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The Wharton Business School Study on SomethingStore
by Sami Bayrakci
Wharton Business School


MBA students from The Wharton School of the University of Pennsylvania have contacted SomethingStore.com for a study they're doing on our business and this is their work.

Marketing Department
The Wharton School
University of Pennsylvania

MKTG 754
Pricing Policy
Professor John Zhang

Group Project: SomethingStore.com

Team members:
Lin Gan
Brie Beeson
Osamu Funatsu
Arlin Tao
Tomohiro Yao

History and Background

Company/Product & Price.

SomethingStore.com is a uniquely original website that offers its customers the thrill of gifting or receiving a mystery product, or as the name appropriately implies, surprising someone with a little “something” for a trivial price of $10 (inclusive of shipping costs). The products offered range from gadgets and handmade necklaces to iPods and camcorders and are cleverly stamped with the catchy phrase “Surprise Yourself”. Launched in October 2007 on Long Island, New York by Sami Bayrakci, SomethingStore.com offers a unique value proposition to its customers. Sami, who previously worked as a marketing manager at UncommonGoods.com (an online catalog gift retailer), was intrigued by the formation of other sites like Woot, MillionDollarHomepage and One Red Paperclip, and one day decided he wanted to create a version of his own. Since December 1st 2008, over 25,017 “somethings” (or $250,170) have been ordered.

Customers.

While the store doesn’t allow customers to tailor products to match individual interests, hobbies, attributes, etc., the concept really is not meant to cater to a specific customer segment, but is designed to appeal to a large demographic, men and women, young and old, etc. Nonetheless, the thrill of surprise tends to be dominated by the following three customer segments:
(1) Gift givers who seek to lessen the hassle of finding the perfect gift
(2) Thrill seekers who desire to add an element of excitement to their lives
(3) Deal finders who are willing to take a gamble to “score” a big ticket item
These particular customers are expected to be relatively affluent individuals with good amount of disposable income and moreover, they are expected to be less price-sensitive because they are willing to assume some risk around the value of goods that they receive. Primarily, the store focuses on the U.S. domestic market, especially the Northeast region, but also delivers “somethings” internationally (+$4.75 shipping to Canada, +$8.75 to other countries).

Collaborators.

SomethingsStore.com sources its products from wholesalers (~50%), liquidators (~40%), and manufacturers (~10%). It uses Google Wallet as its payment service provider, which charges a low 2% + $0.20 per transaction, but no monthly, setup, or gateway service fees. USPS serves as its principle shipping service provider and offers volume discounts to cut shipping costs down. Additionally, many online media and social networks sites help promote SomethingStore.com; however, their support tends to be offered as free PR or viral marketing on account of the novelty of the business concept.

Competitors.

While there have been a few small copy-cat websites that have sprung up since the store launched in October 2007, there still are no credible, direct competitors to SomethingStore.com.
Distribution.
Available only through online channel. (http://www.somethingstore.com/)

Promotion.
SomethingStore.com primarily generates awareness through PR/media pickups, online (Macrobuck promotion, Fat Wallet, ThisNext), social networking sites (Facebook, Stumble Upon, Bloggers), and local guerrilla marketing.
How the Store Works for the Customers
The typical customer purchasing process:
(1) Customer places an order of 1, 2, or 3 “somethings” on the website and pays via Google Wallet.
(2) An order confirmation is sent to the customer and then within 7 business days, a randomly selected “something” is shipped via the USPS.
(3) Customer receives her/his “something” and experiences the thrill of opening a mystery gift.

Customer reviews suggest that SomethingStore.com has speedy delivery and great customer service, yielding high customer satisfaction scores.

How the Store Makes the Deals
SomethingStore.com buys inventory from wholesalers, liquidators and sometimes from manufacturers. The store doesn’t deal with manufacturers directly because it doesn’t tend to buy large quantities of the same item. General merchandise sellers like liquidators are able to offer SomethingStore.com better pricing on a larger selection of merchandise. Since several companies already specialize in performing this service in large transaction volumes, the store prefers to partner with them rather than working directly with retailers. The average of COGS is a little over $6, including shipping cost. Shipping cost is included in order to make the offer more appealing to the consumer and incentivize them to make a “something” purchase.

