The Psychology of Price

by Leigh Caldwell

  “Well, no, of course not,” Elise replied. “Why would I pay more if it was available for a pound less?”

  “Sure. So let’s say you go into the store and it turns out the £1.10 version is a smaller pot and the chocolate isn’t your favourite kind. What is your favourite, by the way?”

  “I like the bitter kind – Green & Black’s is what I usually buy.”

  “OK, so this one is a Cadbury’s Dairy Milk teapot. Still interested?”

  “Not sure – I suppose it depends on my mood. But I’d probably give it a miss and buy the one I originally wanted.”

  Maggie thanked her and walked outside with me.

  “So here’s the main point about demand curves. You have a customer there who’s ready and willing to hand over £2.10 to you. But if you set your price at £1.10 – sure, you’ll get John and the other guy to buy from you, but you’re giving free money to Elise. She told us she’ll pay £2.10, but if we offer it for less, of course she’ll take it for less.”

  “So what are you going to do? If you sell it for £2.10 you’ll lose the business of the other two.”

  “Indeed. What we really want to do is find out from each customer, as they walk into the shop, how much they are willing to pay. Then set the price to exactly that amount. That way, we’ll get the maximum amount from each customer. We might even be able to win over the 40p customer as well, if we can manufacture the product for less than that. If we can do that, we’ll make £4.75 from these four customers – 50% more than we first thought.”

  I protested that this was ridiculous. “Nobody’s going to tell you what they’re willing to pay and wait for you to change the price tag. Why would they? And anyway the shops aren’t going to run around and retag the product for every customer.”

  Maggie nodded. “Absolutely not. But this is where we can be clever. The reason that Elise is willing to pay more than the others is that she puts a higher value on some aspects of the teapot than they do. If we can find out what those are, we can make different teapots for each customer, and each of those can have a different price. We can make a Green & Black’s teapot for Elise, a Dairy Milk teapot for John and a ‘Basics’ own-brand teapot for Mr 40p. Each customer pays the appropriate price and we get maximum revenue.”

  “And what if the person who’ll pay £2.10 actually prefers Dairy Milk?”

  “We need to find another aspect of quality that they value more. We can still make a high-quality milk chocolate version. Or maybe a luxury brand image will appeal to them, or a larger size pot. That’s what our market research will help us find out.

  “We are looking into people’s minds and getting them to reveal what they’re thinking, not by telling us directly, but by which product variation they choose to buy.”

  Case study

  Cereals at Tesco

  In researching this chapter I visited my local Tesco. It’s a large store so has a wide range of products. Certain categories are highly prone to price discrimination. I picked breakfast cereals.

  A box of cereal is available for as little as 31p (Everyday Value Corn Flakes) or as much as £4.39 (Jordans Super 3-Seed Granola). Each of these gives approximately 15 servings, so they are roughly comparable.

  This doesn’t show what an economist would call ‘pure’ price discrimination – where you charge different prices for exactly the same product – but that is very rare. In reality, people who are willing to pay more do get a better product: undoubtedly the Jordans cereal is tastier and, if you care about organic food, it’s better on that dimension too. But the key principle is there: Tesco doesn’t lose the custom of people who don’t value their cereal much, or can’t afford Jordans. But they also don’t lose the extra profits from the wealthier customers who are willing to spend more for quality.

  Those in the middle get to buy Kellogg’s Crunchy Nut Cornflakes at £2.68, Tesco Blueberry Wheats at £1.75 or Country Barn Maple and Pecan Crisp at £1.05. And those who are on a very tight weekly budget and don’t even want to spend 89p can get a mini box of Basics cornflakes for just 65p. There is a product for everyone, wherever they are on the willingness-to-pay spectrum.

  Maggie’s method works in every kind of business. Nearly every market contains a range of customers: some who are willing to pay more, either because they value the product more highly or simply because they have more money; and others who are willing or able to pay less. If you sell a standardised product, you can use Maggie’s method of product differentiation to extract more money from higher-end clients.

  It’s even easier if you are preparing bespoke quotations for each prospect, say if you’re a lawyer or a consultant. You can simply put a different price on each service according to what you think the customer will pay. You may not know this for every client, though. Sometimes the prospect has a budget and they won’t tell you. Or sometimes, like John, the client may not really know what they are willing to pay until they see what is on offer.

  For these clients you can do what Maggie does with the teapots: offer a range of different options and let the client self-select into their budget category. You may have a rough idea – for instance in a public tender, the client may tell you they expect to spend £50,000–£100,000 (or you may know this because of the way in which they announce the tender – if they invite competitive quotes but do not advertise it formally in the relevant official publications). Then you can pitch three options to cover this range. Or you may have no idea at all, in which case you can design a wider range of packages covering a broad price range.

