wtp goalAs mentioned in the previous article, “Can You Measure Your Customer Satisfaction?” the goals are to lower your costs (C) and increase your customers’ willingness to pay (WTP).

However, you need to know where to focus your cost reductions lest you ostracize too large of your customer population without recouping and overcompensating with new clients. Keep in mind that all businesses are different, so all areas of variance (areas that matter) to your clients are different. You will have to determine which aspects matter and which don’t.

With that said, let me tell you two stories as examples.

Shifting Variable Costs to Fixed Costs

Variable costs are costs that are associated with the level of output. For example, if I owned a coffee shop, coffee beans are considered a variable cost. The more coffee that I sell, the more coffee beans that I will need to buy. The cost of input balloons as revenue increases.

toby's cortado

This is very similar to how Netflix operated so profitably in the past and not so much so today. In the past, Netflix bought and rented out DVDs. Every time Netflix loaned a disc, it amortized the cost. It was a fixed cost. The DVD could be rented by 10 people or 10,000 people, but the cost remains the same.

Conversely, now, with online streaming, as the subscriber base increases, guess what, so does the royalty fees charged by the entertainment studios. This is similar to how a landlord might charge a business more rent money as the business becomes more successful.

Example For Small Businesses

When it comes to small businesses, such as a photography studio, time is a large input cost. Time to shoot or edit photos is variable. The more you perform, the more it costs.

Therefore, based on the example that I gave about Netflix, would upgrading equipment (e.g., camera, lenses, computer) make you a more efficient shooter? Less time to get the perfect shot and less time to edit the photo mean lower costs.

apple imac

For example, if you could save three hours per session editing, and you shoot roughly 30 sessions per year, that’s a savings of 90 hours. Can you utilize that 90 hours to bring in more business to amortize the cost of the equipment upgrade?

Let’s imagine that in order for you to save 90 hours of editing time, you need a new iMac for $2,000. Can you generate $2,000+ worth of business with the 90 hours saved? What you are doing is shifting a variable cost to a fixed cost [that can be amortized]. This applies to knowledge, equipment, etc. as well.

Removing the Low Variance Costs

When it comes to lowering production costs, it’s about removing the items that are superfluous to your clients. This is dependent on the price you charge, the elasticity of that industry, and consumer tastes. Let me give you an example.

This weekend, Julie and I were flying back to NYC from Miami. We chose American Airlines. When we got to the departure terminal, Julie was appalled at the horrific operational inefficiencies.

Instead of the full-service airline it once was, most of the staff was removed and replaced with several computer terminals. We don’t mind self-service computers, but we were vexed by the poorly designed process. Julie was extra annoyed.

I asked her, “Would you still book American Airlines, knowing that it sucks this much, if it was the cheapest option? Flies you from point A to B.”

“Yeah,” she responded. “I guess so.”

In a highly elastic tier of (price-sensitive) customers , the little annoyances may not deter them from booking the service. In this case, quality service is of low variance when it comes to price sensitive shoppers.

My point is to lower the costs in areas that do not affect customer decision making.

airplane in the sky

Example For You

Again, this is relative based on price range, elasticity, consumer tastes, and more. However, let’s imagine that you serve a more price sensitive audience. Would wearing a Prada ensemble help you with more business or will an outfit from H&M suffice? Do you get where I’m going with this?

There are certain things that have little to no effect on your business. Therefore, those are the areas that you can cut costs.

I hope that all of this made sense. In the next article, I’ll talk about how to increase your customers’ willingness to pay (WTP).

Below, in my postscript, I wrote about sweets and WTP. What is your favorite sweet? Comment below!

Stay thrifty,

Lawrence Chan

P.S. On the other end of the price sensitivity spectrum, let’s talk about my recent trip in Miami. Since I stayed at Mandarin Oriental Miami, which isn’t the cheapest option, little treats such as the following make me feel special. How much did it cost Mandarin, excluding fixed costs, for some sweets? Maybe $2. How much was the markup / WTP? More than $2. That will be the next post.

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P.P.S. I received a lovely note from Bryant Carlos about my online marketing course on CreativeLive. I’m so happy when people write me of their success.

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