These numbers may not be what you want to charge – because you may make more money by charging less – but they do at least provide a fair justification for a high price. If some customers are willing to pay £180,000 for a diamond necklace, then nobody should criticise you for charging £80,000 to provide the same basic benefit to another client.
When you have worked out the numbers for each benefit, add them all up. The total gives you a number you can use – if you need to – to justify your price.
Then look at your segmentation market research (Chapter 4) to see what evidence you have that people will really pay the price you want to charge. If the evidence doesn’t suggest that they will pay it, you may in fact need to reduce your asking price, or go out and ask more questions to test the market again. Remember that people are led by your asking price. If you ask someone how much they’ll pay for your product they will usually give a lower answer than their true willingness to pay. Imagine their answer is £5. The same person, if offered the product at £15, might well be willing to pay it. So to test accurately, you need to include the price point in your question, rather than expecting the consumer to tell you.
Finally, consider how much risk you are willing to take on the sale. Can you accept a return of the product if it doesn’t sell at the price you claim? Can you prove the value that it will create, or make your price dependent on value?
Chapter summary
• People often have expectations about prices which are hard to change.
• Sometimes these are based on ideas of fairness, and sometimes on assumptions about what others are willing to pay for an item.
• Intermediaries, distributors and resellers think differently from consumers.
• To combat these attitudes and launch a product at your desired price point, you may need to both provide evidence and offer some kind of guarantee such as a sale-or-return deal.
Chapter 6
Memory and expectations, trials and reframing your prices
The alarm clock went off at 5.20am on 1 September. It had been a long time since I’d woken up this early. I dragged myself out of bed and got ready.
By 7am, I was outside a central London branch of Cosanostra Coffee. The doors opened and I went inside to watch and wait for the reaction of the first customers.
The promotional stand looked good – it highlighted the new product, allowed customers to sample the quality chocolate and smell the delicately flavoured tea leaves that went into each teapot. I chatted with the counter staff, who were intrigued by the new product. Both of them had tried it themselves during trials and were willing to recommend it to customers, even if they were not quite ready to abandon their morning espresso habit yet.
I bought one myself with a promotional voucher Maggie had given me, and settled into a table near the counter to listen for customer reactions.
On that first day, the notable feature was how little the price mattered. Customers were motivated by curiosity much more than cost. The prices were within the natural range for an espresso-based coffee (between £2 and £3) and this seemed to be accepted by those who were curious enough to try one out.
One thing that did make a difference was the refund promise. The branch I sat in during the morning offered money back for anyone who was not satisfied. I moved to a different branch in the afternoon which was not offering the same deal, and they had sold only half as many teapots. The perceived risk of trying the new product was substantially reduced by the reassurance that at least the customer’s money was safe.
As I watched a few more branches over the next days, I noticed that some customers had examined the teapots on their first visit but did not buy until later. These people seemed to need to get used to the idea; and as one of them said: “It all looks very interesting, but I’m dying for an espresso.” Moving people off their planned decision path while they are in the middle of purchasing is hard. Introducing a new option before they’ve made up their minds is much more likely to work. Some people on that second day would have set out with the intention of trying that strange teapot thing they saw yesterday; others will have seen it on promotion for three or four days before being willing to give it a try. New products require time to be integrated into the range of potential purchase options for a consumer – and for some products, and some people, they never will be.
The following week I visited a supermarket branch on the first day they stocked the teapots. Sales were not so quick here. A few people browsing for a smoothie or yoghurt did pick up and look at a packet of teapots, but it was an hour or two before anyone bought one. I managed to catch her on her way out of the shop and ask what had led to the purchase. It turned out she had tried one in a café and wanted to have some at home. So the strategy of introducing the product through the café channel seemed to be working.
Sales gradually picked up in the supermarkets over the next few weeks, but an unexpected pattern developed. Smaller teapots, priced at £1.59, were selling out, while the large ones at £1.99 were staying on the shelves. Maggie came into one of the stores with me one day to see how the customers were making their choices.
“We’ve been thinking of increasing the price on the small teapots to encourage people to buy more of the large ones,” she explained. “The revenue isn’t quite meeting the retailers’ targets because too many people buy the small size. But we are not sure if we can put the price up without losing the customers we’ve already got.”
“Isn’t it worth losing a few of the current customers to get your revenue up?” I asked.
“In principle I wouldn’t mind. But this might be a critical time. We are just starting to build our base of initial loyal customers and I’d hate to annoy them. But if we get stuck with this price point we are either going to lose money ourselves or lose orders from the supermarkets.”
“So what are you going to do?”
