The Psychology of Price

by Leigh Caldwell

  If you already sell to businesses, you may want to look at how to make your product especially attractive to people who are not owners of the company. How can the HR director, or the chief financial officer, or the head of sales, improve their career prospects by buying from you? What are the metrics and statistics that might be important to them (productivity, lower tax, meeting their annual budget or sales targets)? What ammunition can you give that will enable them to confidently buy from you and defend their purchase to the board or the shareholders?

  Chapter summary

  • If a buyer is making a decision to spend money on behalf of their company (or some other third party) it takes away a lot of the emotional barriers to spending.

  • There are still emotions present, however, particularly relating to the buyer’s reputation, or their responsibility to be careful with their stewardship of resources.

  • Once these barriers are overcome, the decision can become much more like the rational marginal-benefit decision of classical economics; it often becomes easier to upsell new features when their benefits can be demonstrated clearly.

  In focus

  Should you publish your prices?

  This question is irrelevant for some businesses: in the retail world, and for most consumer products, your prices are on display and this is fully expected.

  For others, this is a crucial question. In business-to-business sales especially, it’s a major dilemma. Should you publish your prices on your website, so that your competitors can see them, as well as your customers, or should you wait until a customer asks and then give them a personalised quote?

  There are different levels of transparency, too. Some businesses will send potential clients a price list if they call and ask, but do not want to include it on their website. A restaurant might include prices on its menu but will lay out the document in order to play down the price so that diners are less likely to use price as a factor in their decision.

  The arguments for publishing are:

  • it sends a signal of honesty to your clients and helps them trust you more

  • it is seen by many people as a fairer approach, since they fear you may otherwise set the price according to how much you think they can pay

  • it simultaneously qualifies out customers who are not willing to pay your price and attracts customers who are annoyed at your competitors’ lack of transparency.

  The main arguments against are:

  • it makes it easy for competitors to undercut you

  • you really do want to set the price according to how much you think the client can pay.

  The right answer will depend on the market you are in and the competitive context. Sometimes companies collectively hide their prices until one competitor moves first and publishes, forcing the others to do likewise. If so, it’s likely to be the lowest-cost company that starts off the process, as they have the strongest interest in encouraging buyers to compare on price.

  Sometimes you can strike a balance by publishing, or emphasising, a low-cost option with the intention of upselling once the customer has started to engage with you. If you consider this option, be aware of the ethical and potential legal issues over ‘drip pricing’. In the UK (in fact throughout Europe) there are rules against misleading pricing. See Chapter 19 for more information.

  Occasionally you might do the reverse, publishing a high price with the intention of creating an anchor point, then negotiating down from it. However, this risks putting off customers who see only the high price and are not aware that they can negotiate.

  On balance, if your salespeople or negotiators are well trained you can lose a lot of profit margin by publishing your prices. My inclination is that the best overall strategy is to publish a limited subset of prices if you need to do so to attract customers, but plan on negotiation and customised quoting to improve your margins.

  3. The Hawthorne Effect occurs when workers in a company know that a new scheme is being tested on them, and that they are being measured – and in response, their productivity increases regardless of whether the scheme works. It was first noticed in a factory where the managers wanted to test whether brighter lighting would improve productivity. They turned the lights up – and sure enough, production went up. Four weeks later the experiment was over and they turned the lights down again – and production went up again! This is one of the reasons it’s important to design your experiments correctly, with randomisation and “double-blind” techniques so that you don’t inadvertently measure an effect which isn’t really happening.

  Chapter 17

  Managing the pricing environment

  When I arrived at the factory for one of my last planned visits, at the height of an early English summer, the reception was empty. I could hear conversations behind various doors, and after waiting a polite length of time (six minutes) I knocked and poked my head into the open-plan marketing office. Everyone seemed to be in a panic. Whoever was not making a frantic phone call was in a very serious-looking conversation at one of the tables or around one of the many kettles.

  I eventually attracted the attention of Sandra, whom I’d met a few months previously.

  “We’ve just found out why our supermarket sales went up so much last month. Cosanostra Coffee have reduced their order by 80% this month. It turned out they managed to place an order via our supermarket sales team – and it’s cheaper for them to buy the supermarket packs and open them up to sell in-store than to order directly from us.”

  “Ouch. Doesn’t that create a load of work for their staff in unpacking all the teapots?”

  “You’d think so, but apparently it’s worth it. We sell in supermarkets at about £2 for four, so our wholesale price is 25p each. We’ve been selling to the café chains at about 70p a unit, so it’s quite a big difference.”

