The Psychology of Price

by Leigh Caldwell

  We are interested in providing our customers with a whole cognitive experience. It’s more than just a cup of tea; we want to encourage them to step aside from life for a few minutes, relax, enjoy the flavour and warmth of a drink, and pay attention to something inside themselves instead of outside. It shouldn’t be just a transaction; that is not in the spirit of the product. So we help manage the buying process, the experience of drinking, and the pathway and rhythm the customer experiences from one purchase to the next. And pricing is a part of that pathway.

  She showed me a few of the emails:

  You should just sell a good product at a good price. Stop manipulating people.

  People can decide for themselves what experience they want from a product – maybe if you didn’t waste time on trying to figure that out for them, you could sell your teapots at a sensible price.

  Ethics

  These emails raise a valid question. Is it our place as suppliers to try to understand how our customers think and feel? Or should we just offer products and let them worry about that? And if we do understand how they feel, is it OK for us to take advantage of that to lead them to pay us more money?

  Each person has their own ethical position, and I can’t tell you for sure what to do. But I can suggest some approaches that may help illuminate the questions for you and help you make your own decision. There are several ways to think about these points, based on both practice and principle.

  One is from a scientific understanding of how people make buying decisions. People really are influenced by how they feel. They are influenced by what they assume a price signifies. There is no way to create an ‘objective’ buying decision that is based on purely rational considerations. And so a supplier has no choice but to try to understand the psychology of their consumer and work with it.

  If you try to act as if people buy your products rationally, it won’t magically come true. They will still be irrational, and your price signals will be interpreted in a way that might bear no relation to the facts about the benefits and quality of your product.

  Another answer is based on competitive market considerations. If your competitors use pricing psychology and you don’t, you will eventually go out of business. In the long run, that will make the market less competitive and provide no benefit at all to your customers. Indeed, with less competition in the market they will be worse off after you’re gone.

  In some cases, your pricing tactics are simply intended to bring people back to a more rational way of making decisions – by lowering the cognitive barriers that consumers put up when they don’t trust their supplier. The example in Chapter 16 on ‘other people’s money’ shows how the pricing proposition was carefully designed to reduce barriers to purchase, and to make clear that the benefits to the client outweighed the costs.

  Finally, remember that customers – as a whole – are out for the best deal they can get. They won’t hesitate to take advantage tactically of promotions, sales and the like in order to get the best possible deal from you and other suppliers. You don’t owe them anything – at least, you owe them a decent quality service and you owe it to them not to mislead them – but you don’t have to be generous.

  The law

  The legal aspects are reasonably clear. Please note that the following is not legal advice and if you have any questions about your particular situation, your own solicitor should be able to help answer them.

  The Office of Fair Trading (in the UK) regulates businesses, and one of the principles of the law is that commercial practices must not be misleading. This is backed up by European law, but the principles of law are interpreted slightly differently in each country.

  In 2010 the OFT released a report called Advertising of Prices, which is available at www.oft.gov.uk.

  The study carried out for this report investigated five key pricing practices in order to determine whether they could be considered misleading to customers.

  The results were in line with existing regulation, which requires that, for example, a sale price which is compared to a reference price – ‘Was £50, now £20’ – must be an honest representation of the previous price. You can’t just make up the £50 price, and you might get into trouble if you sold the product at £50 for only one day four months ago in your Inverness branch.

  ‘Drip pricing’ was a particular focus of the study. This is where an advertised price turns out not to be genuine, because there are a lot of mandatory additional items. The best-known example of this is from the airline industry. Some airlines (notably Ryanair) used to advertise tickets at £5, 99p or even free; but when customers visited the website to buy them, they would discover that there were a number of mandatory additional fees – airport fees, taxes and so on. The actual price usually turned out to be £40 or more. Notionally, customers could then make an informed choice whether to buy the product, having now discovered the correct price. However, because they had already made an investment of time in getting through the website to this point, many customers decided to go ahead and buy the ticket anyway, instead of going to check other airline sites and compare their prices. The OFT considers this pricing practice to be misleading and has warned companies not to use it.

  In any case, most businesses care about how their customers see them. Pricing practices which approach the border between what’s legal and what is not, or practices based on misleading customers, are likely to lead to a backlash. I therefore recommend that you avoid using any misleading price communications or drip-pricing approaches, and stick to the techniques recommended in this book.

  Chapter summary

  • In the UK, pricing is rarely directly regulated but falls within the general laws on commercial practices.

  • It is important not to mislead customers with your price communication.

  • Customers are just as keen as you are to get a good deal. They are happy to play one supplier off against another, so it’s not unreasonable to play the same games against them.