No consumer research has been done to determine whether or not this is the optimal pricing structure, but the pricing structure reflects the fact that the founder wanted to set price low enough so that people would be willing to take a chance, but high enough so that the store would be able to ship higher quality items and still turn a reasonable profit. In the end, he decided that $10 seemed to be the appropriate number.

On shipping day, the store tallies up all outstanding orders, then prepares packages depending on the number of items they are intended to include. The store then places the boxes in a line and starts randomly shipping them via USPS to one customer after another. The store tries to source lighter, compact items to lower shipping cost per item, but the shipping cost is still relatively high (~$2.17 per item on average).

Currently, the store has four full-time employees and two part-time employees hired for the holiday season. One employee is in charge of customer service and light accounting, and the other employees manage the general warehouse work. The founder does rest of the administrative work that they don’t outsource and manages the website and marketing. Low staffing and advertising spend, since the store relies mostly on word-of-mouth, viral marketing, and media mentions, keeps SG&A costs fairly low.

History and Industry Observation for Selected Pricing Tactic

We have seen similarities in the business model for SomethingStore.com when compared to other businesses. With regard to “randomness” or “luck” relative to what customers are willing to pay, “Fukubukuro” in Japan provides insight into this pricing psychology. In terms of single pricing, “Variety Store/Dollar Store” provides insight into a representative pricing rationale.

Fukubukuro

Fukubukuro (lucky bag or mystery bag) is a Japanese New Year's Day custom whereby merchants create grab bags filled with random mystery contents and sell them for a substantial discount (usually 50% or more off the content’s list price). The low prices are intended to entice customers to shop at that store during the New Year season. Formerly, Fukubukuro was a convenient way for stores to dispose of excess inventory and unwanted merchandise leftover from the previous year, since Japanese superstition held that no one should begin the New Year burdened with unwanted “junk” from the previous year. More recently, Fukubukuro represents a lavish New Year's event, rather than a way for stores to dispose of unwanted excess merchandise.

Depending on the type of business, merchants decide what to include in these grab bags and their respective selling prices months in advance. In major department stores, grab bags are usually themed to a specific department (for instance, a store’s young adult section would have Fukubukuro with trendy merchandise, whereas the shoe section would have several high priced shoes in the bag, etc.). In other stores (especially smaller ones), many Fukubukuro are often filled with items that relate to the store and focus on the customers’ perceived needs (e.g. a tea store might offer Fukubukuro in a tea crate with bags of tea, tea cups, and blankets). Many stores often include bonus items, such as expensive purses (sometimes worth tens of millions of yen), tickets to exotic places, and even fur coats and vouchers for expensive electronic items, all to entice shoppers to shop at their store. The mystery, allure, and anticipation of a bag’s contents have resulted in Fukubukuro sometimes being called "Good Luck Bags" or "Lucky Bags."

Fukubukuro have a tremendous variation in prices. Most bags are priced from a few hundred to several thousand yen. However, every year there are also some very expensive Fukubukuro available. This Fukubukuro custom has also spread to other cultures; for example, in the Ala Moana Shopping Center in Honolulu, several stores implemented this tradition in 2004. In addition, many Sanrio Stores in the United States have also adopted Fukubukuro. Finally, for the opening of the Apple store in San Francisco in 2004, $250 "lucky bags" were offered containing a mixture of software, audio accessories, and even an iPod in randomly selected bags.

Variety Store

A variety store (or price-point retailer) is a retail store which sells inexpensive items, usually with a single price point for all items in the store. Variety store products often include cooking supplies, small tools, personal hygiene supplies, kitchen supplies, organizational supplies, small office supplies, holiday decorations, electronics supplies, gardening supplies, home decor novelties, toys, pet supplies, out of print books, DVDs & VHS tapes, food products and automotive supplies.

Some items sold at a variety store would normally be priced at a dollar or less anyway, whereas other items are priced at a substantial savings. There are three reasons why a dollar store is able to sell merchandise at such a low price: 1) The product is a generic or private label, often specifically manufactured for such stores, using less expensive components and processes when compared to products intended for the mass market; 2) The product was initially manufactured for a foreign market, but was then re-imported by an unauthorized distributor; 3) The product is purchased from another retail store or distributor as discontinued and discounted merchandise. Additionally, some stores may have a section of single price point (dollar) items combined on the same premises with a section selling larger, relatively more expensive merchandise (such as CD players, lamps, and silverware).

