Product segmentation chapter one - bicycles

Hooray, I bought a bicycle

After 4 years of long distance running I decided I need some diversity and I am about to try a sprint triathlon this year and maybe later on, an Olympic one. Not to worry, I will not skip my first full marathon planned for Jan, 2012.

What shall I buy?

There are several good brands and each brand has about 2-3 beginner-intermediate models which vary by materials (e.g aluminum or carbon), system's accuracy, weight, and so on.

Now comes the interesting part - if you are not familiar with bicycles, you might think that the price range is "sane", but it isn't. The entry price is very high and the range is immense.

Just to give you a taste, an entry level bicycle costs about 800-1,000$. An upgrade to a slightly better model will up the price by at least 500$. Should you wish to start with the carbon frame (even the basic one) you will pay at least 2000$ and a somewhat nicer carbon set will cost you about 3000$.

I have not even started to describe the choices of wheels, saddles, etc. The prices go up and stop somewhere around the 14,000$ for a "war machine". Guys, this is almost a price of a car.

I asked my coach: "Why are these prices so ridiculously high?" His answer was: "The materials are expensive, the systems are more accurate and the cost of production is high".

Now as much as I respect my coach, neither he, nor I (nor you) is fully aware of the cost of production.

So, what dictates the price?
I am not about to start lecturing you about supply and demand, but I do want to get out of your heads the notion that the prices you see at the stores are related directly to the cost of production - THEY AREN'T!

The only thing that dictates the price is the answer to the question that the sellers ask themselves "how much can we charge? In most cases the sellers are trying to sense how much people are willing to pay and multiply it by the number of buyers.

A simple example (a very imaginary one):

Suppose I produce a new fancy dining table and it costs me about 1,000$ to make (but no one outside my company knows that). Check out the following scenarios:

Price	Number of buyers	Total Income	Net Profit
50,000	20	1,000,000	980,000
10,000	250	2,500,000	2,250,000
2,000	500	1,000,000	500,000

The first conclusion is that the price point point is about 10,000.


Segmentation
My next move will be to think of the potential clients that I lost. There are two groups

1. The people that wish to buy the table but cannot afford it
2. The people that consider the table is too cheap (yes, too cheap) and not fancy enough.

Therefore, I want to have a higher price point and a lower price point for basically the same product. If I am smart, I will do it without any consumer feeling cheated and even more positively, all of them should be satisfied.

First lets address the consumers that consider the price too low. I will use a different wood and make some hand-made carvings. I will use a different color that is considered more stylish, etc.

For the second market, I will do the opposite. I will choose a wood that is still very good (hey, my brand is all about quality) but is considered by people as an old fashion wood and I will brand it as "made in Taiwan".

The nice thing about this method is: Suppose Andrea, Dana and Jennifer are good friends. Each of them will buy a different table and all of them visit each other once in a while, none will feel bad. To them it is a totally different table. For me it is almost an identical product. This is called market segmentation.

The bicycles companies do exactly that. They generate very similar systems but they make sure we see and feel them in a totally different manner. We pay very nicely for different models and we feel good about it.

Are we suckers? good question, if you ask a cyclist, s/he will tell you "no" and start to lecture you about shifters, transmission, materials and how much a 20 grams lighter saddle can save the day during a hill climb. If you ask his/her spouse, well the answer is: "the idiot is spending much money and is likely to get injured"

It is important to understand that there is no good or evil about it, this is a way business is done.

And me? I was lucky enough to find a nice carbon bike, second hand, 2007 model which due to its small size the store could not got ridden off so I got myself a good deal.

Amir

Can a small ripple create a tsunami?

In many companies, trying to do our best (even not according to plan) is ingrained in the culture. We reward these people that stepped up from their comfortable chair and did something extra to fix a broken situation. We tell their stories, we use them as examples, and we honor them.

Consider these two examples that we typically consider as very positive:

• The sales person who was able to convince a client to proceed in the sales process by promising something new and exciting
• The software engineer who added a really cool feature

I am not against creativity. On the contrary, I like to think outside the box and push into uncharted waters. In addition, it is difficult for me stick to the master plan once I see something better. Also remember that Israelis are "masters of improvisation". However, I wish to show you in this post the negative aspects of doing so because the impact of such negative is much higher than most of us imagine.

In a book that I am reading these days, there is a great example of such phenomenon.

In one of the chapters, the author describes a big division of Boeing called FOTV (flight operations, test & validation). The general manager of the division says that their culture is of people that are trying their best to save the day. He explained:

We are under immense pressure to test and validate new planes. Now, suppose a flight test went bad but it was not the plane's fault but rather the weather. The flight crew will try their best to go for another flight the same day which sounds reasonable to them (they wished to do their best to stick to schedule). The crew does not understand the impact on the maintenance team that should wait for them on the ground missing another task. They also fail to realize that the the fuel truck will not be available afterward since it needs to be somewhere else and hence the plane won't have fuel for tomorrow's flight. etc. etc. etc.

The analogy is that in a complex organization where many parts are interlinked, a small ripple starts to create many new ripples and they intensify each other until they form a tsunami.

Consider the "new cool feature" that the software engineer decided to add or that the sales person promised in order to try to save a deal. This new feature creates a small ripple in the development plan of the engineer, and

• it needs a new graphic user interface (GUI) which means that the UI designer to stop an existing task and come to help, and
• it needs a new interface with other programs affecting more engineers, and
• it needs a quality assurance test plan and testers time, and
• it messes with the help guide that was already printed out for all new customers, and
• it messes up the demo for the upcoming exhibition, and ...

You get the picture - not sticking to plan disorients an entire organization. the more complex the organization is, the more effect a small ripple has. But even for small companies the effect can be significant. For a startup company a delay of 2 months might mean "wrap your bag and close the doors, game's over"

So, what will you do about it? My guess is - business as usual (or maybe not)