00:00:07 Willingness to pay and its role in supply chain and pricing strategy.
00:01:00 Examples of successful brands increasing willingness to pay, including luxury brands and Apple.
00:02:09 Scarcity and overstocking affecting customer’s willingness to pay and the role of supply chain.
00:03:37 Traditional departments responsible for pricing and the need for integration with supply chain management.
00:06:08 The importance of excellent products and the role of supply chain in maintaining and contributing to brand value.
00:08:03 Complex human behavior and willingness to pay in different contexts.
00:09:36 Seasonality in demand and willingness to pay, and its impact on supply chain management.
00:11:52 The travel industry’s success with quantitative approaches to pricing.
00:13:27 Utilizing customer data from e-commerce and brick-and-mortar retail for analysis.
00:15:22 Ethical considerations of companies knowing customers’ maximum willingness to pay.
00:17:25 Companies like Apple and Van Cleef & Arpels catering to different consumer preferences.
00:18:30 Importance of understanding market and pricing for better product offerings.
00:19:50 Influence of competitors on shaping market expectations and pricing strategies.
00:21:05 Advice for companies to improve their approach to willingness to pay.
Summary
In this interview, Kieran Chandler and Joannes Vermorel, founder of Lokad, discuss the concept of willingness to pay and its impact on supply chain optimization. Vermorel highlights the importance of understanding consumer perception of value and integrating supply chain management with pricing strategy. He emphasizes that most companies have access to customer transaction data, which can be used to refine pricing strategies and shape customer behavior. Additionally, Vermorel argues that efficient companies offering diverse pricing benefit the market, but stresses the need for competition to prevent monopolies. To improve willingness to pay approaches, companies should assign responsibility within the supply chain department and use quantitative modeling.
Extended Summary
In this interview, Kieran Chandler discusses the concept of willingness to pay with Joannes Vermorel, the founder of Lokad, a software company specializing in supply chain optimization. Willingness to pay is the maximum amount a person is willing to pay for a particular good or service, and it can vary significantly depending on factors such as marketing and trends, as well as between different customers. The conversation explores whether supply chain departments should be part of pricing strategy and how statistics can be used to determine someone’s perception of value.
Vermorel explains that willingness to pay is a key driver behind demand, and some brands have been very successful in increasing it over time. Successful luxury brands, for example, have engaged in multi-decade efforts to increase their customers’ willingness to pay by slowly raising their price points. Apple’s iPhone is another example, with its price consistently increasing over time, even though consumer electronics generally become cheaper.
Supply chain management plays a crucial role in affecting willingness to pay because creating scarcity can make products appear more valuable, thus increasing a customer’s willingness to pay. On the other hand, flooding the market and ending up with massive overstock that needs liquidation through discounts can shape customers’ willingness to pay negatively. When a product is sold with a discount, it can create an expectation for the same discount in the future.
Despite the significant role of supply chain management in shaping willingness to pay, Vermorel notes that the concept is often absent from supply chain organizations. Traditionally, marketing departments or specialized pricing divisions are responsible for determining pricing points and willingness to pay. However, Vermorel argues that the divide-and-conquer approach, in which different teams handle pricing, forecasting, planning, production, and sourcing separately, works poorly in these situations.
Vermorel emphasizes the importance of integrating pricing strategy with supply chain management, as there are feedback loops between the two. If a company produces or purchases too much, it may be forced into offering large discounts, which can affect customers’ willingness to pay. This suggests that supply chain management should be an integral part of pricing strategy to ensure that the two aspects are tightly integrated and work together effectively.
In this interview, host Kieran Chandler speaks with Joannes Vermorel, the founder of Lokad, a company specializing in supply chain optimization. They discuss the intricacies of consumer perception of value, the role of supply chain management in shaping that perception, and the potential for companies to shape consumer willingness to pay for products.
Vermorel highlights the importance of understanding a consumer’s willingness to pay and how companies with successful brands can shape that perception. For example, the expensive watch industry was able to bounce back after the rise of cheap Japanese watches in the 1980s. Despite initial concerns, the hard luxury market has been thriving. This success is attributed to not only effective marketing but also creating excellent products that offer genuine value.
He further explains that supply chain departments should have a positive contribution to the company’s efforts in crafting and designing better products. Vermorel also acknowledges that understanding a person’s perception of value is a challenge, as people’s preferences are highly multifactorial.