A week later, I discovered Maggie’s answer. Three new packages appeared on the supermarket shelves: a larger size teapot, a premium variation with single-estate Ecuadorian chocolate, and a white chocolate version. All of them were priced between £2.10 and £2.49. The original large teapot remained at £1.99, but stock levels were reduced.
After another week Maggie emailed me the sales results for the new products – a success! Revenue per customer had increased by 12%. The product had been successfully reframed, increasing revenue without hurting existing customers.
A product launch is a pivotal moment because it creates expectations in your customers’ minds. Once established, these are hard to change.
Because it is hard to imagine and predict the future experience we will get from consuming a product, we must rely on our memories when we make a purchase. The memory of the last experience we had from a product or service is a complex and slippery thing, with many subtle attributes. The experience we will have when we next consume the product will be different on most of these dimensions. Is the weather different? Are we in a better or worse mood? More or less tired? But our memory of the price we paid last time is a single, simple number. It is much easier to compare today’s price to last week’s price than today’s subjective product experience with last week’s.
This makes it tough to change your prices. If the price today is higher than it was for the same product yesterday, this offers customers a clear reason (however insignificant the increase) not to buy. It is difficult for people to weigh up the relative importance of different reasons for a decision – but much easier to count the number of reasons for and against something. A price rise, tiny as it might be, is one reason against buying; a price cut, however small, is a reason to buy.
Therefore, no matter how clear your justification for a price rise – it may be a rise in the cost of ingredients, or the demand at the old price may be higher than you can cope with – it will hurt sales. You should look for ways to modify the presentation of your product so that customers do not do a straight price comparison between old and new. This is called reframing
the decision.
A common method is to change the size of the package, or offer an extra product feature. Another technique is to increase the baseline price but offer a temporary discount. Sometimes the solution is to change price so often that customers lose their memory. Take a look at the price of a two-litre bottle of Pepsi or Diet Coke in your local supermarket over your next few visits. In the last two months, my local prices have shifted between £1.40 and £1.99, including variations such as two bottles for £2.99, a promotional discount from £1.89 to £1.50, and a variety of labelling strategies: in some cases a £1.79 promotional price printed on the label by the manufacturer, and in others a £1.99 price label affixed by the shop. On one occasion, the price even went both above and below this range at the same time – £2.06 for one bottle or £4 for four.
This inconsistency has the effect of blurring the consumer’s memory of the standard price for the product. On those occasions when it is priced at £1.89, the buyer won’t feel the instinctive antipathy they often experience towards a price increase. It may still feel like the bottle is at the expensive end of the typical range of prices, but the negative emotional reaction that would be provoked by ‘the price has gone up’ is greatly diluted.
Size reductions are commonly used as an effective price increase, though they have the drawback of not directly increasing revenue. However, a smaller pack can create ‘space’ in the range for you to launch a larger version later. Notice that many chocolate bars, which used to be sold in a single size, are now sold in a smaller standard size, plus a jumbo or ‘king size’ version which is more expensive. This method often does work, though you may have to accept some grumbling from clients who notice what you are doing.
How to apply it
Based on the benefit matrix developed in Chapter 1, you should have a number of different variables on which you can differentiate your product. Make sure you always keep some of these in reserve – for example the single-estate Ecuadorian version that Maggie held back instead of launching on day one. This will give you scope to introduce new price points without annoying customers who have got used to the existing prices.
You may want to launch some of these new variations with a temporary discount to encourage people to try them out. Your goal is to break their habit of buying the cheaper product, so that you can phase it out, increase its price or decrease its size without creating resistance or hostility.
Monitor your customers’ reactions to the changes – not just when they are introduced but over time. The reaction will change over time, as they get used to the new strategies. Sometimes an initial price shock will put customers off, but they will return in time. Conversely, they might accept a change in price but as time goes on it will gradually prompt them to look elsewhere. A straight increase in price often has this effect: sales don’t drop off immediately but over a couple of months they slowly decline. You can monitor this by continually speaking to customers, not just in the abstract, but – where possible – at the point of purchase. Ask them why they just bought – or didn’t buy – your product. Ask them if they noticed its price.
The more price changes you make, the more data you will be able to gather about how customers respond to them. Not all customers will respond in the same way. If you are offering a business service to a small number of clients, it may be worth negotiating changes with them individually rather than applying a universal rule. If you are selling to consumers, you should make independent pricing decisions across different sales channels. (For most products, different sales channels, and therefore different buying behaviours, are more important than different demographics, so don’t worry too much about separately asking the opinions of 55-year-olds and 25-year-olds.)
