Is It Time to Raise Prices?

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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.

Calagione borrows more than the wine industry's packaging. He shuns the consumer advertising used by competing brands, instead hosting "beer dinners" attended by beer enthusiasts, early adopters who are likely to spread the word about new products that excite them. Calagione expected to host 18 such dinners in May alone. Taking another page from the wine industry, every time he launches a new product, he makes sure that there's not enough of it to satisfy demand. "We're not a commodity," he says. "By not satisfying demand initially, we create more demand for the future." People understand that a scarce product commands a higher price.

Calagione segmented his market by eschewing the typical American beer drinker and going after customers with high reference prices. Doing so enabled him to do something most businesses only dream about: align prices with objective value. And though he didn't think of it in those terms, that's precisely what Kris Simmons needed to do at his video production company, Fire Eye. His first step was to figure out what his competitors were charging -- the reference price. He learned that he was charging about one-third less than most of his rivals. That was good news. Because his customers' reference prices were a good deal higher than Fire Eye's, a price hike would not seem unreasonable.

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