What tactics do you use in your pricing strategy? There are various ways, such as running promos like “buy one, get one free,” or branding it into your customers’ minds like “everyday low prices.” Some coupons discount 20% off any item in the store or offer subscription discounts versus buying one-time that you submit at the online checkout. However, I learned that organizations make a common mistake in pricing, and you can use science to correct it.
We discussed the tactics and pitfalls of pricing strategy in a recent podcast. At first glance, the general pricing strategy seems basic: get the highest price possible that sells enough widgets to make an excellent profit. However, it turns out that there is more to pricing than that, and no surprise here, some of that extra bit is psychological.
There are two ways to analyze pricing: quantitatively and psychologically. Pricing can produce excellent data, which you can analyze quantitatively and do a lot of fantastic things. There are also psychological impacts of pricing, discovered and published in the behavioral pricing research literature. Neither quantitative nor behavioral pricing analysis is correct while the other is wrong; many times, the two ways to look at the data don’t even conflict.
Price Elasticity of Demand is an example of a concept introduced by the behavioral pricing research literature. Price Elasticity means that people are sometimes more sensitive to price changes than other times in layman’s terms. You can take pricing data and purchase data and compute elasticities around it. Then, you can use those computed elasticities to guide you in making future price changes.
In other words, these two ways of looking at pricing are collaborative, not combative.
Pricing is an area where quantitative people look at behavioral pricing findings and incorporate them into their models. Many of the behavioral pricing folks will also look at the results of the quantitative models and try to develop theories around them.
People are responsive to pricing changes. You find out how much by changing the price and seeing what that does to your demand. From a fundamental perspective, you can see you sold X number of widgets at this price. Then, you reduce the price by ten percent and see you sold Y amount. If the difference between X and Y is only a small percentage, then it means the demand was inelastic around price. In other words, changing the price did little on the sales side. However, if the difference was significant between X and Y, then changing the price did change things a lot on the sales side.
Elasticities are a powerful tool, but they’re also limited by the data that you have. Moreover, you must be careful that the pricing is the only change in the demand situation. Usually, it’s more complicated than that. For example, in a grocery store, you might have reduced the price of your product, and it affected sales. However, did you advertise the price? Through what channels? Was there an end-cap display? Was there signage that pointed the customers to the “deal?” Moreover, these are only the things you can control. What your competitor is doing in the marketplace can also affect what your customers buy from you.
So, the beautiful part about pricing is that we do get these numbers out of it, which produce clean quantitative models. The downside is that even the most sophisticated models that we have do not capture all the influences on those numbers. The most effective pricing models will incorporate as much of that influential data as they possibly can. However, I would caution you to avoid putting blind trust in your models’ output since some unknowns are in the mix.
The Two Levels of Pricing
For my part, everything seems to be on a constant sale. So, discounting pricing appears to be a favorite strategy. However, is there more to pricing strategy to drive customer behavior?
Not surprisingly, the answer to my question is yes. Pricing strategy occurs in two levels: individual products strategy and general price impressions.
With pricing strategy around individual products, you try things with the price to make the sales numbers increase using a set of strategies and tactics involving the established price, and the rate and frequency of the discount, among others.
The second level is general price impressions. General price impressions are what people form about your brand. Some brands have a high price impression, and others don’t. It’s like the difference between the price impression of a Rolls-Royce versus a Kia.
Retailers can have that general price impression, too. Walmart has a different price impression than Neiman Marcus. Therefore, in these cases where the general price impressions influence customer behavior, there are other strategic concerns for pricing. Their prices are part of the brand for the store.
Many decisions customers make on those two different levels will be consistent. If you make a lot of the individual prices in your store low or seem low, then the store will likely seem to have lower prices, i.e., Walmart and its everyday low prices. However, suppose you charge $800 for a designer necktie at Neiman Marcus. In that case, most people will have a high general price impression of your store, even if you price other things amongst your offerings more reasonably.
