Effective pricing methods that maximise profit

Rising material and labour costs, decreasing purchasing power, a competitive market and high promotional pressure: no wonder many companies struggle with price setting in today's economy. There is unfortunately no ready-made formula to follow. Understanding your brand, product, market and customers is essential to get your pricing right. Building a pricing strategy without these insights is like building a house on quicksand. An insight-driven method such as value-based pricing is not the easiest to implement, but it is rewarding in the long run. It allows you to maximise your price potential, especially if combined with increased brand equity as this will result in lower price elasticity.

The importance of a strategic approach

How loyal are your customers? Do you understand how competitors set their prices? What is the price elasticity of your brand compared to competitors? How resistant are they to inflation? Do you know what your customers value the most: your brand, product quality or package design? 

If you rely solely on gut feelings to answer these questions your current pricing strategy might be suboptimal. Whether you choose cost-plus, competitive-based or value-based pricing, you always need a certain amount of data and insights to set the right price. Unlike the other methods, value-based pricing requires a deep understanding of your customers and consumers in general, viewing price as an expression of the value you offer. It is the only approach that allows you to maximise your price potential while building brand equity, because once you know what consumers and customers value and what drives their choice, you can deliver an offer tailored to their needs. This often results in a higher willingness to pay.

5 steps to value-based-pricing

Working with our clients, we have seen time and time again that there are five important steps to implement this approach successfully. The overall company strategy should always be your starting point (1), ensure the price is in line with the brand, product and consumer (2), listen closely to consumers and customers (3), create a win-win for all channel partners (4) and analyse whether your market research data is in line with pre-existing knowledge (5).

1. Start from the overall company goal

Although it might seem obvious, it is not always clear why a company wants to adjust their prices. Do you want to focus on volume, revenue, profit or even increasing customer satisfaction? If your goal is increasing volume, you will probably lower your prices, whereas optimising profit might mean higher prices. The KPI you decide to focus on determines your optimal price, as optimising all is rarely possible.

2. Look beyond price and business KPIs

Regardless of the KPI you prioritise, price isn’t a standalone feature. It should always be aligned with your brand, product or service and target consumer or customer. 

• Whether consumers think of your brand as trusted, premium or trendy will impact the price they are willing to pay. 
• Do you understand why people choose your product? Is it the brand or packaging design? The colour or product quality? This influences the price you can ask.
• And what about your consumers and customers? How price sensitive are they, and are they all equally sensitive or are some segments willing to pay more because they truly love your products or brands?

3. Listen to the customer

You will need data to identify the customers’ willingness to pay and your brand’s price elasticity. It will also allow you to understand how customers value your products. A combination of methods will help you achieve this. Transactional data capturing customers’ past behaviour enables you to predict the impact of past price changes on sales. Qualitative research gives more insights into the value drivers and willingness to pay, especially for customers who are hard to reach. Various quantitative methods (such as Van Westendorp, Gabor Granger or conjoint analysis) will help you predict future behaviour for pricing scenarios that have not yet been seen in the market.

4. Create a win-win for all channel partners

No matter how solid your price strategy is, it will fail if you don’t get your partners to agree and adapt their prices accordingly. Share your knowledge with them, educate them on consumer insights and possibly split some gains to get them on board and build long-term relationships.

5. Build your final price setting on four inputs

Lastly, avoid solely relying on market research for your new pricing strategy. Make sure it is aligned with the company strategy and take internal knowledge, expertise and existing data into the equation. Talk to as many stakeholders as possible and capture their insights, especially if your business has been around for quite some time and already navigated many challenges. Build on the experience you already have.  

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Keen to know more about value-based pricing and how to optimise your price potential? Get in touch!

Have you ever wondered why we sometimes make irrational choices when faced with purchasing decisions? Cognitive biases, the subtle quirks of human thinking that shape our choices, play a significant role in human behaviour. These cognitive biases, or mental shortcuts, lead us down unexpected paths, impacting our choices.  

As marketers or pricing managers, understanding these biases opens doors to crafting persuasive messaging and pricing strategies that resonate with a target audience subconsciously, nudging them towards desired actions. In this final article in our series on psychological pricing techniques, we'll delve into cognitive biases, like decoy techniques, and explore how they influence decision-making processes and sway consumer behaviour effectively.  