  I listened in on some of the calls. Account managers were trying to find out whether one of the supermarkets had placed the order on behalf of the café chain, while salespeople were nervously chatting to other cafés, trying to figure out whether they’d had the same idea without tipping them off. The product design team was already working on how to differentiate the supermarket and café products more clearly.

  Maggie saw me walking past the office and beckoned me in. She was on a call.

  “OK, Valerie, very clever. I have to give you that. You beat us on this one. But we can’t let it go on.” She paused. “Well, if we have to we’re going to change the supermarket packaging. We’ll start by stamping ‘Home Use Only’ on the teapot. And when we can reconfigure the machines, we’ll change the shape of the pots around.” A longer pause. “Look, I don’t blame you for doing this, but we can’t sustain the channel at this price. I’ll discount you the next two months’ supply at the supermarket price, but after that we need to go back to normal … OK, drop me an email. Chat to you soon.”

  She hung up and smiled.

  “I guess we walked into that one. All that trouble to differentiate our products between different consumer segments and we forgot to protect against the retail channels pirating from each other. Valerie Salmon has been waiting to get her own back on me and I guess she figured out how to do it.”

  “What will you do about it?”

  “Well, as you heard, we’ll start with embossing the supermarket teapots with ‘Home Use Only’. A nationwide brand like Cosanostra won’t be keen to have visible evidence on the product of how mean they are, so that will probably work for now. But longer term we will need to redesign the product a little more. We need to offer more concrete value to the in-store chain to maintain the price differential. We’ll probably redesign the teapots so that the in-store versions feel like higher quality and the supermarket ones are more disposable. In fact, we’ve been thinking of a recycling programme already – maybe the cafés will end up with glass teapots which we will take back and reuse, and we will keep the supermarkets on plastic ones. Unfortunately our costs will probably end up higher rather than lower if we r
ecycle, but it will be good for the brand.”

  “Has this kind of thing happened before?” I asked.

  “Not exactly. But managing multiple channels is a challenge. It is part of the difficulty in designing the overall customer experience of our pricing, and for that we have to understand their decision-making processes. We have a flowchart for that – let me find it for you.”

  Out of a filing cabinet she took a bundle of papers, which unfolded into a large poster. It displayed a flowchart showing how consumers first experience the Chocolate Teapot brand, their perception of value and how it changes over time.

  Diagram 7

  “The important thing is to keep the value proposition consistent. We can’t control exactly how the customer experiences our brand over time, so we can’t risk creating any serious gaps in their perception. If the price or product attributes are very different across the different purchase channels, we will eventually lose out in one or more channels. In this case we were relying too much on the cafés themselves to create the distinction between our supermarket product and the café product. That gave the café the ability to capture too much of the price premium – we didn’t retain enough control over the experience of our product.

  “Another example of this complexity is the two-stage process that a customer goes through in order to buy our product. First they have to decide to buy it, and then they have to decide which product to buy. We need them to remember the product as an affordable treat, but then when they buy it, we’d like them to spend more on a larger or premium-flavoured teapot.”

  “And how can you do that?”

  “There’s no perfect way. People aren’t daft – they will remember roughly how much they spent on our product the last time they bought it. But there are a few tricks. For instance, they will tend to classify products into approximate value ranges – for instance £2 to £3. Within that range, it is harder to remember whether you spent £2.19 or £2.65. If people buy a variety of different things on different days, the details will fade. This is one reason why the old £2.99 trick works – by charging £2.99 instead of £3, the consumer shifts us into a lower-value range without us losing too much money.

  “Splitting the purchase into a teapot and biscuit is another way: even though they might spend £4.50 overall, the primary price of £2.79 is associated with the teapot. People subconsciously assume that when they walk into the shop they will just buy the teapot and not the pastry; but when confronted with the choice, they don’t have that much self-discipline.”

  The scientific background to this chapter combines a few disciplines: the study of memory, cognitive dissonance, pattern recognition and game theory.

  The formation of memories is complex but there are some principles which apply broadly. Repetition improves memory, so the more often people see your price communication, the better they will remember it. More time spent looking at the information improves memory, so the longer they are in the environment, the better they will remember.

  Pattern recognition is also a very intricate subject. The simplest message here is to be consistent. In each channel, present an image that reinforces the values that motivate people buying in that channel. Most buyers have little or no time to give much thought to what they buy from you; their first impressions will be powerful, and any further communication which contradicts those first impressions runs the risk of making the customer forget about you, stop recognising you, or stop considering you in their buying decisions.