  The demand curve now looks like this:

  Diagram 3

  Quantity sold

  Instead of earning the revenue in just one of the three rectangles, you can earn the combined area of all three. Often this results in an increase of up to 50% in total income.

  The difference between this and the anchoring approach is that, in this case, the customer already has some idea of what they are willing to pay, but you don’t know what it is. Anchoring is more useful when the customer has no idea at all and you want to shape their expectations.

  Some companies, when using this technique, sell the lower-cost products under a different brand. This is especially visible in the fashion industry, where top designers (Giorgio Armani, Donna Karan) will launch ‘diffusion’ brands that may refer to their name but are clearly distinct (Emporio Armani, DKNY). Sophisticated buyers know that the original brand is designed and manufactured independently from the diffusion brand, and the existence of the cheaper product does not damage the brand image, but the diffusion label still borrows some of the cachet of the original name.

  Case study

  Jewellery maker

  LM, a jeweller, has two distinct customer groups: individuals who wear his pieces; and retailers who sell them. For simplicity we will focus on the individuals: small shops are often content to simply set a retail price which is double the wholesale price, so LM has a lot of control over the end-price offered to consumers even via the retail channel.

  Jewellery is valued in part according to the rarity of the materials used – diamonds are more expensive than rubies, and platinum costs more than silver. However, materials costs make up only a small share of the price of most pieces, so the real determinants of price are the designers’ and makers’ skills.

  This creates an opportunity to shape the perceived value of each object through pricing.

  We start, as usual, with an analysis of the consumer’s values.

  • Making myself look beautiful.

  • Impressing my partner with a thoughtful gift.

  • Showing off to my friends.

  • Creating a token of our memories.

  • Acting as a symbol of our relationship.

  Each of these can be communicated or reinforced with a particular pricing choice.

  Let’s take as an example ‘Making myself look beautiful’. Often this value is satisfied by proxy – a person may buy a bracelet or necklace for their partner in the hope t
hat the partner will like it. There is a great deal of uncertainty for many people in making a purchase like this; they feel unsure about whether their partner will actually like the piece.

  Price is a good way to provide implicit reassurance that they will. The jeweller, while not knowing the personal taste of the recipient, is in a good position to know what customers in general are likely to like. So LM creates a hierarchy of products – in the bracelet case, starting at £120 and going up to £250, £390 and £750. He decides to decorate the cheapest bracelet with fussy and inelegant flourishes to make it clear that this bracelet, although it’s available if you really want it, is not the right choice for someone who wants to impress their new lover.

  As price goes up, the aesthetic initially becomes simpler and more classic, with subtle details introduced at the high end – details which add nuance and distinction to the design, but are inconspicuous enough to avoid ostentation.

  A lot of buyers who are not confident to make a decision purely on aesthetic value will be guided by the pricing structure into an understanding of which bracelets are regarded as the most beautiful. In case anyone does not get the message, the £120 bracelet is originally sold at £140 and clearly marked down to £120. Similarly, the £250 piece is reduced from £290.

  A money-back offer is available on full-priced merchandise, so that if the recipient doesn’t like it, it is easy to return it and choose an alternative. However, this offer is not available on sale items – and thus the buyer who wants to be absolutely certain has another reason to choose a higher-end product.

  To support the price distinction it is important that other product attributes are consistent with the pricing message. Thus the £750 bracelet contains platinum, or a higher grade of gold, and is heavier. The £120 bracelet might be silver, or a thin, light and slightly flimsy gold band.

  Some suppliers do not like the idea of making a product which is deliberately designed to be less attractive than their premium offer. However, it can be shown in economic theory that this approach achieves the best combination of price and quality to make the products available to as many people as possible.

  LM decided to use a different brand name on the £120 bracelet, in order to maintain the exclusivity of his name, and to more strongly define the expensive items as high-quality pieces. This is a good approach to positioning, and keeps his options open for mass-market sales of the lower-quality brand – a diffusion label – if he should choose to pursue that strategy later.

  How to apply it

  To use this technique with your own products, you need to figure out two things. First, what is the range of willingness to pay across your potential customer base? Second, what factors do they value which you can use to customise and differentiate your product range?

  Both of these can be estimated by talking to customers. In my own work, I use different interviewing techniques to elicit what people are really willing to spend – just asking them the question is unlikely to get at the real answer. There are some examples of these interviews in the next chapter, and at www.psyprice.com. You can also find out on the website how to get in touch with me if you’d like to find out more.

  Working out what customers value is sometimes easier – you can do a lot of this yourself by just putting yourself in the customer’s place and thinking about why they might buy your product or service. This process is called value modelling and it is a basic step for many of the techniques in this book, so I recommend you do it either now or soon, before testing out some of the more advanced approaches. You can use the table on page 39 to record the values that your customers hold.