  Epilogue

  Two years later: how Maggie fought the investment bankers and what happened next

  As I left the factory one afternoon Maggie said she might not be able to see me for a while. “Some people” were apparently sensitive about the book, and didn’t want their details to become public. She promised to fill me in on everything later, “after everything is completed”.

  I guess she did plan it all, then – or at least she wanted me to think so. I’m still not sure what to believe. Looking back, though, it’s clear that Maggie realised that all the techniques she had developed to use with consumers could also be used on corporate executives. She was now ready to negotiate.

  In any case, the next time I arrived for a session I couldn’t get into her office. She was locked away in meetings that day, and the next, and the next week when I came back again. The head of PR, whom the company had now got round to hiring, was helpful with facts in an official kind of way, but he wouldn’t – or couldn’t – say what was going on behind closed doors. Once I caught a glimpse of four people in dark suits leaving the building, but nobody was talking.

  My story in this chapter is pieced together from what I could infer from third parties, dropped clues and snatches of conversation. Eventually I did get confirmation of some of these facts from Maggie. But they must be interpreted cautiously.

  It seems that there had been some corporate moves in the consumer goods world. Maybe you read about them in the FT. Global consumer products company Leverkraft & Gamble had taken over Cosanostra Coffee as part of a strategy of acquiring higher-margin businesses and building a closer relationship with their consumers. When the Chocolate Teapot Company’s sales through the major supermarkets had reached five million units, Valerie Salmon, now promoted to vice-president of Leverkraft & Gamble, gave Maggie a call.

  “We keep an eye on fast-growing suppliers in the food and drink sector,” she explained. “Would you be interested in talking – no particular agenda, just to see what sort of relations
hip we could develop?”

  To Maggie, this was clearly code for “You’re a competitor now – we want to buy you or get rid of you.” So she suggested Salmon pay a visit – and made a few other calls too.

  When Salmon arrived she was left in the reception to wait, and saw her counterpart from another of the major consumer goods firms leaving Maggie’s office before her. I am sure this could have been no accident. What she didn’t see was the investment bank adviser who sat in the next room listening in.

  When Salmon was invited into the office, Maggie laid down three conditions before she would enter into negotiations on a relationship.

  First, any acquisition must be on a multiple of at least 24 times annual profits. This demand was designed to anchor the buyer to a high value, even if she only expected to get a multiple of 20 in reality.

  Second, it should be structured for a payout over four years, using hyperbolic discounting to reduce current resistance to payment; after all, there was a good chance that the executive making the acquisition might not be in the same job four years later.

  Third, the payout should be 80% in equity and adjusted for stock price increases in the meantime. This condition made the purchase feel less expensive because it removes most of the cash element, which is much more salient than a purchase based on shares. It also has the advantage that the acquiring company itself does not have to pay directly for the purchase; instead, its shareholders implicitly pay through the dilution of their shares. Structures like this are often much easier for executives to stomach than anything which directly hits the financial results their bonuses are based on.

  Salmon couldn’t, of course, know what – if anything – her competitors had agreed to, but apparently decided it could do no harm to note Maggie’s requests and continue the conversation. She noted the caveat that any offer would have to be agreed by the board. Maybe her intention was to negotiate downwards later, or walk away from the deal if necessary, but the door was now open to an agreement.

  Then Maggie shifted the premise of the conversation. In fact, she said, the real reason we should be talking is not about chocolate teapots. It’s because we have built this business using a completely new approach to designing prices and product ranges. If you buy us, you have the opportunity to use these techniques across all your other products. She pointed out that the net profit achieved by the Chocolate Teapot Company was nearly 60% of revenue – about four times the average level achieved by Salmon’s employer on their food range.

  Salmon agreed that this could be a factor in her company’s reasons for wanting to work with Maggie. At this point Maggie started to put in place the pieces of a possible deal.

  “Let me run a repackaging trial – I will talk to a few of your product managers and work with them to design a new pricing strategy for some of your products. Whatever net profit increase I can achieve, you can keep 75% of it and I’ll take 25%. Can I talk to your pricing people and see who’s interested in working with me?”

  Salmon may not have been wild about this idea but, with her competitors walking in and out of the same building, she wanted to keep Maggie interested. A conditional profit share wouldn’t be too harmful. And what harm could it do to let her talk to a few of Salmon’s colleagues?

  Well, Maggie is a persuasive woman. The next week when she spoke to the company’s product and pricing managers they liked what she had to offer. She was ready to put some power in their hands – power that had always previously been with the finance and operations people in Leverkraft – and some real rewards. Her offer was accepted almost unanimously across Leverkraft’s 600 pricing managers.