One of the main difficulties in analyzing consumer preferences for luxury items is the limited number of data points. However, Vermorel notes that willingness to pay for products often follows mundane statistical patterns, such as seasonality. Most supply chain departments focus on the seasonality of demand, but few consider the seasonality of willingness to pay.
End-of-season sales in the fashion industry are one example of how companies react to changes in willingness to pay. However, Vermorel suggests that these sales are usually just a reaction to overstock rather than a planned response. He also points out the two-fold penalty at the end of a season, where demand drops and the remaining customers have a lower willingness to pay. Most companies do not analyze these two elements.
The travel industry, on the other hand, has been taking a quantitative approach to consumer willingness to pay for decades through yield management for plane tickets. The industry’s success with this strategy is evident in the fact that companies not implementing yield management have disappeared.
When asked about the level of granularity required for this approach, Vermorel explains that most companies already have the necessary data within their sales history with clients. He emphasizes that it is not about extracting large amounts of data from social networks, but rather looking at the history of individual sales.
Vermorel explains that most companies have access to customer transaction data through their ERP or CRM systems, allowing them to analyze the impact of offering discounts on customer behavior. He suggests that testing hypotheses based on customer data can help businesses shape their clients’ purchasing habits and refine their pricing strategies.
The conversation moves to the ethical implications of companies using data to nudge customers towards their maximum willingness to pay. Vermorel argues that having companies that are efficient in servicing their customers and understanding their willingness to pay contributes to the overall benefits and diversity of the market. However, he acknowledges that monopolies can be harmful, and vibrant competition is necessary for a healthy market.
Vermorel discusses how dynamic pricing can benefit both rich and poor customers. For example, airlines with high fixed costs can offer cheaper flights to price-sensitive customers by adjusting pricing based on demand. Similarly, luxury brands like Van Cleef can charge high prices for their products, while some customers may choose to wait for discounts on platforms like Veepee.
The interview explores the idea of companies producing higher quality products for higher prices or cheaper, disposable products for lower prices. Vermorel suggests that companies that Excel at understanding the market and their pricing are ultimately benefiting the market, as long as there is competition. He emphasizes the importance of monitoring competitor pricing as it also shapes customer willingness to pay.
To improve a company’s approach to willingness to pay, Vermorel recommends first ensuring that someone in the supply chain department is responsible for the quantitative modeling of willingness to pay. If not, the company is likely flying blind, and there is room for improvement. He suggests starting with simple heuristics and gradually refining the approach, rather than ignoring the issue entirely.
Full Transcript
Kieran Chandler: Today on Lokad TV, we’re going to understand where the supply chain department should be part of the pricing strategy and also how statistics can be used in order to determine someone’s perception of value. So, Joannes, willingness to pay seems very basic on the surface. Perhaps you could tell us a little bit more about it.
Joannes Vermorel: Willingness to pay is something relatively obvious. It’s a key driver behind demand. Some brands have been incredibly successful in increasing over time the willingness to pay. Successful luxury brands have played this game of increasing the willingness to pay over time. It’s a multi-decade effort for the top brands that exist nowadays. To do that, you slowly raise your price point so that if you’re buying, let’s say, a very expensive watch, it increases value over time. It’s not exactly like you’re spending money, it’s like an investment and an asset. From a marketing perspective, it’s quite a feat to do that. But actually, this is not just for luxury. Apple has been doing the same with the iPhone. Consumer electronics are getting cheaper, but not the iPhone. The iPhone is just getting more expensive, which is again, quite a feat. The bottom line is that it’s very successful when you look at it. So, why is it impacting from a supply chain perspective?
If you create some degree of scarcity, you can make your products appear as marginally more valuable and increase the willingness to purchase of your customer base over time. Conversely, if you flood the market and you end up with massive overstock that you need to liquidate, you end up offering major discounts, which is typically what’s done by many fashion companies. Then you’re actually shaping the willingness to pay of your clients by creating an expectation to get a discount next time. Willingness to pay is something where supply chain has a big role to play because it’s not that they have a big role to play, it’s that they play a big role, period. What is striking to me is how absent this notion is from most supply chain organizations.
Kieran Chandler: So, you say that supply chain organizations are not involved. Who is the traditional department responsible for this willingness to pay and determining a pricing point?
Joannes Vermorel: Typically, I think it’s more on the marketing side. Some companies even have a pricing division. But fundamentally, the problem I see is that divide and conquer works poorly in these situations. By divide and conquer, I mean large organizations decide to have a team that does the pricing, another team that does the forecasting, another team that does the planning, another team that does the production, and another team that does the sourcing. You separate the problems entirely. However, when it comes to willingness to pay, you have feedback loops between production or purchasing and the need to give large discounts if you end up with too much inventory. You can’t just say we have a team that decides the pricing and another team that does the planning and expect everything to go well if those two aspects are not tightly integrated.