Where possible, keep open the option of reverting to previous prices, sizes or product options. Occasionally a change simply won’t work, and you can often win back customers by switching back to a version of the product that they are already familiar with and in the habit of buying. If you plan the change correctly and manage it carefully, however, it is unlikely that you will need to reverse course.
Chapter summary
• Once a price precedent has been set, it is hard to increase.
• By temporarily varying prices downwards with a promotion, you will be able to raise them back to the original level afterwards.
• To increase overall prices you need to introduce new product variations or sizes.
In focus
Should you increase your prices in line with inflation?
Inflation drives pricing policy in several different ways. Your business’s costs will increase over time. The purchasing power of a given amount of profit will decline. Your customers will have more money (in cash terms) over time. And, most importantly from a psychological point of view, customers expect prices to rise with inflation. This expectation is something you can use.
At the levels of inflation we have seen in the last 15 years – even the unusually high 5.4% rate that the UK reached in 2010 – the real effect of inflation on costs and incomes is likely to be drowned out by the specific changes in demand and costs for your particular products. If your product is energy-intensive, you will have seen big swings in costs as oil prices fluctuated between $50 and $150 per barrel. If your service involves software technology, the salaries of programmers have gone up a lot in recent years, but demand is likely to have jumped even more. Inflation has rarely been one of the biggest direct influences on business in this period (with the exception of fast-developing countries, especially China).
However, people still expect prices to go up every year. And this creates one of your only opportunities to adjust price outside of a new product launch.
In general, customers are suspicious of changes in price. They will notice a rise in price – however small – and if they have formed a habit of regularly buying your product, a price increase is one of the prompts that might lead them to reconsider their routine. A price cut, of course, is unlikely to have the same effect.
Increasing your prices due to inflation, however, is accepted as a fact of life. It commonly takes place in January, and aligns with the end of Christmas promotions or sales. Some companies impose a flat increase across the board based on the current published inflation rate. This at least lets them keep up with the average increase of costs and prices in the market, but it can be a wasted opportunity.
A better approach is to use the inflationary increase as a way to adjust relative prices within your product range. It is likely that you will have seen reduced demand for some products or services during the year, and increased demand for others. This is a chance to capture some of the increased demand in higher profits, by increasing the price of the high-demand items a bit more. For items which aren’t doing so well, you might freeze or even cut prices. Customers are unlikely to work out the average increase overall, so there’s no particular need to make sure this averages out to the precise inflation rate.
Make sure you promote the prices you have frozen – a phrase like ‘Inflation buster’ lets you point this out while implicitly explaining why the other prices have gone up. Customers who are very price sensitive may switch to the price-frozen products – while those who stay with their normal purchases are signalling a willingness to pay more (information that you can use in future promotions).
Should you do this in January with everyone else? You could keep your prices fixed in January and promote this fact, to show your customers that while their budget is under pressure everywhere else, at least they are getting a good deal from you. The problem is that when you get round to increasing them in June, you might be the only company doing so – and some customers may switch to your competitors. If your whole industry has adopted an annual price cycle outside January, it is probably best to align with that. A better approach may be that followed by the Pret A Manger sandwich chain, which changes several items in its product range every month, and can therefore impose an average price increase without anyone be
ing able to tell. If an egg and roasted tomato sandwich costing £2.99 replaces a smoked mackerel baguette costing £3.50, is this an increase or a decrease? Only Pret’s finance department knows.
These small individual decisions make a significant difference across the whole economy. Economists suggest that a little bit of inflation is a good thing because it allows companies to make adjustments to relative prices and wages which people would otherwise resist. For an economy to grow, it’s important that prices and salaries adjust – so that products which are more valuable become relatively more expensive, and people who are more productive are paid relatively more – but this means conversely that people who are less productive or products less in demand must earn less money. Companies find it as difficult to cut salaries as they do to raise prices, but inflation does the job of automatically cutting wages by a few per cent each year; so companies can reduce the relative rewards for less productive people by simply not increasing the wage every year. In general, economies with inflation of 2%–5% a year are likely to be more flexible, and do better, than economies with either zero inflation or inflation in double figures.
Chapter 7
Anchoring
Sometimes a customer just doesn’t know what your product is worth to them. We are used to thinking of this as a problem. If someone doesn’t know the value of what you do, it feels as though they won’t be willing to pay for it.
That’s not necessarily so. We call this “unknown expected utility”, and it gives you a superb opportunity to shape the customer’s perception of what your product is worth. The primary method for doing that is called anchoring. I learned all about this on another visit to the teapot factory.
The Psychology of Price Page 6