  Once you’ve filled in some initial values, try bringing this table to some customers or potential customers and talking through their reasons for buying your product or service. They’ll probably come up with some values or benefits you hadn’t thought of before. And if they mention ones that you already have, put a mark in the second column so that you have a record of how often people mentioned this particular value (see the example on page 38). This will give you an idea of how important it is and to how many customers.

  Talk first to them without showing them the table, so you get their unprompted thoughts. Then if the conversation runs out of steam, you can show them the table and see which of the values you already have written down they agree with. Be warned – you will probably get more than you expect! Most times when I do this exercise with a business we come up with 20 to 30 values on our own, before we have even spoken to their customers.

  After this, you should take the top answers – usually the top five or so – to a new set of potential customers and ask them what kind of product they would associate with those benefits. In the example below, with top-quality chocolate and luxury brand image, they might talk about Green & Black’s or Godiva chocolates. This will give you an indication of the price level you can charge.

  Next, pick various subsets of the benefits that will fit naturally into a differentiated product range. Think about designing product or service packages that emphasise different combinations of the benefits. For instance, perhaps the top benefits of your chocolate are that it tastes good, feels like an indulgence, is fair to cocoa bean farmers, and is friendly to the environment. You could design a more expensive product which emphasises the luxury aspect, with better packaging and tasting notes. You could develop a version with an extra subsidy to the farmer – a ‘super-Fairtrade’ version. Or you could sell a non-organic version for more price-sensitive customers.

  Value

  Frequency

  Quality of chocolate

  llll

  Luxury brand image

  ll

  Chapter summary

  • Different customers have different budgets, which are reflected in the amount they are willing to pay for your product.

  • To maximise your profits, and ensure that more customers have access to your products, you should design a range of prices so that those customers willing to pay more can pay more. This is called price differentiation or price discrimination.

  • In order to encourage better-off customers to pay more, you should differentiate the products and offer a more expensive version that is more attractive to them.

  • To work out how to differentiate the products, look at the values or benefits that the product gives to your customers, and design product versions that provide different amounts of those benefits.

  • You may have to deliberately reduce the appeal of the cheaper versions of your product in order to encourage wealthier customers to pay for the expensive version.

  Chapter 4

  Segmentation

  ‘Customers don’t know what they feel, don’t say what they know, and don’t do what they say. Market research is three steps removed from real behaviour.’

  Ascribed to David Ogilvy, founder of advertising agency Ogilvy and Mather

  I next saw Maggie on a street corner in the City of London.

  She’d asked me to meet her there to watch her interviewing people as they passed – and while I waited for her to finish with some real customers, I decided to try answering her questionnaire myself.

  1. How often do you drink tea?

  Once every two or three days

  2. What kinds of tea do you normally drink?

  Breakfast tea, sometimes Darjeeling. Occasionally peppermint

  3. Where do you buy your tea?

  Sainsbury’s or Costa

  4. What are the experiences or feelings you most associate with drinking tea?

  A nice relaxing drink before bed. Or something to drink at work when I’ve had too much coffee already

  5. If you decided not to have a cup of tea, what might you have instead?

  Decaf coffee

  6. What do you eat or drink alongside tea?

  Bacon roll. Or a croissant

  7. Here’s £10. If I asked you to go and spend some of it on buying tea, where would you go?

  Starbucks, probably

 
8. How much would you expect to pay for it there?

  £1.40, perhaps?

  Over the next half an hour I watched some people answering the last couple of questions. Maggie was moving back and forth between two adjacent streets, and it was noticeable how much the answers were influenced by where people were standing. On one street there was a branch of Tesco, and people tended to point to it when offered their £10 note. On the next street there was no supermarket, but there was a Starbucks across the road. And most people on that street said they would buy at Starbucks.

  Maggie explained: “Most people don’t have strong opinions or even very clear memories of the products they buy. So it’s quite easy to influence their answers by changing the way you ask a question or the environment they are in. In fact, one of the things that market research can best measure is not the actual answers to the questions, but how easy it is to influence the decisions people make.”

  “So if you figure out that 60% of people will change their answer according to which street they’re standing in …” I started to ask.

  “ … then we know that’s how many people are likely to be susceptible to being pointed towards one shop or another to buy the product,” she replied. “Quite useful to help us design our promotional offers or adverts.”

  Over the course of the day Maggie had collected about 40 questionnaires, and she said there were another 200 back at the office. The next week we met again and she showed me some of the results.

  Segment

  Willingness to pay

  Other attributes

  1

  5p–15p

  Never buy tea outside the office or home; always brew it themselves

  2

  50p–75p

  Tend to like “builder’s tea” with sugar – use as a morning stimulant