I can’t believe that I bought a $600 backgammon set. But somehow I did. Sure, I enjoy playing backgammon, and they can be beautiful things. But $600! How did that happen?
The clues sit within this overview of that vital organ of business success: pricing.
How we’re supposed to think about pricing
The default belief about pricing, thanks to the economist in us all, assumes that price is a relatively linear reflection on quality. Cheap should mean inferior quality. Expensive should mean better quality.
The relationship between pricing, supply and demand is also assumed to be relatively linear. A high price should mean lower demand and vice versa. Similarly, plentiful supply is assumed to place downward pressure on pricing, while scarcity drives price upwards.
The exception to this is with products that are elastic, where changes in price have a disproportionate impact on demand. Giffen goods (e.g. essential items flying off the shelves during a natural disaster) and Veblen goods (rare or luxury items people must have whatever the price) are examples of when price increases create a disproportionate increase in demand.
Another aspect of the rational view of pricing is that we assume that it is better to pay a low price, and paying more than you need to is an inferior purchase decision. In everyday discussions and research focus groups, you’ll commonly hear people proudly say things like: “I only buy what’s on special”, or “I buy whatever is cheapest”.
This makes us feel good as a sensible and worthy consumer, but in general, it is a poor guide to reality. If it was, markets would only support minimal price differences and the cheapest products would lead every market. We would all be driving around in cheap cars like the Chery J3 or the Suzuki Alto, there would be no delicious Whittaker’s chocolate, and there would certainly be no demand for a $600 backgammon set.
How we actually interpret pricing
A lot of work done by behavioural economists on the irrationality of pricing and how people use pricing to make purchase decisions.
One of the key insights is that people interpret value using relativities rather than absolutes. In other words, we place meaning on a price based on context, not on the price per se. Consequently, the more human view of pricing is a more subjective and imperfect sense of value.
That value calculation can be influenced by a wide variety of factors that might be concrete and factual, or wildly emotional. It is entirely up to us as individuals. We might compare a range of product/price alternatives alongside one another and do a mental trade-off calculation. We might have a sense of price shifts over time (last week it was expensive but today it is better value). We might place a premium on things we love and happily pay whatever we have to.
Price relativities are contextualized and learned. For example, we might be very sensitive to small price shifts in small prices of a dollar or two for fresh fruit. But we may easily accept much larger price changes for other products like phones or cars.
This innate sense of relative price comparison is a type of ‘Goldilocks’ effect. We find what it is right for us with the aid of guiding reference points or anchors. Too hard, too soft, or just right is replaced by price points, reference value items and value bundles. Things like the 99 cent loaf of bread, the two for the price of one, or the $2 shop sign tells us that there is value to be had.
Price point anchors are also convenient tools for us to negotiate and justify our decisions with ourselves, and others. Consider a $9.99 block of chocolate. If you really want the chocolate the cent under $10 makes it seem much better value. But if you are not emotionally committed then you see it as an expensive $10 block.
Over time we build up a set of price acceptability thresholds for different categories and how we relate to them. Whether it is shoes, or phone plans, or lamb roasts, or Kiwisaver accounts, we acquire an understanding of what we think is acceptable to pay for different products we buy. From individual to individual this will vary. Some people’s expectation of 4-person family’s weekly grocery bill might be $200, but for others, it might be $400, yet both might be satisfied.
‘Free’ is a magic word with pricing. It has an almost primal response that makes us go weak at the knees. It reduced the risk of purchase to zero. ‘Buy one, get one free’ is far more effective proposition than ‘two for the price of one’, free samples are a great tool to drive trial, and it is true that free floor mats can sell cars.
A sage car salesman once explained to me that most people hate the negotiating process with salespeople. They often feel out of their comfort zone but are obliged to haggle, and feel that when they buy a car they should come away with a good deal. Good salespeople understand this. So they will hold fast on the price of the car but give away free car mats in order to give the customer the feeling of a good deal but retain their margin on the car. That way everyone walks away happy.
Pricing works in different ways
Pricing is a powerful tool that should be aligned to the strategy of a business or brand because it is instrumental in how people determine value. How pricing plays out can vary immensely.
For many years The Warehouse consistently promised customers bargains, thereby building a retail empire based on low cost, high volume and a wide range.
Categories that are relatively stable, in constant supply, and are widely available tend to have fairly stable pricing, with more modest fluctuations. Consumer thresholds of price acceptability are relatively narrow because people know what they should pay today and tomorrow. Most fast-moving consumer goods are like this.
In contrast, categories that are in scarce supply, when there is uncertainty can fluctuate wildly based on what people must pay today, knowing that the product might not be there tomorrow. Auctions work like this, sometimes driving property or Art prices up spectacularly beyond expectations.
In consumer goods categories there is a lot of debate over the merits of deep discounting compared with maintaining everyday low prices. Loss leading discounts can attract attention and connect people to higher-margin supplementary purchases, or simply drive foot traffic. An everyday low price approach is designed to reassure customers that they always pay less.
Some categories will support massive premiums beyond the cost of manufacture based on some form of meaningful differentiation. Indeed, the allure of being ‘reassuringly expensive’ can be a powerful driver of demand. In the fashion industry, a $4,000 Gucci handbag might be beyond the reach of most, but a $400 Gucci t-shirt might be more accessible, even though it might cost only $20 to make.
