Fair enough. Of course, it's hard to imagine anyone coughing up tens of thousands of dollars for a weekly e-mail newsletter. And indeed, you'd be hard-pressed to find a pricing expert who would suggest that as an appropriate price.
That's because there are two kinds of value: objective value and perceived value. The former is what Cenedella came up with: the price of a product or service assuming the customer has a perfect understanding of its value -- and understands it in the same way the seller does. Think of objective value as the most that you could rationally charge for a product. At the other end of the spectrum, the least you could rationally charge for a product would be the incremental cost of producing it -- a breakeven price. Somewhere between the two lies what is known as the perceived value of your product -- that is, what a person actually is willing to spend. In a perfect world, your customer would see the value of your offering and be willing to fork over the full amount. But in many circumstances, there's a disconnect, and what people are willing to pay is very different from your product's objective value. (In those cases, you'll have to use marketing and other tricks to try to change your customer's perception of value. But more on that later.)
How do you determine what people are willing to pay? Study after study has demonstrated that when it comes to purchasing decisions, people are irrational. In one classic study, researchers asked consumers whether they would be willing to travel an additional 20 minutes to save $5 on a calculator that costs $15. Most said yes. Then they were asked the same question about a $125 jacket. Most answered no. Now, rationally, $5 is $5, whether you're buying a calculator or a jacket. But it's seldom that simple, according to Richard H. Thaler, a professor at the Graduate School of Business at the University of Chicago and author of "Mental Accounting Matters," an article published in 1999 in the Journal of Behavioral Decision Making. "People make [purchasing] decisions piecemeal, influenced by the context of the choice," writes Thaler, who won a Nobel Prize for his work in behavioral economics.
As it happens, the greatest influence on the context of a purchasing decision is whether the consumer believes the price is fair. Expectations play a big role in this. In a 1985 study conducted by Thaler, people were asked to consider the following hypothetical situation: You're lying on a beach on a hot day and you crave a cold beer. A friend offers to get one and wants to know what you're willing to spend. When she offers to go to a small grocery store, the median response is $1.50. But if the friend is buying the same beer at the bar of a fancy resort hotel, the price jumps to $2.65. Context and expectation drive the price up nearly 80%. Because we expect to pay more for a beer at a resort, we're willing to pay more.
The real trick in setting prices, then, is to understand -- and try to shape -- your customers' expectations. One of the key ways people set their expectations is to base them on what they've paid for similar products or services. Academics call this the "reference price," and it's one of the easiest pieces of competitive intelligence to gather. Simply shop your competitors.
Overcoming the power of the reference price is not an easy thing to do. At TheLadders.com, for example, the maximum objective value was $40,000. The product's reference price, however, was quite a bit lower: zero, since most job-listing services are free. There's a lot of room between nothing and $40,000, and free is the most difficult reference price to overcome. But it can be done. Satellite radio companies, for example, have been able to charge annual subscription fees of as much as $142 -- even though most listeners are accustomed to getting radio for free. How do they do that? Primarily through marketing, which in this context means taking the customers' reference price and making the case that they offer more value.
But starting at zero definitely limits how much you can charge. Cenedella priced a monthly subscription at $50 -- a number he admits to pulling out of thin air. Unsatisfied with the number of people signing up, he cut it to $35, and finally settled on $25. TheLadders.com now has nearly 300,000 subscribers, but Cenedella is far from satisfied. "From our point of view, we're charging only a fraction of the value we provide," he says. But he's stumped as to how to fix the situation.
Plenty of entrepreneurs are in the same boat. "The price you get for a product is a function of what it's truly worth -- and how good a job you do communicating that value to the end user," says John Gourville. If Cenedella, for example, could guarantee customers that subscribing would shave a month off their job searches, he might be able to charge more. Or he could try to change his customers' reference price. E-mail newsletters may have a going rate of zero, but a good career counselor can cost hundreds, if not thousands, of dollars. If your marketing can convince people to put you into a different price category, it'll be a lot easier to charge more money for it. It's also important to remember that different customers have different expectations and reference prices. Cenedella might, for example, offer a special newsletter for investment bankers at a higher price than he would for, say, marketing executives.
Sam Calagione, president of Dogfish Head Craft Brewery in Milton, Del., is a master at playing with pricing expectations. Dogfish Head's revenue grew 52%, to $8 million, in 2004 -- in large part because of Calagione's approach to pricing. Some Dogfish Head beers retail at about twice the price of most microbrews and four times that of most mass-market brands. How does Calagione do it? He encourages customers to use fine wine, rather than competing beers, as their reference price. "Wine customers," he says, "understand that an amazing bottle of pinot noir should command four times the price of an average bottle." He conveys this message, in part, with smart packaging. The company, for example, sells its premium Pangaea beer in 750 milliliter cork-finished wine bottles -- at a cost of $14 a bottle. That's well above an average beer drinker's price expectation. But it's right in line with that of a wine connoisseur.