Kieran Chandler: Intrinsically linked to demand, but also, if you’ve got lots of stock, then you’re gonna want to get rid of that stock. How much can companies actually shape what a consumer is willing to pay?
Joannes Vermorel: When you look at very successful brands, I would say quite a lot. Just look at the expensive watch industry, for example. In the 80s, you had super cheap Japanese watches like Casio, and people were thinking that watches, which used to be expensive, would be worth ten dollars max. However, the luxury market has never been doing so well over multiple decades. So clearly, there are ways to shape quite extensively the willingness to pay. Of course, it’s not just a pure marketing gimmick; you need excellent products. The latest iPhone is more expensive than the iPhone 1, but arguably it’s also much better.
For example, if you look at very expensive watches, the things you can get nowadays are literally masterpieces that were simply technically infeasible 40 years ago. So, it’s not as if you’re buying the same thing just at a higher price. Crafting and designing a better product is not exactly in the realm of supply chain, but making sure that you don’t undo the effort of the design and engineering department with your supply chain department is pretty much in the realm of things where supply chain should be having a positive contribution instead of a negative one.
Kieran Chandler: It’s a real challenge, isn’t it? Because it’s all very much based on someone’s perception of value. So for me personally, I might look at a really nice watch and appreciate its great engineering, and I might perceive that watch is worth a lot of money. Someone else might look at the same watch and decide it’s just a bit blingy and probably not worth the same amount of value. From a statistical perspective, how easy is it to understand this person’s perception of value?
Joannes Vermorel: Indeed, if you’re dealing with hard luxury, everything is way more complicated just because you have very limited data points. It’s not that people have super complex preferences; the way people choose a cheap shirt in the supermarket is also super complicated, because you’re dealing with humans with highly multifactorial perceptions that are driving their choices. The situation is not fundamentally more complicated; it’s just that you have way less data points.
Interestingly enough, many companies are selling much more mundane products than high-end luxury watches, and willingness to pay also follows many statistical patterns that are just very mundane. For example, willingness to pay is seasonal for many products. Let’s say you want to buy a swimsuit. If it’s April, you may be using this suit for the entire summer, so you might be willing to pay a good price for that. But if it’s the last week of August, the summer season is nearing its end, and your willingness to pay for a new swimsuit is much lower. Most supply chain departments or planning divisions in large companies have entire teams of people dealing with seasonality profiles of demand, and a total number of people looking at willingness to pay of the clients each season as well.
Kieran Chandler: What strikes me is that most supply chain departments, or let’s say planning divisions in large companies, have entire teams of people dealing with seasonality profiles of the demand. However, there are typically no people looking at the seasonality profile of the willingness to pay, which strikes me as profoundly at odds with the basic reality.
Joannes Vermorel: That’s true. What fashion companies do with their end-of-season sales is a good example. At the end of the summer, people would pay a lot less for a swimsuit, so that’s when they introduce discounted pricing. However, this is just a reaction to overstock; it’s not something that’s really planned for. They just estimate the amount of demand, but the willingness to pay has no part in that. The willingness to pay is usually not even quantitatively analyzed, and it’s only considered when establishing the initial price of the product. Discounts, if they ever happen, are just a matter of dealing with overstock. There’s no analysis whatsoever of the drop in demand and willingness to pay.
Kieran Chandler: Are there any verticals where companies are doing this well and taking a more quantitative approach?
Joannes Vermorel: Yes, the travel industry has been doing this for decades. When it comes to yield management for plane tickets, they’ve been doing it for four decades, and they’re good at it, sometimes to the point of being infuriating. You might wonder why you end up paying five times more for the same flight ticket just by moving your dates by one week. That’s just highly optimized yield management, and it’s very rational. Companies that aren’t doing this in the industry have disappeared quite a while ago.
Kieran Chandler: What sort of level of granularity are we talking about when looking at it with this kind of approach? Are we looking at it from an individual customer perspective, and how can companies actually go about that?