In economic terms, the pricing strategy of dollar stores may be considered inefficient, since some items may actually be sold elsewhere for less than a dollar. However, this is balanced by the marketing efficiencies of a single price structure since consumers potentially also accept overpriced items. The pricing inefficiency becomes unacceptable at higher price points. Consequently, there are no "100 dollar stores" where all items sell for $100; since consumers are more sensitive to price inaccuracies at higher pricing levels. It is important to note that most merchandise in these stores are inexpensive imports, primarily from Asian countries, which are imported by a general merchandise importer/wholesaler, then sold to the stores at a wholesale rate.

Pricing Tactic Rationale

SomethingStore.com’s pricing strategy applied many concepts we learnt in class.

Consumer Psychology

We know that consumers will make a purchase if their Uconsumption + Utransaction > 0. Thus, even when a consumer’s utility from consumption is equal to zero, it is possible that he/she may still derive utility from the transaction itself. This is the case for SomethingStore.com. In the best case scenario, consumers receive something of value and potential use for their $10. In this instance, they gain consumption utility and thus, guarantee the completion of an equitable transaction. Alternatively, in the worst case scenario, consumers receive something of no value and potential use that may cost significantly less than $10 retail. While in this instance they may not gain consumption utility, they still may attain utility from the transaction due to the following emotional benefits:

- Surprise and delight from the unknown
- Convenience of not needing to browse through countless potential gift ideas
- Thrill of possibly getting a higher value item, similar to the thrill of gambling

In fact, based on consumer reviews, most people purchase “something” for the transaction utility rather than the functional benefit of the items they receive. Interestingly, even when consumers receive an item they deem useless, most still claim to be happy and satisfied with their purchase overall.

Consumer Price Sensitivity and Reservation Price

SomethingStore.com’s business model is less susceptible to price sensitive consumers because (1) it provides a unique value that is not easily substituted by other products or services, (2) the transactional nature of the company’s offering/value is difficult to be compared with competitors; it is difficult to put a dollar amount on how one values the “Surprise and Delight with the unknown”.
Further, the company attracts consumers that are less price-sensitive and have a higher reservation price for this “surprise” they’re purchasing. The company predominately reaches media channels such as NPR, social shopping sites, social networks that appeal to demographics that are more affluent, younger, and have a high preference for exploring new, interesting products. These demographics are less budget constraint, so $10 is relatively a low outlay for trying something different (yet high enough for SomethingStore.com to ship higher quality items and still turn a profit). They also place more value on the purchasing experience from SomethingStore.com rather than the actual product itself; as such, customers tend to be less price-sensitive and have a higher reservation price.

Value Pricing

SomethingStore.com was able to differentiate itself from other online options in the gift industry by creating several positive differentiation values as illustrated in appendix 3. First, SomethingStore.com positioned itself as a fun, quirky business that offers an element of surprise and mystery in the gift-giving and gift-receiving process as previously addressed. Second, it dealt with an unmet consumer need. Many consumers are frustrated and aggravated by the gift selection process given the countless gift options out there. The random gift selection at SomethingStore.com is an added service and provides positive economic value for shoppers in this segment. Further, it takes the risk out of gift-giving. Even if the gift is not useful or not liked by the receiver, the gift giver bears no blame, which is another positive aspect. Lastly, the possibility of getting something worth more than $10 also provides additional economic value. In this case, the purchaser could resell the item for a profit.

Consumer’s perception of the total economic value is further elevated since SomethingStore.com only highlights the “big ticket items” on its website shipment tracker (SomethingTracker), which may skew consumer’s perceived probability of getting something valued higher than $10. On the other hand, the perceived $ loss is reduced because the value of the product and the emotional benefit from the transaction partially offset the loss of $10. Consequently, the perceived gain is much higher than the perceived loss, which results in a higher perceived value and leads to a higher willingness to pay from the target consumer.

