Yesterday, I had a group of professionals join me for a pricing and estimating boot camp where I dug into the methodologies and psychology of pricing. Pricing is one of the largest dictators of firm success, but it also might be the most difficult strategy to master.
As we sat around the table discussing different options for pricing methodology- cost plus, value-based, promotional, premium, penetration, bundle, psychological, and unit- the group came to a realization. Regardless of your approach to pricing, the most critical aspect of your strategy must revolve around a deeply-rooted understanding of the customer.
Price wars have become prominent across the board. The cost-leader Walmart has shaped consumer expectations in the grocery industry. Southwest’s low-fare travel options have caused a spike in price competition among airlines. Nearly all construction firms now compete on below 5% profit margins due to extreme pricing pressure. But how does this pricing impact the customer decision?
Pricing psychology revolves around the customer’s perceived value of the product or service. The trick in crafting an effective pricing strategy is understanding how to get the customer to give you more credit for your pricing.
So what influences this perception?
- The first step is gaining insight on what types of customers are buying your products. Are they price sensitive and are you able to meet their needs with a lower price point than competitors? Or are they buying your brand at a surplus? While this may seem simple, misunderstanding customer motivations can devastate a brand. For example, luxury clothing brands are often diluted when they create an inexpensive offshoot. They misunderstand the motivation of their primary customer, the high-end buyer, in purchasing costly apparel- quality, exclusivity, and status.
- The second step is understanding that consumers have an inaccurate awareness of prices. A supermarket study showed that over 50% of shoppers couldn’t estimate the price of commodities within 10% of their actual price point. Value perception is not based on fact, but a construct in the consumer’s mind. The more difficult information to gather is in understanding how are these value constructs created. What is too expensive and what is the reason it is too expensive? In the grocery store, a large determinant is size or price per pound. Figure out the specific aspect of your product or service that customers value and tie the price to that feature.
To gain this information, survey customers and experiment. Gain useful insights from customers and attempt to apply it in your business- but with caution. Consumers don’t know what they don’t know and so it is important to constantly test the waters and determine where value intersects price to create the best situation for your bottom line.