When Is The Price Right?

Much of conventional economic theory revolves around the assumption that an economy comprises rational actors seeking to maximize utility. One implication of this hypothesis is that, all else being equal, people will tend to favour a lower-priced product over a higher-priced alternative.

However, research by behavioural economists and psychologists—among them Daniel Kahneman of Princeton University—has cast significant doubt upon the thesis of Homo economicus. Contrary to the assertion that human beings tend to make rational decisions, scholars have consistently found that decision-making is influenced by cognitive biases, the perception of risk and reward, social pressures, oversimplified snap judgements or prejudices, and various other subjective factors that have very little to do with rationality.

This partly explains why many individuals choose higher-priced products, even when all else is apparently equal—the authentic Prada handbag versus a more affordable alternative; the glamorous Porsche, BMW, or Ferrari versus a high-quality, reliable vehicle for half the price; a painting by a famous artist for no reason other than its uniqueness and the renown of its creator.

In conclusion, trying to compete on price is not always an advisable strategy. But when can you reasonably expect that raising the price of an item will deliver higher revenue? When is it best to stay put or even go lower?

Subjective perceptions of price

I often pass by a restaurant that attracts long line-ups on the weekends, starting just before noon and continuing well into the evening. This establishment offers tasty Mediterranean-style comfort food, at a price that enables it to undercut its nearest competitors. Understandably, it is tremendously popular.

Yet even in this case, we can see less-than-rational economic behaviour at work. On rainy and chilly days, lengthy queues still form outside this restaurant—which suggests that in the name of a modest saving, customers gathered outside are willing to forgo both their physical comfort and their precious time. (Is it really worth it?) Adding to the complexity of the dilemma is the perception of sunk cost—the queuers may think to themselves “I’ve been standing here for half an hour already; I might as well stick it out to the end.”

On the other hand, in my neighbourhood there is a restaurant offering somewhat higher-quality Mediterranean fare for a higher price. This business has also enjoyed commercial success and recently expanded—but I have yet to encounter a line-up stretching out the door and halfway around the block.

Some customers may perceive products with higher prices to be superior, even if this is not necessarily the case. Do you want your enterprise to be perceived as a low-cost provider, a high-quality outfit that people will be willing to pay a little extra for, or somewhere in the middle? What value do you offer that others don’t? Answering those questions will help you not only formulate a pricing strategy, but more clearly define your brand identity too.

Merits of cost-plus and value-based pricing

As the name suggests, cost-plus pricing is based on tallying the fixed and variable costs that you incur to provide a good or service to your customers, and then adding a mark-up that enables you to turn a profit. On the other hand, value-based pricing is a reflection of what you believe customers are willing to pay for the product or service you offer.

Generally, cost-plus pricing is more apt for industries in which the items on offer are generic or easily substitutable, and there are many competitors. If your business is a convenience store, or sells items that are readily available elsewhere, you will probably need to maintain a cost-plus strategy and keep a watchful eye on local competitors’ prices.

Value-based pricing is better suited to industries in which the items on offer have some subjective quality—such as association with a particular brand or celebrity, atmosphere and ambience (as in a restaurant), or an inimitable experience or flavour. Businesses that deal in goods and services of this kind enjoy more pricing flexibility, and can often get away with raising prices gradually as their profile and reputation grow. On the negative side, this strategy can invite more competition, and complicates the task of establishing an appropriate price in the first place.

Determining the right price for your products is a challenge that doesn’t necessarily lend itself to a straigthtforward answer. Particularly in the early stages of a business, some trial and error may be necessary. Nonetheless, a coherent pricing strategy begins with defining the type of brand identity you want your business to embody.

Pricing Tips That Work

The right price for your product or service will make all the difference between using red ink or black ink on your accounting books. Unless you have a smart pricing strategy all your hard work of getting your business up and running could collapse.

Here are some tips for how you should approach your own pricing methods:

Not All Prices Should Be the Same

A research study conducted at Yale University found that when two of the same type of products were priced exactly the same customers shied away from making a purchase as opposed to when the items were priced differently. This doesn't mean you should mix up your prices on the same products. Just understand the mind of the consumer. Perhaps it's more about changing the pricing with an item that has a noticeable variant like size or design. This idea also comes into play when stacking your product line up against competitors. You should always keep an eye on competitive prices.

Try Price Anchoring

Price anchoring taps into our tendency to exclusively factor the first price we see when it is set against a second higher price. Restaurants will use this tip when they are selling expensive items together. The $50 lobster looks pretty good compared to the $75 Kobe steak. The result? More lobsters are sold. The basic premise is that you're creating a sense of value for your customer. In other words, give them something to compare to.

To Make a Sale, Decrease the Sticker Shock

What sounds more like a bargain: a subscription for wine of the month club at $50 a month or $600 a year? They are actually the same price, but the consumer thinks the monthly cost is more affordable. This is the approach you should take in your sales campaign. A fee attached to a product should be a "small fee." Bundle products together into a single "great bargain package." Appeal to the grander solution of a problem.  

Use the Number 9

The number 9 has become so ingrained on the shopper's mind that it actually holds appeal. You can reduce a product from $80 to $60 but it might be stronger to go down to $59. It works every time!

Test Your Prices

There is a trial and error when it comes to finding the sweet spot of pricing. You might have to experiment with different price points to see what works best for your product. If you start a new campaign with a lower price point, make sure you get your marketing up to speed so all your customers will know. 

Pricing Mistakes that can Slow Down Sales

Pricing your product is just as important as your marketing plan. In fact, without the right price you could see all of your hard efforts of your marketing collapse around you. Not only can solid pricing turn your account books from red to black, but it can also help engender strong customer loyalty.

You should know what it costs to make what you're selling and get it to your customer. How you determine the price on top of those hard costs could be the make or break of your business.

Here are some common pricing mistakes that can slow down your sales or even bring them to a screeching halt!

Pricing without a strategy.

Your pricing strategy should always support your company’s marketing and operational goals. If you’re holding a discount promotion on a product at below cost, make sure that you can upsell your customer so you make a profit down the road. Likewise, price raises can only work if the customer feels that they are getting a lot of value from your company. A good pricing strategy should allow your products to be sold, with long-term profitability goals in mind and also being competitive. 

De-valuing your service or product.

Underselling is just as bad as overselling when it comes to pricing. You might know down to the penny what an object costs to manufacture and deliver but what about all the other costs associated with selling that product? What does it cost for you to hire a staff, rent a space and market that product? Those line items should all be factored into your price point. Remember you're hoping for volume sales to amortize all of those overhead costs.

Chasing your competitors.

If you're constantly matching your prices to your closest competitors you could be doing a disservice to your business. Unless you're aware of the same overhead and manufacture costs your competitor is applying to their products, their pricing is meaningless. Yes, you should keep an eye on the competition and make appropriate adjustments but don't let that be the total basis for your pricing structure. This issue also comes into play if your slash a price to beat a competitor. In the short run you might get a decent sales bump but those figures could be misleading if those customers won't be coming back for repeat business because they're out looking for the next cheap bargain. Always think of the long game.

Drastic price drops.

Yes, everyone wants to pay a fair price for a product or service. However, if you find yourself dramatically dropping your price for a particular customer they might think they were paying too much for that product to begin with. You don't want to alienate your customers with your drastic pricing policy.