Moreover, SomethingStore.com consistently highlights the abovementioned positive differentiation value to customers on its website and all marketing communications, which sets customer expectation at the right level and effectively manages customer experience and satisfaction as evidenced by the high repeat purchase rate the business has experienced.

Operational Rationale

Because consumers don’t know what they will receive, SomethingStore.com benefits from asymmetrical information. As such, it can easily adjust the percentage of merchandise that costs above $10 wholesale downward to ensure a profitable business. Currently, about 10% of the merchandise SomethingStore.com ships costs more than $10 with an average COGS of $6. Overall this year, SomethingStore.com is expected to make about 20% margin after SG&A and other expenses.

Opportunities to Increase Profitability

Based on what we’ve learnt in class, we believe there are several opportunities for SomethingStore.com to capture additional profitability through adjustment in its pricing structure.
Pricing Discrimination through Multiple Tier Pricing
Quantity Discount. During the holiday season, more than half of SomethingStore.com’s orders are multiple items including 10, 15, 20, and even 30 items for offices and larger families. For the rest of the year, about 30% of the orders include 2 or more items. We believe that using a quantity discount structure could incentivize shoppers to order more. This pricing tactic would be especially effective with “deal finder” shoppers with a more “gambling” mentality who may believe purchasing more items may increase their probability of getting something of higher value (see appendix 8 for a non-linear pricing model simulation).
Versioning. Because different consumers may get different values from the “surprise” element of the transaction, they may have different willingness to pay. A flat $10 linear pricing may be leaving money on the table. SomethingStore.com may increase profitability by introducing “somethings” at different price points (e.g. $10, $25, $50) whereby higher priced “somethings” will be selected from a range of higher cost merchandise. This multi-tier product offering will have the following benefits:
(1) Capture consumer surplus by allowing consumers to self-select what base price is used to determine the value of utility that they receive from purchasing a “something”. Someone who highly values the element of surprise and is willing to pay $50 for the chance to receive a higher value “something” will be able to do so. This is contrary to the current pricing scheme in which he/she can only pay up to $10 maximum and tends to only receive items of lower value. In this way, SomethingStore.com is able to price discriminate and charge customers their reservation prices.
(2) Create a reference price of $50 which would anchor the consumer at the higher price point; thus, making the mid-range price point (i.e $25) more desirable and increasing their willingness to pay a higher purchase price.
(3) Capitalize on the price-quality correlation, thus driving consumers to go with a higher price purchase

Appendix 5 demonstrates how versioning could maximize profit by pursuing margin and quantity simultaneously.
Subscription Model. According to the owner of SomethingStore.com, there is a surprisingly high amount of repeat orders. This observation is perhaps due to the high level of customer satisfaction it has been able to achieve with unique, fun, and high quality items that are very equitable for a $10 transaction. In fact, some customers purchase every month and have even requested a “Something of the Month” service. One way of providing additional value to this segment of repeat customers may be to establish a subscription model that combines the quantity discount and versioning concepts. Consumers would pay a discounted annual fee for 12 “somethings” a year and then automatically receive a new “something” in the mail every month.
Further Lower Consumer Price Sensitivity and Increase Willingness to Buy
Addition of Different Product Segments. Based on consumer feedback, one key reason some consumers are reluctant to buy a “something” despite of their interest to try the concept, is that they are afraid to receive something completely useless and are skeptical about receiving something nice. This characteristic significantly increases the previously mentioned negative differentiation value for this segment of consumers and reduces their total economic value. One way SomethingStore.com could reduce such negative value is by providing ways to reduce the perceived risk of getting something bad by giving consumers more control over what products they might receive. Some potential ideas include:
- Male vs. Female “Somethings”
- Providing customers the option to select from a list of product categories from which they would be interested in giving/receiving products. For other customers, they could still buy something without such selection and be completely surprised.

Branding.

As SomethingStore.com become more mature in the industry, it is important that it develop a reputation of sending nice, unique merchandise and maintain/improve its customer satisfaction level. Such investment will pay off in the long-term as positive word-of-mouth would significantly increase its market share and consumer’s willingness to buy.

