Goldilocks pricing and it just seems to work.

Ed Kless: Yep, the Apple, right? Shuffle, Nano, Full Ipad. When an Ipad comes out it's always three editions. I think the latest is 16 megabyte, 32, 64 gigabyte, right? They work their way at that way. They just differentiate based on that particular. There's only one particular feature. There are story after story of the three. I mean, really, just go get your car washed. I can almost guarantee that your car wash will offer you three choices.

Ron Baker: Yep, and the smart ones offer a fourth, kind of like the American express black card that's a detail, right? You'll get a full detail, you might even get five, three coupons for your next five washes but it will be a very high price.

Ed Kless: Yep, and there are some people that put off by that and there's a limit, right? I think there's a limit. I personally, one of the things I don't like about Southwest Airlines other than being kind of herded around like cattle is the fact that when I go to book a flight on Southwest, sometimes it gets too many choices.

Ron Baker: Correct.

Ed Kless: I can't figure them out like there's sometimes seven choices but for the same flight which is really a little bit bizarre.

Ron Baker: We can actually be paralyzed by too many choices and end up not making any choice or whatsoever. Too many is a problem but also too few too doesn't seem to be enough and we can talk about that too, we have lots of examples of that.

Ed Kless: Ron there's a great case study that was done, that illustrates our point really well and it happened so long ago that a lot of people were not aware of this.

For the longest time, Wendy is the old fashion hot and juicy square hamburger store had the single burger and the double burger on the menu. You walked into the store, I don't want to be a pig, I'll just have the single burger, that would be enough for me.

Well, it turns out that the margin on the double burger is significantly higher because in the end it's only like another patty, right? It's really where it comes out, you have same amount of mustard, same amount of everything else. Really, it's just that additional patty and of course the price is so much higher that the margin does way up on the double burger.

The solution to the problem it turned out to be introducing the triple burger, so you kind of walk in, and go, well, I don't want to be a pig, I won't have the triple burger. The double is just fine. To this day, Wendy's doesn't sell a ton of triple burgers. They sell them, don't get me wrong, there are people who want the full on Wendy's experience with the triple burger but they will never take the triple burger off because the purpose of the triple burger is not to sell triple burgers but instead it's to sell the double burger.

This is what's known as the anchoring effect.

Ron Baker: Exactly. Isn't that a smarter strategy than dropping the price of the double burger to sell more. Just add a triple burger. Not many people will buy it but it will provide this anchor and it will make the double look that much more palpable.

Ed Kless: Perfect example of why supply and demand completely breaks down in this particular case, right? Because, what we're doing here is we're offering an additional option that really has no relation to the product that the lower product or whatsoever in terms of supply and demand.

Ron Baker: Exactly. Supply and demand can't account for this acceptable range of prices that we're all wiling to pay and one of the ways to present that acceptable range is by giving people choices. This is why you'll see a $14,000 handbag in a Prada store.

They don't sell any of them but it makes that $2,000 handbag seem that's much more affordable and Prada stores that have this so called anchoring items, the expensive items that nobody buys actually have higher per customer sales than stores that don't have them.

Ed Kless: Tony, I saved you 12 grand.

Ron Baker: Exactly. You can bet, Prada has tested this, right? If you ever been into a three or four star restaurant that have a $10,000 bottle of wine on the wine list.

Ed Kless: Yeah, they'll have it.

Ron Baker: It might not be even in their cellar but it will make my Far Niente $600 wine, that's much more palpable and you're more likely to buy that.

That's bottle anchoring effect and again this is how we humans make decisions. We're subjective. We're subjected to these types of influences on what we're willing to pay for something.

The other one is the framing effect and this is just as powerful, isn't it?

Ed Kless: It is, and when used in combination it's almost irresistible. I think Disney is probably the best at putting these two things together but framing effect is what do you compare it to outside, like what would be perhaps the next best alternative and the more famous example that is used is Woolite, right? I guess it's PNG, right? That develops Woolite. When they set the price for that, they're not comparing it to the other detergents in the line of detergents that they sell Tide and all of these other brands. Woolite is compared to dry cleaning.

Ron Baker: Right. They want you to compare it to dry cleaning. That's how they claim it. They even put in a different bottle, where it looks concentrated. It's the exact same thing Red Bull did.

Ed Kless: Brilliant.

Ron Baker: Had Red Bull put itself in a Coke or Pepsi size can, why would you pay 2.50 or 3 bucks for this. I'll just go buy a Coke.