However, we sometimes discover that our general price impression was wrong once we take a deeper dive into the individual pricing strategy. I was doing some shopping on the Publix app the other day. Publix is a grocery store in the Southeast US. It has a high general price impression, combined with a reputation for high-quality goods and a high level of customer service. However, I didn’t want to overpay for groceries, so I also downloaded the Walmart app. After comparing prices between the two brands, I was surprised to learn there wasn’t a significant price difference between the two, even though my general price impression of each brand is quite different.
Now, on average, Publix is more expensive than Wal-Mart, but not by a lot. It was a pleasant surprise. It turns out that we humans have a hard time with magnitudes in our general price impressions. We get it at a product level but not at a comprehensive level for the entire experience.
So, What Can You Do with This Information in Your Pricing Strategy?
There are some strategies you can use to use science in your pricing strategy. Start by understanding the following:
For most stuff, people don’t have great reference prices, so give them one. People don’t always know what an appropriate comparison for your price is. There are exceptions. If you drive a lot, you probably know how much gas is per gallon. If you shop for groceries, you can estimate the price of a gallon of milk. However, if you don’t drive or do the grocery shopping, you probably don’t know either of those basic prices. Therefore, if we know people don’t always have great reference prices, we can make a price more attractive by giving people reference prices making our price look more attractive. For example, Amazon might have the price struck through and a new price listed next to the items you are considering. That’s because you might not have a reference price for a lamp/hockey stick/hairbrush when you initiated the search, but now you do because Amazon gave you one. Amazon gave you a way to evaluate the price. This strategy is anchoring, which provides people with a starting point from which to negotiate. One of the results most replicated in research on pricing is that if you give people a reference price, they’re going to use it—and hopefully evaluate your price more favorably.
People will skip complicated mental math when comparison shopping. “Buy one, get one free” works to obscure comparisons. If you are comparing two brands of Ginger Ale at the grocery store, you can compare those prices easily. However, if one of the Ginger Ale brands throws in another bottle for no additional money, the math gets harder (not really; the price per bottle reduces by half, but I digress). Because the math with buy-one-get-one-free offers involves another step, many people won’t bother, eliminating direct comparison. (Moreover, the buy-one-get-one-free promo promotes stockpiling, which is a win for manufacturers and retailers. If they can get you to pull forward that demand and buy all those Ginger Ales simultaneously, they will. After all, why should they put off a sale until tomorrow when they can get you to buy it today?)
Now, putting these two pricing truths to use has some practical advice:
- Determine your pricing goal. I would encourage you to recognize that there are multiple pricing goals that people can have. So, is your pricing goal to move this one item or service? Then, there’s a set of pricing strategies that work for that. Is your goal to create a price impression for the brand overall or the retailer? That requires a different approach that collaborates with your individual pricing strategy; otherwise, you can send mixed signals. So, know what your goals are and what’s important to manage.
- Know what reference price your customers have. Often, we assume it is our competitor’s price. Sometimes it is, but sometimes they’re comparing our price to a different category, like a previous experience. If the last time you bought a refrigerator was ten years ago and you remember what you paid for at that time, you’re going to be shocked when you go back to purchase refrigerators now.
- Consider how you can influence those reference points. Can you give them other reference points to use, comparison ads or markdowns, etc.? Controlling those reference points can help your price look better by comparison.
- Don’t oversimplify pricing influences. Remember, like everything in the Behavioral Sciences, pricing is complicated. Pricing strategy requires some attention, deliberate design, and testing to get right. From a learning perspective, try to understand the variables influencing pricing to illuminate your quantitative findings, like seasonality, competitive disruptions, or economic conditions. The combination of both hard data and psychology will help you establish a winning pricing strategy.
It’s no surprise to me that some organizations devote substantial resources to managing pricing strategies. It’s an essential and evolved area. However, by understanding the influences, managing the parts of the decision-making process that you can, and being deliberate and flexible, you can ensure that you stop making pricing mistakes and use science to help you ensure that the Price is Right.
To hear more about this idea in more detail, listen to the complete podcast here.
Colin Shaw is the founder and CEO of Beyond Philosophy, one of the world’s leading Customer experience consultancy & training organizations. Colin is an international author of six bestselling books and an engaging keynote speaker.
Follow Colin Shaw on Twitter @ColinShaw_CX