How do you determine a price for your goods and services?
This is actually a very complex question because the price has an enormous impact on how much product you’ll sell. And, the whole issue of pricing is ripe with myths. Use 1 of these myths to price your brand and you may be hurting rather than helping your brand.
Pricing is an often overlooked element of the marketing mix and many companies abdicate marketing’s role to their accounting or finance teams. This is a huge mistake, as you see as you read on. That’s because price sends clear messages that consumers interpret and use in making purchase decisions. Choosing to sell at the lowest price under the assumption that more consumers will choose your brand is sometimes a bad decision because consumers use price as only ONE element in making a decision and a low price might also send the signal that your product is low quality. If you ever shopped on the Wish app (or its highly promoted cousin Temu), which is full of cheap products made in China, you know the prices seem almost too good to be true and they are. After buying a few things, you might quickly decide the products aren’t worth even the low price as they’re made of substandard materials that don’t look as good as the pictures and take weeks to arrive.
The price you charge also determines profitability. A low price means you must sell a larger quantity to compensate and a high price might mean you sell fewer products but the relationship between the two isn’t linear and isn’t always true.
Pricing strategies account for many of your business factors, like revenue goals, marketing objectives, target audience, brand positioning, and product attributes. They’re also influenced by external factors like consumer demand, competitor pricing, and overall market and economic trends. [Hubspot]
First, let’s discuss some of the myths associated with pricing strategy before moving on to the psychology of pricing.
Myth #1 — use a standard mark-up
Using a standard mark-up is one of the most common strategies for pricing your brand likely because it’s so easy. To use this strategy, you simply add up all the costs associated with your product or service, then add 20% or 50% or some other amount (commonly you’re targeted ROI – Return on Investment) to come up with the final price.
Pricing using a standard markup is common for retail businesses and manufacturing — situations where you can easily determine how much each product costs. But, since the price doesn’t take into account consumer views of value, the price might cost you a significant number of sales.
Price myth #2 — you should price your brand lower than competitors
Pricing based on what competitors charge is also a common pricing strategy. And, for some goods, lower prices look very attractive. For instance, many people have little brand loyalty to their soft drinks and commonly buy either Coke or Pepsi depending on which brand is cheaper this week. If Coke were CONSISTENTLY higher priced than Pepsi, it is likely Coke would see a decrease in the amount of product it sold.
That’s Walmart’s strategy — to feature lower prices than their competitors such as Target or Kroger. Of course, lower prices come at a cost — and one that consumers pay. Walmart can only keep prices lower by paying less for the items they stock. WalMart pays less because they buy huge quantities of a select number of options in each product category. This reduces the options consumer find in their local Walmart store and creates conflict with sellers that may result in other problems down the road.
Price myth #3 — consumers prefer the cheapest products
This is actually a dangerous myth because it leads businesses to make bad pricing decisions — it’s also the reason marketing broke off from economics 95 years ago this month. The image below shows the demand curve you learned in Econ 101 but this only applies when there’s no intrinsic reason to prefer one band over another. Sure, when it comes to buying a commodity like apples, consumers want the cheapest ones around. If you charge more than everyone else, you won’t sell a single apple.
But, when products are different (branded), consumers vary in their responses to price. Apple is an excellent example of this. Apple products sell for a significant premium over all their competitors — from iPhones to tablets to computers. Are their products so technologically superior that they do tasks better or last longer? Don’t even get me started on THAT debate. But, the reality is that their price premium has little to do with their technology and everything to do with their brand image and brand loyalty. Apple owners would rather fight than switch (to borrow the slogan from a cigarette company). Buying Apple products is a symbol of coolness that Apple owners are willing to pay for.
Price myth #4 — companies that charge more make more money
This is categorically untrue. In fact, LOWERING your price may actually generate more income than a higher price. That’s because income is a function of both price and quantity. So, when lowering your price leads to enough additional sales, you can make MORE money by lowering the price than charging a higher one.
In fact, it may be better for a firm to lower its price rather than spend a lot of money advertising its brand heavily. Of course, this only works for brands that already have sufficient advertising to make consumers aware of their products in the first place. Firms can use sensitivity analysis to determine when lowering their price makes sense.
Pricing myth #5 — you should charge the lowest price you can
This is a corollary to myth #3 which assumes consumers buy the lowest-priced brands. In fact, especially in cases where it’s hard to determine how “good” something is, consumers often use price to tell them something is good or better than something else. Cialdini tells a story in the first version of his book Persuasion about a store selling jewelry. The store owner leaves word to discount the jewelry by 50% so she can get rid of the slow-moving inventory and replace it with something that might sell better. She comes back from a trip to discover her strategy worked — all the jewelry is GONE. In discussions with her manager; however, she discovers the manager misunderstood her instructions and doubled the price of the jewelry.