Well, put it in a tall skinny can that looks like a concentrated energy drink, it's a different category. There's a different range of acceptable prices in the consumers mind. This is the example of the framing effect.

Ed Kless: Yeah, and these are all around too, Starbucks is famous for this as well. I mean you pay $3.5, $4 for a cup of coffee that you can make at home for [a quarter 00:40:53], right?

Ron Baker: Right, unless Ed, you have one of those pod coffee machines. There's another example isn't it of this framing effect. You're comparing that pod coffee, I don't know what's the product called ...  the little pod that makes one cup design.

Ed Kless: Yes, I think when you really ... If you got them at Sams, if you go full on board, you can get and down turn around. I don't know, 30 - 35 cents a pod.

Ron Baker: 35 cents, which is a fortune. Really, when you compare it to other types of ways that you can brew coffee at home but you're comparing it to that. You're comparing it to ... even Dunkin' Donuts or Starbucks and it's looking like a fantastic deal.

Ed Kless: Yeah, do yourself a favor. Don't take the little lid off of it because you'll just get really upset because there's hardly any in there, and you say, like what ... [crosstalk 00:41:38] it's mostly empty space.

Ron Baker: And you know who's really good at doing this. There's a whole science, known as menu engineering.

Restaurant menus, how they frame things. How they put things in context. The words that they use. Do they show a photograph of the meal? Like for instance, it's really interesting if a lot of menus don't have dollar signs. They don't want to remind you that you're spending money. They take out the dollar signs and they've learned that people will spend more if they don’t see dollar signs.

Ed Kless: Yeah, I'm constantly surprised by the higher end restaurants that I go into that occasionally they will have this 95 or 99 pricing.

When I buy a stake, I'm not thinking, "Oh, I want it for 90.95", right? Or even 29.95, it's just ... I as a consumer would much rather see the little 30 with a line after it. That makes me feel better about this purchase. 29.99 for the stake, no. I want 30 with a line. It kind of connotes to me, "Oh, this is a good piece of stake".

Ron Baker: With high quality. the reverse side of that is the price can be too low. Look what happened in the New England States this year with a lot of lobster. A lot of restaurants cut their prices because there was a lot of this stuff. What happen to lobster sale? They didn't go up, they went down because people started to question the quality of cheap lobster. It be kind of like buying sushi from a gas station. It's just not the right framing.

Ed Kless: Well, where as barbecue in Texas is often times purchased at the gas station. That's where you get the best barbecue.

Ron Baker: That's true. The other thing that choices do is from the consumers perspective, they changed the question from should I do business with this company or should I buy this product or service to, how should I buy this product or service or how should I do business with this company and that's a very powerful psychological change that's going on in the mind of the consumer.

Ed Kless: This is in a way ... this gets ... is this manipulation. We should do a show on this. Is this manipulation or is this assistance because you could really looked at it as giving assistance to people to buy what they really want to buy giving them proper context.

I think when done right it smacks less of manipulation and more about assisting the buyer and making a good choice.

Ron Baker: Right. I don’t think you can argue manipulation if the customers keep coming back, right? I mean, we might be able to manipulate them once, maybe twice but not repeatedly over time.

Ed Kless: Yeah, exactly. I think that's where this crosses the line because it can smack a manipulation. I've talked to some people who get upset with me when I talk about this as, "Oh, you're trying to fool people". No, I mean, it's just the way our brains work, right? When you are presented, and it seems to be again this magic Goldilocks three pricing, when you're presented with three choices, your brain starts to think which one of them should I pick.

Ron Baker: There's a technical word, it's called heuristics, right? A mental shortcut, heuristics that we all use and we looked at three things and we say, "Well, the most expensive one is probably a rip off or it's really probably more than I need. The cheapest one is probably is not that great. So, I'll be saved and stick to the middle one." It just kind of a default. This doesn't apply at all the time but that's kind of our default setting and in fact that's what we see when there is three options, most people pick the middle one.

Ed Kless: Yep, but what's important is that there's lots and lots of stories to say what your choices are on the low and high end, will have an influence as to whether the people will go up or down. So it's really really interesting.

Ron Baker: Right. We didn't get into this too much Ed but you start adding a fourth option to the third and you might be able to take advantage of that anchoring effect and drive up sales even more. I mean I often wonder what would happen if Wendy's have a quadruple cheeseburger.

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