[Shotimes] (OT) How to avoid the pitfalls of pricing Former Porsche boss: There's no 'right price' for a car

[Ron Porter]

One of the "other" lists had some who posted this excerpt from Peter Schutz
new book that appeared in Automotive News yesterday (12/19, if anyone is
subscribed). It is a rather interesting view of a car-pricing discussion. 

Actually, I feel that this has some SHO-related content when I think of the
cheapest '89 SHO with a list price of over $22K in '89 (including basic
stuff, no options, & destination, just like my '89...thousands higher than a
Z28 or Mustang GT), '95s listing for over $27k, and '97s listing for $33K
(before they went to the "one price" in '98 & '99). I wonder how well the
SHO would have done if it was priced no more than $1K more than a loaded
SLO??

Ron Porter
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How to avoid the pitfalls of pricing
Former Porsche boss: There's no 'right price' for a car

By Peter W. Schutz
Automotive News / December 19, 2005

When Peter Schutz became CEO of Porsche AG in January 1981, the German 
carmaker was in big trouble. Sales were declining. The company was losing --

yes, losing -- money. Employee morale was in the basement, and the iconic 
911 was about to be discontinued. In his new book, The Driving Force: 
Extraordinary Results with Ordinary People, Schutz tells how he turned 
around the company by challenging conventional thinking and motivating 
people to perform at peak levels. In this excerpt from the section entitled,

"Pricing the Porsche 944," Schutz discusses the pricing strategy for a new 
key product.

In 1981, Porsche was faced with the opportunity to introduce the Porsche 944

automobile into the U.S. market. In its day, this constituted a 
significantly differentiated product. It offered unique performance and 
styling. The question arose: What is the appropriate price for this 
automobile?

We had a big pricing meeting. The sales department had done its homework. In

concert with the financial establishment, a cost had been determined for the

car. At the time, a production level of about 70 cars per day had been 
projected.

I remember posing the question, "What is the proper price for this new 
product in the U.S. market?"

Armed to the teeth with the best and latest financial cost information, the 
sales people responded, "$24,000."

I asked, "Why $24,000?"

"Because that is what it will take to make a reasonable profit," they 
responded.

I had reached a point where I had to be careful about what I did next. I 
could have disagreed, told them what I thought was right, and tried to use 
my authority to force the decision my way. Everyone would have been sure the

new product would fail because Herr Schutz had insisted on doing it "his 
way" instead of "the right way." We might have taken a great leap backward 
in our efforts to make the best of the driving force in the organization. On

the other hand, I could not let this decision be made in a way that I was 
pretty sure would not lead to maximum success for the new product. I did not

disclose what I believed was the "right" answer. I challenged their thinking

instead.

Specifically, I decided to put a spotlight on their reasoning and the 
statement that a price of $24,000 would "make a reasonable profit." I 
replied with, "That is not what I asked you. I would like to know: What is 
the proper price for Porsche to optimize the return on the investment we 
have made in this car?"

This response resulted in major confusion. Cost-plus pricing was an integral

part of the company culture; it was the way it was done. Nobody had thought 
about how to optimize the business by selling large numbers of cars; they 
were thinking instead about how to achieve a reasonable margin on each car 
we might sell.

To clarify the issue, I rephrased the question by making my request more 
specific: "At what price would this new product generate a volume level of 
150 units per day? At what price would this new product be a major success 
in the U.S. market and make full use of available production capacity?"

Setting the target

After some discussion, the answer was, "To accomplish that, the price would 
have to be $18,500."

"All right then," I replied, confident that people knew what they were 
talking about. "The price is $18,500."

A few days later, it was time for our periodic management meeting that 
included all of the company's top managers. The issue of the 944 
introductory price was addressed.

To my amazement, the sales department said the price was going to be 
$24,000.

"How can that be?" I asked. "I was told that the proper price to make this 
product a success was $18,500."

"Well, at that price, the company will not make any money," was the 
response.

My chief financial officer was quick to side with the sales department, "At 
$18,500, we would lose money on every car sold," he said.

"Even if we build 150 per day?" I asked.

"Well, we really cannot compute such a situation; we have never built that 
many units per day," I was told. "But it is quite certain that even at that 
level, costs would not be covered by an $18,500 price."

We were trapped by:


Viewing a new product as a commodity before it was introduced (a reflection 
of the company culture at the time), and


The concept of cost-plus pricing.

It took a lot of effort to get out of that trap and get general agreement to

experiment with a lower price in an effort to maximize the product's initial

sales success.

The Porsche 944 was introduced to the U.S. market at a price of $18,500 in 
the summer of 1982.

The car was sold in significant quantities; it was a resounding success and 
a real bargain in customers' eyes.