So, how do you explain that the jewelry sold better at twice the price?
Easy. At twice the price the jewelry appeared to be genuine, while at half the price, the jewelry appears to be cheap costume junk. Enter the concept of value that is the true driver of consumption decisions, as we’ll discuss later.
Of course, this pricing strategy only works with products that consumers find difficult to judge (determine their true value) — jewelry, professional services — and items that only show their value over a long time — cars, major appliances, furniture.
Price versus value
These myths exist because firms fail to understand that consumers exchange money for benefits. In economic theory, consumers are utility maximizers who want the most stuff for the money. In this theory, consumers trade off money for more stuff. However, if your brand provides better or more benefits, it can charge more and still provide excellent value. And, remember, some of the benefits might be psychological rather than tangible benefits.
Often the right pricing strategy varies by product category.
I talked a little about bundle pricing in my last post. But, there are more psychological issues when it comes to pricing a bundle. For instance, an HBR article shows that customers make very different decisions based on the price of products when bundled together. For instance, a phone bundle that includes the phone, a case, earbuds, and a screen saver often convinces a customer to buy the bundle at a higher price than buying the phone because the price is lower than the price of buying the entire bundle separately, even if they likely wouldn’t buy all the products in the bundle without this offer. This suggests businesses benefit from knowing how consumers think about their prices.
Pricing based on product category
One of the biggest challenges related to pricing is accepting that consumers DON’T always buy the cheapest brand. We seem to think that price wars are the best way to gain customers and that’s often wrong. So, let’s take a look at how most customers look at pricing based on product category.
Products (both goods and services) are categorized as:
- Convenience — including most grocery store items and other low-involvement products
- Shopping — things you care more about, like clothing
- Specialty — expensive, high-risk items such as cars and furniture
- Unsought — things you’d rather not buy, such as funeral expenses
How do product categories impact pricing? I’m glad you asked.
Generally, prices are more important for convenience items because you buy them frequently and don’t care a lot about them. For instance, if you want meat for dinner, you might consider chicken because it’s less expensive than beef. If Green Giant beans are on sale, you might buy them rather than Del Monte. Generic goods survive in this arena by offering manufacturers more volume by selling their products under a generic label, thus allowing them to offer two-tier pricing that optimizes revenue.
Online price comparison is really easy, so if you’re selling convenience items, you’ll likely feel a lot of pressure on your prices — you’ll need to be at about the same price point as your competitors.
Shopping goods have a lot more flexibility in terms of pricing because the brand name is more important to consumers. If you really like the way a pair of Levi’s fit, you’re not likely to settle for a cheaper brand. More likely, you’ll wait for a sale or purchase fewer pairs of jeans, rather than settle for a brand you don’t like.
Online competition in the shopping goods category comes from off-price etailers offering name-brand products at discounted prices and discount outlets that act as a means to sell products that were seconds or left over at the end of a season.
Specialty goods – are often expensive, purchased infrequently, and consumers have a lot at stake when buying them. Hence, price becomes relatively unimportant. Instead, consumers likely set a range of prices they can afford. If your product fits within their range of prices, they’ll consider it. If not, you’re out. We call this the consideration set and consumers may use other criteria to determine whether a product fits in their consideration set. Basically, consumers compare products within the consideration set without consideration of whether the product is the cheapest in the set.
So, if you’re looking at cars, you may have a variety of models you’ll consider within the $10,000 – $12,000 range. You don’t necessarily buy the lowest-priced model, but the one that fits your needs the best from the models in this price range.
Unsought products include things like insurance, emergency products such as a replacement for a flat tire, coffins, and healthcare. Because these products are considered immediately necessary, consumers often don’t care how much they cost. This is especially true in the case of healthcare because someone else pays most of the bill. Don’t believe me? When was the last time you asked around to see which doctor performed an appendectomy cheapest?
Because there’s little price pressure on unsought products, especially emergency ones, the prices are way too high — hence why healthcare cost increases far exceed inflation.
Understand customer goals
Knowing what products consumers want most helps in determining your pricing. So, if you’re Domino’s Pizza, knowing whether consumers want your pizza or pasta most, helps in determining the price that results in the biggest order. If the consumer really wants a pizza, offering pasta at a lower price might convince them to add it to their order. The opposite is true if the consumer really wants one of your plates of pasta.
In the real world, you can’t individualize pricing, but online, it’s a snap. Just track what product the visitor searched for first when they entered your website — likely that’s the one they really want. At checkout, offer a reduced price for the pasta (or any other add-on) and the chances of increasing the total purchase increase significantly. The experiment reported in HBR shows consumers prefer this to getting a small discount on the pizza and pasta combination — even when the resulting price is the SAME.