In contrast, pricing can be used as a category disruptor; when brands spectacularly redefine value. Some prominent examples of this include Spec Savers, Grab a Seat and AS Colour. Each, in their own way, has tilted demand in their favour by recalibrating people’s price acceptance thresholds.
The evolution of ecommerce has brought some great pricing innovations, especially in the realm of choice architecture – or how product/price offers are presented. We have all seen the software as a service freemium options presented on websites that look confusing at first, then we are happily nudged in favour of the ‘most popular’ option.
Technology is also allowing more personalized and flexible pricing models. For example, it is now possible to buy car insurance policies priced according to how you use your vehicle as measured by a black box device installed in your car. Uber has disrupted the taxi market with low prices, and they have also innovated with demand-driven surge pricing.
Some companies use pricing to mask profit gouging. They might keep the price steady but reduce the size of the product or use cheaper and inferior ingredients. This is a questionable approach and can result in public relations disasters and consumer backlash.
In New Zealand, we are heavy hitters when it comes to promotions. Comparative data from Nielsen shows that a whopping 50% of all supermarket purchases are bought on promotional pricing. This is significantly higher than in Europe (28%) and slightly less than in the UK, which sits at 54 percent.
Looking closer, there has been a recent softening of promotion selling (down 2.5% in 2016). The frequency of product promotions overall is increasing in supermarkets, with an average time spent on special price of 69% compared to 64% of the time in 2016. While the frequency is increasing the overall depth of promotional pricing is stable at around 10 percent.
Promotions can be great at driving a spike in short term volume, but they should not be seen as a long term driver of growth, especially in terms of profit. Promotions can, however, become something of a sales drug habit. Some retailers and suppliers overuse promotions in the hope of continued short term results. But this can create a shopper immunity in which they learn to only shop by promotion and the effect is to make the discount price the normal price.
The nature of different categories makes them more or less responsive to promotional pricing, and consequently, different price/promotion strategies should be adopted. According to Nielsen, there are four types of pricing strategy depending upon the elasticity, or responsiveness of shoppers to price changes. The key is to understand where your brand and your competitors sit on this framework, and then to use the right price/promotion for you.
20 Pricing & Promotional Tactics
There are many different tools available when it comes to pricing tactics. Here are 20 of them.
|Pricing & Promotional Tactics||For Example||When To Use|
|Price points||Target anchor price points (e.g. $4.99)||In most situations as an ongoing price position, being just under a mental barrier seems much cheaper|
|Price discount||Amount you save (e.g. $5 off)||Short term promotion, especially when the price is medium to high|
|Percentage discount||Proportion you save (e.g 10% off)||Short term promotion, especially when the price is relatively low|
|Conditional discount||Saving if you do a defined action (e.g. 10% off if you buy after 6pm)||Good when you want to direct behaviour|
|Price guarantee||Commitment to never be beaten on price||When you want to own lowest price|
|Value bundle||The AS Colour buy 5 items for $120||Can be very disruptive, good when the marginal product cost is low|
|Unique experience||Buy now and you can do this (e.g. kids dine for free)||Good when the experience carries little cost but high perceived value|
|Cash back||A cash refund with purchase||Good to convert hesitant shoppers, and people often forget to redeem the cash back|
|Buy one get one free||Two products for the price of one||Use the magic word ‘free’, good when the marginal product cost is low|
|Gift with purchase||A token gift for a limited time||Depends on the perceived value of the gift|
|Competition||Buy and go into the draw to win||Very common and powerful if the prize structure is right (trade off between few winning a lot or many winning a little)|
|Deferred payment||Buy now and pay later, or over time in small installments||When there is a high purchase price barrier|
|Auctions/Dutch auctions||Competitive price bidding upwards or downwards (Dutch)||When there is an emotional purchase for a one-off item|
|Assembly pricing||The product is deconstructed and priced according to how the customer specifies it (e.g. airline tickets)||When customization is worth paying a premium for, and allows the offer to be both cheap and premium at the same time|
|Usage pricing||Pricing according to how the customer uses the products (e.g. energy)||When there is broad diversity in how people use the product|
|Progressive value||‘But wait there’s more’ – value is built up to an unbelievable level||When it is a product people aren’t seeking out – you make it irresistible|
|Differentiated pricing||Different prices for different types of customers||When different customer categories warrant different prices based on their volume use, or VIP status etc.|
|Alternative currencies||Buy and earn points – tends to be polarizing||When you want to build loyalty an repeat purchase|
|Greater good||For every purchase there is a donation to a charity||When you want to tie your brand to the PR value of a good cause|
|Gamification||When you buy you get to play the game||To make the act of purchasing fun and engaging|
So, how about that backgammon set then?
The $600 backgammon set was hand made by Manopoulos in Greece out of walnut with mother-of-pearl pieces and a special carry-case. I found it after an exhaustive search locally and online. After looking at dozens of designs that weren’t quite right, I discovered ‘the one’. The Goldilocks instinct in me was truly exhausted. I had developed an acute sense of value anchors: the wood, the finish, the materials, the design and price points. By this stage there was no chance of me being satisfied with a common garden set. I had discovered something of rare beauty and I was emotionally involved. My price acceptability threshold was free-wheeling and I my pricing relativities had become fairly irresponsible. I had to have it.
Negotiating the value with myself I concluded that the price was actually very reasonable compared to what I could have paid for higher specified sets, and I conveniently suppressed the foreign currency difference and shipping costs.
I clicked and waited in delicious anticipation.