Joannes Vermorel: The interesting thing is that most companies nowadays already have the data they need. I’m not talking about extracting terabytes of data from social networks or anything like that. It’s much more straightforward; it’s literally looking at your sales history with clients. For example, if you’re an e-commerce company, you know almost 100% of your customer base, except for perhaps around 0.5% due to fraud. When it comes to brick-and-mortar retail, you also know your customers to a large extent through loyalty or rewards programs. So, typically, you know anywhere from half of your customers or more, depending on the type of business.
Kieran Chandler: So, you have a lot of data from the point of sale that tells you which client bought what. Even if you don’t have 100 percent, for example, you can make relatively straightforward analysis of, for example, what is the impact of offering a discount to a client. Is this client going to change his or her behavior and only return when a discount is offered? You can literally test this hypothesis and see exactly how much you’re shaping the behavior of your clients. And again, it’s just basic transactional data that most companies have as part of their ERP or CRM.
Joannes Vermorel: Yes, it can be a bit worrying and consuming. There’s this idea that a company will know the maximum I’m willing to pay, and they’re going to nudge me in that direction. It’s interesting in terms of ethics, I believe.
Kieran Chandler: So people might say, “Oh, those capitalist companies, they’re trying to be efficient; it’s so bad, they exploit their customers.” But what do you think about that?
Joannes Vermorel: The reality is that having companies very good at servicing their customers and understanding how much they are willing to pay for something is actually quite important for the wonders we see in the market nowadays. If there’s only one company in a market, then you end up with a monopoly, which is a terrible thing. However, if you have a vibrant ecosystem of companies that compete, it can be very interesting.
For example, when I was talking about those travel costs that fluctuate a lot, it means that if you’re not wealthy, you can still travel relatively cheaply if you choose dates when the rest of the market does not. It results in a situation where wealthier people subsidize transportation costs for others. Airlines have to deal with large upfront investments, like investing in an aircraft. If some people are willing to pay a lot of money at a certain point in time, then others who don’t have that much money can still get the same service at a much cheaper price by being flexible with dates.
Ultimately, that’s also the essence of very successful companies like Vente-Privee. Either you’re very rich and you can buy your high-end items at full price, or you can decide to wait three years on Vente-Privee until one day you might have the opportunity to buy it at a much lower price. But then that means that you have to be very patient, and this opportunity may never arise. Being super good at tuning those prices goes both ways. Companies are not always going towards producing something worse and worse.
Kieran Chandler: There is this trope that all things get worse over time, and if you let companies just do some cost-cutting, their products are inevitably going to get worse over time. However, if there are smart companies that identify that people are actually willing to pay more for something better, like Apple, it might actually work. You might be able to charge more for a product that is better. So, if people just decide that they want something more low-quality but at a cheaper price, maybe because ultimately there are many products that people are only going to use once or twice, or you would even think of having something disposable, it kind of makes sense as well. I mean, it’s so again, I believe that having companies that are very good when it comes to price, understanding the market, and understanding their pricing, ultimately, it’s doing a favor to the market as long as you have a lot of competition. Otherwise, it’s like, and it’s so easy with the internet nowadays to be able to check out what the competition is doing. So, in terms of willingness to pay, should we be analyzing all the pricing of our competitors as well?
Joannes Vermorel: Absolutely. I mean, shaping the willingness to pay is something that you can do, but your competitors are doing it as well. If we go back to Apple, you can see that Samsung has been able to piggyback on the path opened by Apple, and it happens that the expensive Samsung phones have been increasing in price as well. So, it’s literally your customers shaping the expectations of the market both ways. You can have competitors that drive the prices to the ground because they just want to super mass-produce and lower the price of their products, or the other way around, they want to go upmarket, and you can actually follow in that path. Obviously, if you want to do that, you need to improve your products as well, because your clients may not just be willing to pay more for the same thing.
Kieran Chandler: So, what can a company do to improve their approach to willingness to pay and improve that philosophy? Because you said it’s something they’re not doing so well at the minute.
Joannes Vermorel: First, I would say, by just doing a reality check in your supply chain department. Is there someone who is responsible for the quantitative modernization of the willingness to pay? If there isn’t, that means you’re flying blind, which probably means that you have a lot of room for improvement. So that’s the upside. I think my first advice would be to make sure that this part is covered. And then, when it comes to covering this part, even very basic heuristics are better than just ignoring the problem altogether. So, you can start very simple with relatively crude ideas, but at least you start dealing with the problem instead of pretending it doesn’t exist.
Kieran Chandler: Brilliant, we’ll have to leave it at that. Thanks for your time. So, that’s it for this week. Thanks very much for tuning in, and we’ll see you again next time. Bye for now.