Similarly, add the cost of shipping to your online products (high value) rather than charge shipping separately (low value).
Offer low-value items free or at a reduced price
Sometimes consumers don’t put a high value on certain items in your inventory. Bundling these items for free or at a very reduced cost increases the chances they’ll buy items with a higher value. Clinique uses this strategy. A couple of times a year, they offer free products with a $25 minimum purchase of other products and the lines circle the counter with women who wait for the free bundle before buying refills (and it draws in new customers, as well). The bundle normally includes lipstick, moisturizer, maybe mascara, and some eye shadows — all in an attractive bag.
Not only does the free bundle provide a strong incentive for customers to buy products, but it also allows them to sample other Clinique products they’re not already using, which encourages them to buy these products in the future.
Price of high-value add-ons
Actually, this isn’t part of the HBR article, but it works. Let’s say you don’t want to offer a low price on the product everyone wants from your firm — in our Dominos example, it’s the pizza. Why? Remember from the first post in this series, price impacts how consumers assign value to your brand — a cheap pizza can’t be very good. Or, maybe you don’t want to get into a price war with your competitors — like Pizza Hut and Papa John’s.
What’s your solution? Offer other items to make a bundle at a really low price. In my house (and probably many others) we want breadsticks with our pizza (like the pizza alone doesn’t contain enough carbs). While I might be indifferent between Domino’s and its competitors regarding the pizza, I’ll likely order from Domino if you offer a large discount on the breadsticks.
Coupons and discounts
Coupons and discounts increase sales, right? Well, maybe not. A recent experiment shows that consumers aren’t any more likely to choose a high-value coupon than a low-value coupon in certain cases.
And, consumers may suffer coupon burnout, meaning that they’re bombarded with so many coupons, they don’t really feel motivated by them. A recent survey by Kissmetrics shows surprising results based on coupons and discounts.
- Only about 1/2 of consumers say a coupon will make or break their decision about which brand to purchase
- About the same number of consumers say they spend more when offered coupons
- Only 42% of consumers view coupons as very or extremely influential — although 86% consider coupons somewhat in making purchase decisions
- About half of all consumers decide on the brand first, then search for a coupon — implying the consumer would buy the brand at full price if they couldn’t find a coupon. Thus, coupons result in lower ROI, without a substantial impact on sales.
- Coupons had the greatest effect in remarketing campaigns aimed at those who abandoned their shopping cart.
The downside of coupons and discounts
Of course, reduced ROI is only one result of offering coupons and discounts. Here are some other major drawbacks to offering them: Coupons/ discounts
- don’t generate customer loyalty
- don’t increase satisfaction with the purchase
- consumers become used to them and won’t buy unless you’re offering them an incentive, this happened when a former Apple retail employee took over at JC Penney and removed all sales, which is the norm at Apple stores. Instead, he created a section of the store featuring discounted products that weren’t popular or past season and everything in the store sold for full price always. But, JC Penney customers were used to their weekly sales and didn’t want to shop in the store without them.
- can create price wars resulting in lower profitability for all firms
- may lessen the brand image
Others are equally cautious about using coupons, citing similar drawbacks. That’s especially true for BOGO (buy one get one free) offers, which may be more than any consumer wants. For instance, offering buy 1 pizza get 1 free might exceed most consumers’ needs. Or offering a free product with purchase means you must have sufficient capacity to satisfy the demand for both products.
A freemium pricing model is very common for software firms, especially SaaS companies. The model works by giving access to a free, stripped-down version of the product then hope to move customers to a premium version with more bells and whistles. this works because the incremental cost of adding a new user is so low, that a company can add as many users as it can without increasing its cost much.
The advantage of this pricing model is that you bring in a bunch of customers with the free version. However, moving them to a premium version has some problems.
First, free members don’t like to discover you’re discontinuing their membership when you move to a paid version of the product. Or, that you drastically change the offering to convince members to convert to a paid subscription.
Another problem with this pricing strategy is that the stripped-down free version might not do the job so it presents your product in a poor light.
Finally, you don’t make any money on the free version, which may mean you lack the resources to improve your paid versions.
The same is true for free trials of software. However, many free trials involve a steep learning curve (ie. Adobe Creative Cloud), which means users can’t learn to do anything of value in the free trial (Adobe’s is only a week), or that they’re unwilling to invest the time necessary to use the software knowing they won’t get to use it for very long. For instance, using the Salesforce free trial means entering information into the Salesforce database for your customers and prospects, which is a daunting task if you have a large database. And, if you have a small database, it’s easier to manage it without the use of Salesforce. Hence, you would only use the free trial if you were already pretty convinced you wanted to buy Salesforce.
I hope this brief treatment of pricing strategy convinced you to spend more effort in developing a strategy based on sound marketing considerations so you can improve your company’s performance.
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