The ABCs of Pricing
"To start out with the customers' utility, with what the customer buys, with what the realities of the customer are and what the customer's values are—this is what marketing is all about." - Peter Drucker
Pricing strategies and methodologies are a good bit of science coupled with an equal amount art. To make sure your price is right, you have to continually balance your own cost structure and profitability with customer perceptions of value and your competitors' tactics.
The good thing when it comes to pricing is that a lot of the work is done for you if you know what to look for. When searching, however, you have to understand that the buying process isn't as rational as our old econ professors or common sense would have us believe. It's irrational—predictably so.
If you try to look at the market from a strictly rational point of view, you'll end up setting prices that make sense to you but not to your prospects. The far easier path is to have a pricing strategy that plays to your prospects' own irrational behaviors. I'll give three frameworks—anchors, bumps, and charms—that'll help you do so.
Let's take a look at the world of personal electronics since it's something very familiar to most of us.
Apple recently developed an iPod Shuffle that sells for under $50 and AppleTV, which sells for under $100. Those price points aren't arbitrary. Many of us have the $50 and $100 price points anchored in our minds. In general, we are conditioned to accept them as reasonable for certain types of products and services. Were they to sell either product for $10 more, they'd get dramatically fewer sales, even though the relative cost hasn't changed much.
Every established industry already has anchors in play. The art of pricing, though, is determining how you'll use those anchors. Significant value-adds allow you to use those anchors as baselines rather than straightjackets. But you still need to recognize that established anchors have a very, very strong effect on your prospects' first reactions to the pricing of your product.
If anchors set the baseline, bumps let people know what grade of product they're getting.
Imagine that you're looking at a car in the $25,000 price range. Would you check to see if it had power locks, windows, and steering? Now, what if we were talking about a $15,000 car?
There's a pretty clear demarcation between entry-level cars and mid-grade cars. When a car crosses that $20,000 threshold, we start expecting the features and luxuries of a mid-grade car.
The thing to remember about bumps is that we're primed to make certain assumptions about the quality of the offer. When we go from that $25,000 car to one costing $35,000, we have even higher unconscious expectations.
What often gets people to buy a higher grade of product or services isn't the benefit or features, but rather, the way the prospects view themselves. Many people who buy Audis know there's mechanically little difference between them and Volkswagens, but they're buying the premium version because they view themselves as premium customers.
The other dynamic that increases purchases of higher-grade products is the fear of under-buying and having to buy either the higher grade or the same grade sooner. We see this play out in electronics and computers quite often—we know that the mid-grade desktop computer is going to be obsolete in a few years, but surmise that the high-end configuration may live long enough to be worth it. Many people will pay more to overbuy rather than have to replace something all over again in the near future.
When you're setting your prices, you have to make sure you haven't unintentionally set a bump that either blurs or mistakenly mismatches the grade of product or services. For instance, a $19.99 and $22.99 pricing methodology isn't nearly as clear as a $19.99 and $29.99 framework. In the latter example, it's pretty clear that there's a bump in grade rather than something relatively minor like a difference in the type of oil used.
At the same time, if your competitors have anchored the price of the basic oil change at $19.99 and yours costs $29.99, you can bet that you're going to have to position or bill that service as premium. That's what your prospects are going to expect.
A price that's a little less than the round number is called a charm price. I've already used one in this piece when I used $19.99 rather than $20. As annoying as we might find charm pricing, it's a market dynamic that affects buying decisions.
The rationale behind charm pricing is that it somehow gets us to perceive the value of the offer at the right amount while we at the same time view the cost as lower. When we see $19.99, we assess the value at $20 but the cost as the same as something that's in the $10 to $19 range.
Many people think that using charm pricing is somehow demeaning or tricky to prospects—or that playing such games diminishes the seller's credibility. Still others think that charm pricing doesn't work on savvy, smart buyers.
While there may be grounds for some of the concern about manipulation, we have to return to our premise that the buying process is irrational, even for savvy, smart buyers. Rolex, Mercedes, Apple, and Louis Vuitton—all premium, sophisticated brands—use charm pricing and yet we don't feel tricked or that their offers are anything but premium. What makes your business better?
Putting it all together
If you have an offer that will provide legitimate value to your customers, your job is to make it as easy for them to get it as possible. One way we do this is by making our prices match their perceptions and economic reality. If those are grounded in a bit of irrationality, so be it—our business is about our customers, which means we need to meet them where they are, not where we think they should be.
Anchors, bumps, and charms are just a few frameworks that will help you with the science part of setting prices. How you take the science and make an art of it is up to you.
If you'd like some additional reading on the art and science of pricing, check out:
Predictably Irrational by Dan Ariely
Priceless by William Poundstone
The 1% Windfall by Rafi Mohammed
Charlie Gilkey is a writer, speaker, and business advisor for creative entrepreneurs. He shares strategies for thriving in life and business at www.ProductiveFlourishing.com.