  Maggie swiftly deployed all the tools she’d developed at the Chocolate Teapot Company. In every product category she encouraged the product and marketing managers to examine the emotional and material values of their consumers, and to develop a model of the competitive environment and existing product price anchors. She showed them how to invent new product options by reframing the product to disrupt existing anchor points, and how to persuade consumers to pay more by deferring payments into the future. They developed new bundles and launched their new products through a range of different channels. There was a new energy at Leverkraft, and suddenly the industry started to notice that new ideas were emerging from one of the big groups for once, not the upstarts.

  You may have seen the resulting change in the consumer products market over the last two years. Maggie has called it the “cognitive revolution”. Consumers are not just making choices between commodity products any more. They enter into a relationship with a retailer, a brand and a series of consumption environments, where their cognitive benefits are as much part of the outcome as the physical benefits of consuming the products.

  Perhaps you have tried the new Washing Powder Subscription Service that was launched last year, or the high-priced Energy Vodka Yoghurt products now being sold in nightclubs around the country. No doubt you will be familiar with the Bling Nappies range made famous by Brad and Angelina’s new adopted baby, and the new consultancy that Leverkraft & Gamble is offering, helping large companies improve staff productivity by laying on a range of personalised consumer products for them in the workplace. There’s even a partnership with a well-known search engine, which is giving away free chocolate bars for the first 50 people to find a secret search engine keyword every day.

  Of course, these new consumer relationships come with more opportunities to create value for the customer as well as to make money. Leverkraft has managed for the first time to establish its corporate brand alongside its product brands in many consumers’ minds. As a result of these innovations, Leverkraft has changed the competitive dynamic of the industry. The stable and comfortable equilibrium that had prevailed for decades was disrupted. Maggie’s schemes increased the company’s profit margin in two years from 8% to 18% – especially impressive on a worldwide turnover of £75bn, translating to an increase in pre-tax profits from £6bn to £14bn. Of that £8bn increase, the Chocolate Teapot Company collected £2bn in profit share.

  This was far beyond what anyone had expected – the value of Leverkraft shares soared, making its management rich and its shareholders happy. Maggie had written her deal in advance, and the acquisition had been agreed on a multiple of 20 times profits.

  It was at that moment she managed to get Leverkraft to complete its acquisition of CTC. The transaction was timed perfectly. Based on 20 times £2bn, and her holding converted to equity in the parent company, Maggie ended up owning over 20% of Leverkraft & Gamble’s stock.

  The competitors have started fighting back with their own pricing schemes, and the profits may not last. But the new company – now renamed CTC Group – has established itself as the undisputed industry leader in a way they had never managed before. The annual shareholders’ meeting came round just a few weeks ago, with Maggie hailed in industry magazines as the visionary figure of the sector. The meeting was expected to nominate her as CEO. Shareholders eagerly awaited the announcement of the next step in her vision for pricing, for branding, for distribution – whatever the next shakeup in the sector was going to be.

  The anticipation made it all the more shocking when she did not show up. Perhaps you saw her message on the news, announcing her resignation from the board and nominating her replacement, the previously out-of-favour vice-president Valerie Salmon. You might have noticed that Sir Charles Leverkraft was unceremoniously fired from his position as CEO – though you might not have known that his investment company CLH Property was the one that evicted Maggie’s parents from their shop several years ago. You may have speculated with the rest of us about the foundation into which her shares were placed, what its plans are, and who might be in charge of it. Maggie hasn’t been in touch with the company since that message and neither they nor I know where she is. And yet – I can’t imagine that we’ve heard the last from her.

  Pricing and your business

  Maybe this outcome is not what you want for your business. You m
ight prefer simply to increase your margins and not worry about revolutionising your whole industry. That’s fine. In either case, this book has shown you how to do it.

  In Chapter 1, we looked at how to use pricing as a positioning tool, especially when launching new products or services, although this is also a fundamental question for your existing products too.

  In Chapter 2 we looked at the baseline cost to give you a floor under your prices and to examine one of the factors that sophisticated customers may consider in their decision about how much to pay you.

  In Chapter 3 we showed how to estimate what your customers are really willing to pay for what you offer, and how to differentiate your product versions to capture maximum revenue from each customer class.

  In Chapter 4 we examined customer segmentation, how to ask questions that will uncover the truth from consumers, and how to make your pricing fit each group of customers and their perceptions of your product’s or service’s value.

  Chapter 5 examined how introducing a new product may need both self-belief and belief by third parties in your pricing power. It showed how to communicate your evidence confidently in such a way that your partners or resellers will believe in it.

  In Chapter 6 we launched the new product and discovered the power of first impressions and the difficulty of changing a consumer’s mind, along with some techniques for doing so.

  Chapter 7 introduced the power of anchoring, showing how high prices can create a value perception in the mind of a consumer with only a vague idea of how much to pay for your product or service.

  Chapter 8 discussed competition and what to do when people try to undercut you – or how to successfully attack other companies with an aggressive pricing strategy.