Validation and Empirical Support

Due to the lack of data, we looked at customer reviews and feedback from the owner of SomethingStore.com for empirical evidence to support our pricing rationales.
Consumer Psychology / Consumer Price Sensitivity / Value Pricing
Overall, SomethingStore.com has a relatively high customer satisfaction rating of 4.15 out of 5. Positive customer reviews suggest that customers for the most part are satisfied with their experience purchasing from SomethingStore.com, even when they receive merchandises that they don’t find useful to them. This validates our rationale that consumer are getting positive utility from the overall transaction even when the utility from consumption is equal to zero.
Furthermore, many consumers commented that $10 was a minimal price to pay for a “surprise”, suggesting their relative price insensitivity at the $10 price point. A significant portion of multiple purchases and repeat purchases also suggests that consumers view the $10 price point as a relatively good value.

Operational Rationale

The streamlined operation of Somethingstore.com allows them to achieve two key operational efficiencies: (1) Low COGS, averaging $6 per item, even after adding $2.17 shipping cost by sourcing ~40% of its products from liquidators. (2) Low SG&A costs through leveraging of viral marketing, maintaining tight inventory management, and utilizing a flexible labor force to augment the peak holiday sales season. Based on the founder’s feedback, we have reconstructed SomethingStore.com’s financial statement to highlight the profitability of the business to-date (see appendix 7).

Pricing Tactic Application

This tactic is applicable in a variety of industries or firms, especially in situations where people have difficulty making decisions, have limited information, or with low-involvement goods. This is also great for suppliers who have low marginal costs. A good example is grab-bags or gifts. Many people have difficulty in choosing gifts for others and this system allows the retailer to choose the gift for the person, thus adding an element of surprise, taking away the blame factor from the gift-giver in case the gift is not ideal, and allows retailers to get rid of extra inventory.
Another good idea is for restaurants. Currently, tasting menus allow guests to pay a set price and have the chef decide what will be served at a given restaurant, but these are often at high-end establishments and the price is very high. We can extend this idea so that everyday guests can pay a pre-determined amount and get served a surprise meal. Many people have difficulty making up their minds about what to order. This also allows restaurants to better cope with perishable foods. This tactic could work well with alcoholic beverages as well. Patrons who are indifferent as to what to drink can pay a set price for a drink and the bartender can deliver the surprise. Taking this idea further, we can give customers who cannot make up their minds about which restaurant to eat at the option to pay a set fee and be given a meal at a surprise restaurant.
Where marginal cost of providing an extra product or service is low, this strategy could be very effective. For example, in the airline or hotel industry, un-booked seats or rooms can be provided at almost zero marginal cost. We can have services that book mystery vacations to people who are not sure where they want to go for vacation or just want a surprise. Companies could charge a set price, and since the marginal cost is low, can afford to give better deals. Airlines and hotels benefit, as they can book vacations according to availability and greatly increase revenue at very low marginal cost. Vacationers can benefit from getting a great deal on a vacation as well as the fun and excitement of a surprise as well as getting exposed to places they would never otherwise think of going.
The same theory goes for other suppliers that have low marginal costs, such as movie theaters, whereby consumers can pay a set price that is lower than the regular cost of a movie ticket and get a ticket to see any movie or at any time, or both, at the establishment’s choosing. Often times, theaters have a lot of unsold tickets. They can establish a system to sell them at a discount, the catch being the customer won’t know the exact time (but the timing can be within categories, such as 10am to 5pm, 6pm to 12am, etc), or customer won’t know the exact show with the time being fixed (such as customers can see a movie within the next 30 minutes), or both factors can be determined by the theater for an even lower price. This allows customers who are indifferent to movie times or show selections to see a movie at a lower price and allow theaters to sell tickets that will otherwise go unsold. The same strategy can be applied to musicals, ballets, symphonies, sporting events, etc.
The ability to allow suppliers to chose what to supply, especially when marginal costs are low, could greatly increase revenue without increasing costs. This tactic also boosts consumer surplus by delivering goods to people at a lower price, while taking away the headache of having to make choices, and adding fun and excitement to ordinary transactions. This is an effective way to capture more of the social surplus for both consumers and suppliers. By supplying goods to consumers who are willing to pay above the marginal costs, without sacrificing overall price, suppliers can make a higher profit and capture more potential revenue.



 
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