The meaning of Buffet’s famous quote is straightforward: Price each good to match the value it provides consumers.
But value is relative; it can change with factors as disparate as the economy or your customer’s mood.
And what’s more, if you focus on trying to chase how others value your product, you give up the power to direct the value yourself.
So how do you dictate the terms of your product value and price strategically, in a way that actually brings customers closer instead of driving them away? The key is to have an understanding of the psychology of pricing.
When and how you price a product can affect your customers’ perception of it as much as the actual dollar and cents amount. When looking for ways to boost or maintain customer retention, use the psychology of pricing to your advantage.
The following information can help guide you to inspire long-term loyalty in your customers—while making you a few extra bucks in the process.
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John T. Gourville, Harvard Business Professor and expert on the psychology of pricing, explains product consumption best when he says, “consumers are more likely to consume when a price is vivid and fresh than when it is obscured or distant.”
The terms “vivid and fresh” may seem confusing when used to describe price. But we’ve all experienced a vivid purchase.
Imagine yourself faced with a new gym membership. It costs $400 upfront for 12 months—not exactly the cheapest option in your area, but it’s the gym you’re most excited about. You feel some trepidation at the cost, but then you feel elated and excited once you commit to the new purchase. After all, this is the best gym in your area, and it comes highly recommended from all your friends. Most importantly, getting in shape is going to change your life.
The first few days, all you can think about is using the gym—what machines you’ll try, what classes you’ll take up, and how great you’re going to look in your jeans in a few weeks. The $400 spent, you tell yourself, will keep you on track.
This financial commitment, known as sunk cost, inspires product consumption. You saw the $400 dollars disappear from your checking account; the price is vivid and as fresh as it gets.
But then a few weeks roll by. You don’t see the exact changes you had anticipated. It’s getting a bit colder outside, and you’d rather stay warm in your bed in the mornings than make the commute to the gym. You make excuses for days on end, and the days turn into weeks, and the weeks into months, until one day a friend asks how the new gym is treating you, and you finally have to accept that you’re no longer going to the gym at all anymore.
So what happened? Gourville would tell you that the sunk cost effect has worn off, and as a result you are no longer actively consuming your gym membership. What are the chances you’ll sign up for a second year. Almost none, right?
Right now you might be thinking to yourself: How does this relate to my business? We’ve built the best product possible. Isn’t that the most we can possibly do to promote product consumption? The rest is entirely up to the customer.
Although you can’t force a customer to use a product any more than a gym can force you to show up, you can use pricing to inspire motivation in consumers. Through the use of installment plans, the sunk cost effect can be delivered in regular intervals to bolster a customer’s experience and maximize value.
Think back to the gym example: if you had to pay the $400 over the span of 12 months, you are going to consistently feel the financial commitment you have made over that span of time. As a result, you are more likely to go to the gym, see results, and sign a contract for the second year.
Customers who come to you because you have the cheapest price are fair-weather consumers. They’ll spend their dollar elsewhere as soon as something cheaper comes along.
That’s why it’s your mission to use pricing to frame your product in a category of one. But can you turn customers into value-seekers before they even purchase your products? Consider the following pricing strategies to change their thinking.
While it can be important to keep pricing competitive to stay afloat in the marketplace, too much undercutting devalues your product and communicates to customers that your product is cheap.
It also puts you in the position of earning significantly less revenue then you could and threatens your bottom line. Part of establishing your optimal product price point is finding a way to use your competition to raise your price, instead of lowering it.
In the book, The Psychology of Price, author Leigh Caldwell encourages readers to use competition to their advantage. According to Caldwell, making your product similar to your competitors’, to a certain degree, validates your product to your potential customers. The key, Caldwell points out, is to avoid direct comparison, which would force you to compete on price alone. Instead, make your product appear distinct enough to speak to consumers looking for a unique value proposition. As Caldwell puts it:
The psychological goal is to piggyback on existing demand…while attracting them with the extra benefit to consider paying a little extra.
The example Caldwell uses is Inca Kola and Coca Cola. If the two products are viewed as competitors, you can see how Inca Kola provides a unique value proposition to consumers: it’s a carbonated soft drink with an “authentic” edge (it bears the name of an ancient and indigenous civilization), that can speak to consumers that object to Coca Cola’s overly corporate image. For this reason, it doesn’t have to compete on price, and can even demand a premium.
They say the customer is always right, but the customer may not know what your product should cost. The truth is, customers don’t always intuit the value of your product, and that’s a good thing—it creates an opportunity for you to direct their perception with conscious pricing practices.
So how do you take advantage of this to create greater value? Focus on the power of anchoring. Anchoring is a psychological term for how we make decisions that are disproportionately influenced by the first piece of information we receive. In pricing terms, this means the first price the customer sees plays a big role in how they put other prices in context.
Here’s another example from The Psychology of Price: Caldwell describes a friend’s company, Chocolate Teapot Company, which sells specialty chocolate teapots. The customers who entered the north entrance of the company’s shop were introduced to two types of teapots: a £1.30 milk-chocolate pot and a £2.55 vanilla white chocolate and dark chocolate pot. The majority of the shoppers chose the cheaper option.
But those who entered the south entrance were presented with a different selection. These customers were immediately introduced to high-end products, including £6 individual pots and £25 gift baskets.
The result? The south entrance customers were much more interested in the £2.55 teapots than the £1.30 version. And as a result, those who entered the south entrance on average spent 60% more than those from the north entrance.
Chocolate Teapot Company’s head of merchandizing, Julie Robinson, explains:
First impressions are really important. When a customer is wondering about the worth of a teapot and the first price tag they see is £1.30, it sticks in their mind…But when the first one they see costs £6, their subconscious assumption is that £6 is what people pay for this kind of thing. £2.55 looks reasonable, and £1.30 is downright cheap. Too cheap, in fact, for some people—and so they tend to opt for a more expensive version.
Offering consumers the right forms of payments is crucial to keeping customers on board. If your customer cannot use his payment method of choice, he might consider switching over to your competitors. Additionally, offering a large variety of payment options can help your customer feel secure if his preferred method of payment changes.
Consider payment options like:
If you are concerned about some of the fees on certain transactions, try to negotiate with the payment provider before ruling it out. And if a customer is late on a payment, check their history before taking action: is this a customer that has otherwise been loyal? Offering her a flexible repayment plan can go a lot further in terms of customer retention than slapping on some fees.
There’s a lot to consider when updating or modifying your pricing strategy. But we hope the information above helps you seriously engage your customers through the power of psychology. Regardless of what tips resonate with you, it’s still important to check in with your customers through chat, email, and surveys; more than anyone else, they know if your product is worth the price, and how likely they are to remain loyal to your company.
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