What is a decoy technique?

The decoy effect is a powerful technique for pricing and portfolio communication, both online and offline.  
The mother of all decoy techniques involves introducing product alternative options that are either overly expensive, too small, or irrelevant, ultimately steering consumers toward a desired purchase/product. By creating a context in which choices are evaluated and influenced through comparison, the decoy effect can lead individuals to make decisions they might not have otherwise.

Initially described by Joel Huber, John Payne, and Christopher Puto of Duke University in a 1982 paper, this decoy effect was explored through multiple experiments testing consumer preferences across various products like beer, restaurants, and cars. Respondents consistently favoured the target product or service when presented with a decoy option, showcasing the impact of this cognitive bias on decision-making.

How to apply cognitive bias & decoy techniques to pricing communication?

Let's now examine some fundamental cognitive biases affecting conversion rates and offer valuable insight into consumer behaviour. From the instantaneous bias to the powerful decoy effect, which subtly guides decision-making through comparison, each bias presents an opportunity for marketers to fine-tune their messaging for maximum impact.

1. Know when to communicate your prices as you promote your products

The timing of when your customer sees the price of your product can significantly impact their decision to purchase. If the price is displayed before the product (and its detailed features/specs), customers are more likely to make their purchase decision based on the price alone. As the price was the first product specification they received, they anchored it and used it as a reference to evaluate all the other elements.

However, if the product is shown first in all its glory and details, and the price comes afterwards, customers are more likely to consider the quality and features of the product before making a decision. You first “seduce” the consumer with all these great product features and make them dream. At the end of the product exploration, you communicate the price in little detail—i.e., the cost of all these nice features. It's essential to keep this in mind when deciding how to display your prices.  

For luxury products, it's best to showcase the product features and specs first and then the price, while for everyday (i.e. cheaper) goods like food, it's more effective to display the price first (as ‘decoy feature’) and then the product details.  
Remember, your customers' first impression of your product can heavily influence their decision to purchase, so it's essential to get it right the first time.

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2.  Add a decoy option to subtly steer choices toward the preferred option

When you have two product alternatives - one cheap and one primary - it's common for consumers to choose the more affordable option. To counteract this, you can use the decoy pricing technique mentioned above. I.e. adding a "dummy" product that is a worse deal than the primary option. This makes the main product appear more appealing and can increase the likelihood of being purchased.  

Sometimes, when we have to make a choice between different options, we may need clarification on which one to choose. Adding an 'irrelevant option' - an obviously wrong option - to the list can nudge us towards your preferred choice. This applies to pricing decisions, but also to other situations like social gatherings where bringing in a less attractive friend can make us appear more appealing to others. Similarly, in politics, adding irrelevant candidates can sway votes toward a particular candidate.  

The Economist example: The importance of irrelevant alternatives

In case you want to know more about this last example, check out the work of behavioural economist Dan Ariely, the author of Predictably Irrational, who uses classic visual illusions and his own counterintuitive (and sometimes shocking) research findings to show how we're not as rational as we think when we make decisions.

He uses an example from the Economist.com subscription options and pricing to explain this theory.  

Ariely presented MIT students with three options: web-only ($59), print-only ($125), and print+web ($125). When offering all three options, 84% chose print+web, 16% chose web-only, and (obviously) no one chose print-only.  
When he removed the print-only option and presented only web-only and print+web to another group, most students chose the cheaper web-only option. This demonstrates that the seemingly irrelevant print-only option served as a decoy, making the ‘print&web option’ appear much more valuable by comparison. Without this point of reference, people defaulted on the cheapest choice.  

This experiment shows how the presence of a strategically placed, less attractive option can significantly influence consumer decisions by providing a favorable comparison for the option the seller wants to promote.

Dan Ariely-Pricing the Economist > https://youtu.be/xOhb4LwAaJk

3.  Raise your prices gradually

One effective pricing strategy that makes use of cognitive bias in a clever way is gradually increasing your prices in smaller increments using the 'Just Noticeable Difference' (JND) technique, also known as Weber's law.  