  The phenomenon of cognitive dissonance occurs when the customer is presented with two pieces of evidence which are apparently contradictory, for example if they remember you as a premium-quality supplier and they are suddenly presented with a scenario in which your product is the cheapest option. Cognitive dissonance creates negative feelings and makes people more uncertain – even fearful – and less likely to buy.

  In most situations, you want to keep doing the same thing again and again, to reinforce the customer’s perception of your product and increase the chance that they will remember you confidently when they make a buying decision. In some scenarios, brands can afford not to do this – for instance, the apparently deliberate price-blurring strategy of Coke and Pepsi, which we discussed in Chapter 6 – but these brands make up for it with immense pre-existing brand familiarity and very strong design and brand communication outside the pricing sphere.

  Game theory is a way to understand the best possible strategy for each party in a competitive situation or negotiation where they are trying to get the better of each other. A full discussion of game theory is outside the scope of this book, but there are some recommendations in the bibliography. The key point is that it applies most strongly to parties who have the time to act ‘rationally’, by considering your interests and theirs, working out the strategy their opponent is likely to follow and responding accordingly. So game theory is of little use in understanding how a consumer buys a sandwich or a teapot, but it could be powerful in predicting the strategy of a major retail chain that is distributing your products. You can work out their main options, predict which will be most profitable for them, and set your pricing strategy and product range accordingly. If you can foresee – as in the CTC example – that somebody might have an interest in taking actions that you do not want them to take, you can adjust your own strategy to forestall this.

  How to apply it

  The principle here is to think a few levels deeper than your customer. In most cases, the customer pays much less attention to the purchase than you do. After all, they are only buying your product occasionally and have other things on their minds, while you sell it all the time, to many customers, and it is your job to think about how to do that better.

  Think through the whole life cycle of how your customer experiences you. What is their first impression? What conclusions will they draw the first time they hear about your product? Will they compare it to something else? What are their instant conclusions likely to be? (And they should be instant, because chances are they will quickly forget about you.)

  Then, the next time they see your brand, or your product, or are prompted to think about your category, will the message be consistent with the first time they saw it? Customers are driven on an instinctive level; they mostly don’t have time to think logically through the process of buying your product. You have to plant the seed subconsciously that your product is the right solution to whatever problem or desire they have, and reinforce that until they can’t forget it.

  Much of that is done with branding and product communication rather than pricing. But the price is a very important clue to how they think about your product. And so you need to manage the price so that it is consistently communicated across all your different channels and in the different ways you communicate to clients.

  Price arbitrage

  Sometimes a price structure that is consistent for the consumer – in the Chocolate Teapot case, the difference between supermarket pricing and café pricing – opens you up to being ‘arbitraged’ between different channels. This can happen in two ways.

  Professional buyers may spot a difference between channels and realise that they can take advantage of it. When someone is regularly buying your product, the effects of psychology are reduced and they pay more attention to the opportunities for profit.

  Similarly, if you regularly have short-term sales, consumers may start to notice this and wait for the sale before purchasing. This is obvious in some industries such as clothing, where everyone knows that sales are coming after Christmas and in the summer, and many people wait until then to buy something which they might have been perfectly willing to pay the full price for.

  If you sell a business-to-business service such as consulting or accountancy, once you have offered your client a discount, they know you are willing to work for the cut rate and it will be hard to persuade them to pay the full price next time.

  So you need to defend your prices against each of these forms of attack. The mos
t powerful way to do this is to create a product distinction each time you want to offer a discount. The Chocolate Teapot Company changed its product design for the supermarket channel, using plastic teapots while the café channel gets glass, clearly distinguishing the experience in a way that is psychologically consistent with the different experience of each outlet.

  Some clothes retailers deliberately restrict availability of the most popular stock, to let customers know that by waiting for the sale they risk missing out on the garment they really want. And successful consultancies only offer discounts with a clear rationale: for instance, using more junior staff, or delaying the client’s project to a later delivery date by fitting the work into hours that are not being used by clients paying full price.

  Customers, even when behaving irrationally, still like to believe that the world is logical (this is sometimes known as the ‘just-world phenomenon’). So give them a reason for a price difference and they’ll be more likely to behave in the way you want them to.

  You may recall the argument in Chapter 12 on bundling that fast food shops should ensure that their meal prices are consistent with the pricing of individual items. This is based on the same just-world rationale – it is counterproductive to confront consumers with an illogical pricing structure. This simply draws their attention to price in a way that you don’t want. Paradoxically, for all the focus that you as a supplier should give to pricing, you don’t want the customer to think about it at all.