NOTE: The following is a guest post from Laurie Peterson. If you want to submit your own guest post, click here for more information.
In business school they teach us to set prices by plotting the demand curve and then choosing an output level and price where your marginal costs are equal to your marginal revenue in order to achieve profit maximization. HUH?
I should have lost you at “demand curve” because in real life nobody has detailed enough data to create this sort of graph (Amazon is an exception).
So if micro-economics is letting us down, what can we turn to instead to guide our price setting?
Answer: our customers’ EMOTIONS!
Below I’ve highlighted a handful of consumer behaviors and related price setting tactics. I was lucky to learn from the best: world renown Pricing Professor Teck Ho. I am happy to pass along a few tidbits of his wisdom.
1. Your customer uses reference pricing to determine if they are getting a good deal
How your customer values your product is relative to the products they consider to be similar.
For example, tonight I was trying to book a couple of airline flights, departing from San Francisco. One flight was going to Las Vegas, and the other to Los Angeles. The trip to Vegas was going to cost me $200 more, so I didn’t book it. Why? Because it didn’t seem fair that the price was so much higher than the one to L.A.
Even though I value the trip to Vegas more, (who wouldn’t? Vegas, baby!) I can’t stomach paying more because the service provided seems about the same. My reference price is similar products currently available (other flights, like the one to L.A.) and my past experience with this product’s pricing (I’ve had lower fares on past trips).
Even though it’s perfectly rational for the airline to charge more for Vegas based on the demand, my emotions tell me, “Don’t book. You are not getting a fair deal!”
What this means for product managers is that you should identify what products/services your customers consider to be references. You can try to influence this (like generics do by placing themselves right next to the branded version in the grocery store isles), but ultimately you need to listen to your customer to determine who your references are.
Next, calculate the additional (or negative) economic value you provide to your customer compared to those references. For example, if the flight to Vegas was twice as long as the flight to L.A. I could justify paying a higher price because it’s taking me twice as far.
2. If you do too many price promotions customers will only buy when you have a sale
If you are a frequent shopper at Macy’s like I am, than you know this to be true. Macy’s has so many great sales you would have to be a moron or independently wealthy not to wait to shop during one.
This relates back to reference prices. It’s not just your competitor who is setting them. By discounting your product you may be setting a new reference price that is lower than your full list price.
If you are having a sale, be sure to present higher alternative prices alongside the actual selling price. Or, display your regular item alongside a more expensive item to create a higher frame of reference.
3. For some goods, price = quality
There are some goods that you have to experience in order to place a value on them. For example, you can’t read the ingredients on a perfume bottle and know if it is going to smell good, attract a date for Saturday night, and not result in hives.
For these “experiential” products, consumers use price as an indication of quality. The higher the price, the better the quality. If your product falls into this category you may actually hurt your sales, and reputation, by pricing too low.
4. Sometimes, $100 doesn’t equal $100
The mind is tricky. A $100 discount on an iPod touch seems like an AMAZING deal! But give me that same $100 discount on a Toyota Corolla and I will be less than impressed. When a customer evaluates markdowns it’s in relative percentage terms based on the overall ticket price, rather than absolute dollars.
This works the other way around as well, for price increases. For example, upgrades on cars are more likely when ticket price is high: “sure, throw it in!”
Similarly, if you are in the B2B world, consider how much your product or service costs relative to your customer’s overall buy. If it’s a small percentage of the overall buy the customer will be less price sensitive.
5. It’s hard to raise prices, but if you do, make sure your costs have increased as well
Customers can be influenced to believe a price increase is “fair” if it is known that your cost of goods have increased (publicize your cost increases). As an example, just recently the chocolate maker Hershey’s stated it was raising prices by about 10% across the board, due to price increases in raw materials, fuel, transportation costs etc.
6. Odd is best, unless your product is the best
$24.99 is perceived as MUCH more affordable than $25. But don’t use this tactic for high quality image products where price is an indication of quality. It will make your product look cheap. You’ll never find Louis Vuitton selling their own handbags for $749.99.
7. The middle of the road is the safest
If given a choice of 3 service options, customers will often choose the one priced in the middle. For example, if a car wash offers three service levels, most people will choose the mid priced one. The least expensive one seems like you are missing out on key washing services, and the highest one seems like you might overpay. The one in the middle feels just right…
Consider if you can increase upsells by adding something expensive to your product line, even if you never sell it.
Tweet this: @onpm Your customer is only human – 7 Emotional Pricing Tactics #prodmgmt #prodmktg #pricing #sales
Laurie Peterson is an award winning product manager for interactive consumer products and websites. She is graduating from Haas School of Business in May of 2011. Check out Laurie’s product management tips and tricks at sfgirl.us/blog