Former Porsche CEO Peter Schutz ran into resistance when setting the rpice 
of the 944.
But where's the profit?

As predicted, Porsche lost money on every unit delivered.

So, we fixed the problem. We raised the price in succeeding increments. The 
production volume reached 150 per day, resulting in significant cost savings

on a unit basis. Within two years, the car was selling for $22,500; later, 
it sold for more than $24,000. Porsche earned a substantial profit.

What did I learn from this?

The proper price of a product or service is not a simple number. There is no

such thing as the "right price." The price is a band, a spread around a mean

value. In engineering, this is known as distribution tolerance.

Because of this and the unknown value-added impact of a new product or 
service, the most reasonable answer to the question, "What is the proper 
price for this new product?" is: "We do not know!" Until such an offering 
actually hits the market and is in the hands of a customer, it is not 
possible to know. Only the customer can determine the value-added impact of 
the new offering and thus the right price.

So how do we determine a price when we do not know? If we try to determine a

price in isolation, we will quite likely not get it right.

We can run a potential problem analysis: What can go wrong, and what will we

do when it does?

What happens if we err on the side of pricing the new offering too high?

We could make a good profit on paper. However, if we have priced too high, 
it will not generate significant volume. How do we resolve this dilemma? The

sad truth is that we have not become any smarter. We know that our price is 
too high, but we do not know how much too high. Sales are sluggish and the 
offering is in trouble. What can we do?

We are forced to lower the price.

Once this is done, not much good can happen. The customers who have bought 
the offering at the too high initial price will feel embarrassed. It is 
unlikely that they will tell the world of their purchase. Others who buy the

product at the reduced price will wonder, will the price drop still further?

The market will view the situation as an offering in trouble. Further price 
reductions will have only a minimal effect on volume until the price is at 
the lower level of the spread around the proper price.

A promising offering can be sabotaged by introduction at an initial price 
that is too high.

This circumstance can result if costs are too high.

Often it is the result of

Arrogance. Somebody believes they know a proper price level when they in 
fact cannot know it - the offering is "new."

Greed.

Impatience.

What happens if we price a new offering at a price below the unknown proper 
price?

The offering is likely to sell in large volumes. It is perceived as a 
bargain. It is a bargain.

The problem now is, we are not making money.

The solution? Raise the price.

If this is done in discrete increments, we can anticipate the following 
results:

Customers who bought the offering at the introductory price will tell the 
world. They will spread the word. What a great offering! What a great value!

An existing customer will never be upset by a price increase.

Sales volume will be maintained, or increase, as the word spreads.

Volume will not moderate as the price is raised until we reach the upper 
level of the spread around the proper price.

The offering will be perceived as a success, and the upper level of the 
price spread will likely generate an optimum profit level.

What did I learn?

If the proper price is not known, strive to price at a level that is safely 
too low. The lack of profit can be solved by subsequent price increases.

If the introductory price is too high, the lack of sales volume cannot be 
corrected by a price reduction and a distress situation can result.

The Porsche 944 situation is not unique. I believe Toyota followed the same 
pricing strategy in the market introduction of the successful and profitable

Lexus LS 400. Porsche repeated this effectively in the introduction of the 
Porsche (Boxster) sports car almost 20 years later.

Nothing goes to the bottom line like effective pricing. Nothing can drain 
performance more destructively than improper, thoughtless pricing.

Danger of pricing high

The low-price, sales volume-oriented concept for a new offering sounds risky

and expensive. Nothing is in fact riskier and more expensive than the 
failure of a new offering introduced at too high a price.

What I am describing here is a pricing strategy. Strategies are often 
important aids and guides during decision-making. As the leader, I had an 
obligation to clarify the strategy to be used. When I did that, people 
arrived at a very different price than they had at first.

Was this a democratic decision-making process?

Management is never easy. Building a culture and introducing strategic 
concepts must be incorporated into the process.

I did not set the Porsche 944 price; I raised strategic questions. I relied 
on people in the organization to come up with sound answers. Beyond that, it

established the merits of strategic thinking.

Much as I had done when I said, "We will never go to any race without the 
objective of winning," I now said, "We will not price a Porsche on a 
cost-plus basis as though it were a commodity or an appliance." I had set 
limits on the range of decision.

It is necessary for a leader to set a new direction by clarifying strategic 
issues involved in a decision. Asking questions about what the objective is 
or what will happen under different scenarios can help change the basic 
strategic framework with which people approach a decision. It is far better 
to exert influence on a strategic level than take control and force a 
decision on the organization without their understanding.


Excerpted with permission from the publisher, LeadershipPublishing.com, a 
division of Harris & Schutz Inc., from The Driving Force: Extraordinary 
Results with Ordinary People by Peter W. Schutz. Copyright 2005 by 
LeadershipPublishing Inc.