The JND refers to the point consumers will perceive a price change. This method allows you to gradually introduce price increases to your customers without causing sticker shock. This is particularly useful as people tend to be biased toward the idea that prices will remain constant, which can make sudden price increases jarring.

4. Avoid mentioning defective items when selling a set (e.g. in second hand store)

When selling a set of items, it's best not to mention any damaged or inferior pieces that may be included. This was confirmed by an experiment conducted by Christopher Hsee at the University of Chicago. The experiment asked participants to evaluate the price of dinnerware sets sold at a clearance sale in a local store. The store regularly priced these dinnerware sets between $30 and $60.

The experiment had three groups: one group evaluated both sets mentioned above, while the other two evaluated Set A and Set B separately. The dishes in both sets were of equal quality. The question posed was: which set is worth more?

The outcome showed that the group who evaluated both sets was willing to pay a little more for Set A than for Set B: $32 versus $30. This is a rational and logical outcome when comparing both sets. However, the results were reversed for the single evaluation groups: Set B was priced much higher than Set A, at $33 versus $23!

The psychological explanation behind this phenomenon is that sets and bundles are often evaluated based on norms and prototypes. Set A's estimated value was lower than Set B's because people wanted to avoid paying for broken dishes. Consumers read ‘broken’ and think ‘junk’. ‘Broken’ usually comes with associations of ‘junk’ or ‘lesser value’. When the average or norm dominates the evaluation, it is not surprising that Set B was valued more.

Interestingly, its value was improved by removing 16 items from Set A (7 of them intact). This shows that sometimes, less is more regarding bundles and sets. The prevailing standards and norms regarding the quality of sets and bundles can bias our perception.

5. Charge a little more for add-ons / updates / product accessories

Did you know you could charge relatively more for add-ons, updates, or product accessories? This is thanks to a psychological theory called the Sunk Cost Fallacy. People and companies are more likely to continue with a product or project if they have already invested a lot of money, time, or effort, even when it's not the best or most economical thing to do.  

A classic example of this concept, is the printer and toner market. Printers themselves are often sold at relatively affordable prices. However, the cost of replacement ink or toner cartridges, especially when purchased from the same brand, can be exorbitant.  
Once you've invested in a printer from a specific manufacturer, you're more likely to accept these inflated prices for compatible cartridges because you're essentially "locked in" to that brand's ecosystem. This phenomenon is sometimes referred to as being "married to the hardware”.

In other words, consumers are willing to pay more than a reasonable, conform price for add-on products if they have already invested in the basics. This could be as trivial as filling in an email address on an info page in the context of considering a future internet provider…

6. Go for an acceptable/fair price, instead of the lowest price

It's often wiser to opt for an acceptable or fair price instead of the lowest possible price. This is because consumers tend to be wary and suspicious of deals that seem too good to be true.  

In a world of rampant overconsumption, people have had enough bad experiences to know that nothing comes for free. As a result, they tend to view excessively low prices with prejudice and assume that they must be deficient in some way.  

To address this issue, many businesses use the Propensity Score Matching (PSM) method, or what we call the “Van Westendorp” pricing method which suggests that an ideal price range lies between "a great buy for the money" and "on the high side”. Van Westendorp's Price Sensitivity Model is based on a comprehensive, multi-question approach to indirectly measure willingness to pay, as opposed to directly asking potential buyers for a specific price point. This model assesses a range of prices rather than just one or a few, providing a more in-depth understanding of what is a ‘correct’ price for your product/service.  

Conclusion

Using psychological pricing (messaging) techniques for your goods/services is one thing, however setting an accurate price at the base is something else. Price setting should be based on market insights on brand strength, product evaluation, customer needs and expectations, etc. This approach allows you to look at psychological pricing techniques as ‘the icing on the cake’.  
You need a well-thought-out, insights-based price at the start. And rest assured, once you have this, you can use psychological pricing messaging techniques to maximise your earnings.

If you're looking to take your business to the next level, you need to nail your pricing strategy. At boobook, we understand this and are committed to helping you navigate the complexities of pricing. Our approach combines robust consumer-based data analysis topped with insights from behavioural economics to create pricing strategies that align with your customers' decision-making processes. This drives profitability and business growth.  

As we wrap up our series on psychological pricing (messaging) techniques, we hope we inspired you to explore more about pricing strategies and how to integrate them into your overall marketing strategy.  

If you have questions or want to know more, reach out to our team!  

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Pricing and price visualisation plays a crucial role in impacting consumer choices through the intricate web of psychology. Understanding psychological pricing can give you an edge in marketing and pricing strategy. It's all about understanding consumer psychology to make your offerings irresistible, rather than just the numbers on a price tag. As we continue our series on scientifically supported principles, in this part of the series, we’ll discuss Prospect Theory and Loss Aversion.

The intersection of behavioral economics and marketing has created some of the most ingenious techniques for capturing consumer attention and inciting purchasing action. At the forefront of this technique is Prospect Theory – a concept so potent that its creators, Daniel Kahneman and Amos Tversky, altered fundamental assumptions about human decision-making and rewrote the rules for 21st-century marketers.

What is prospect theory?

Prospect theory is all about how we, as human beings, perceive value. It underscores the simple reality that people are not always rational, and economic decisions are not always made based on final outcomes of maximal utility. Instead, losses and gains are immediate, causing emotional reactions that can transform the landscape of what's considered 'valuable.'

Prospect Theory proposes that individuals tend to value losses and gains differently. This theory, also known as Loss Aversion, suggests that people tend to make decisions based on potential gains rather than potential losses. The foundation of this theory lies in two key principles: Loss Aversion (the feeling of loss being stronger than the pleasure of an equivalent gain) and the importance of Framing (the impact of how options are presented).

Understanding this theory is the first step in leveraging it to create pricing (and communication) strategies that appeal to the deeper workings of the human psyche, but it's just the beginning. As we continue our series on psychological pricing techniques, we're going to explore in-depth how you can apply Prospect Theory to revamp your pricing communication and gain a competitive edge in the market.

How to apply prospect theory when messaging your prices?

How many times have you seen a banner flash 'Only 5 left!' and it's those last few that seal the deal for you? This strategy is not just a coincidence but a clever use of scarcity to trigger loss aversion. The fear of missing out (aka FOMO) is a powerful psychological motivator, compelling consumers to act quickly lest they 'lose' an advantage.

Or let’s take a warranty as an example to make things even clearer. Money-back guarantees, free trial periods, and satisfaction assurances not only reframe the purchase as an opportunity (the possibility of extra gain) - but can also drastically reduce a potential loss (i.e. being unsatisfied with the purchased product, seen as ‘money lost’) in consumers’ mind.  

To implement the Loss Aversion principle in your pricing, consider these messaging approaches:

1. Arrange prices strategically: When you arrange your products from highest to lowest price (e.g. as standard sorting in the web shop), customers are more likely to opt for the pricier options that are presented at the start. This behavior highlights how people gravitate towards avoiding losses, considering choice as a loss, and feeling the impact of loss.  
   By showcasing the more expensive items at the top of the list, customers perceive a decline in quality as they scroll down or look further onto the shelf, ultimately choosing the initially presented, more expensive selections as the 'safe choice'. So, think twice before prioritizing your lowest-priced items by default just to create an image of being an affordable brand.

2. Strategic timing for discounts: Offering discounts towards the end of the month can significantly boost the effectiveness of marketing campaigns. Research shows that customers are more financially capable at the beginning of the month, making it an ideal time for promotional, non-discount activities. Discounts, conversely, are more positively received towards the end of the month as individuals prioritize saving money during this period. This timing aligns with the 'Bottom Dollar Effect' in behavioral economics, where expenses feel more burdensome towards the month's end.  
   So, to link this with the Loss Aversion theory: the pain of losing extra dollars at the end of the month is harder than losing them at the beginning of the month. Making price discounts many people’s best friend at the end of the month.

3. Implementing a steadily decreasing discounts (SDD) pricing strategy:  
   The steadily decreasing discounts (SDD) pricing strategy engages consumers in a psychological game. By gradually reducing discounts (instead of keeping them the same or increasing them!), customers are driven by a fear of missing out, anticipating future price increases. This fear prompts them to make purchases sooner (i.e. stimulating impulse buying) to avoid higher prices later, again leveraging the principles of loss aversion and scarcity.

In all these cases, the key is to gently guide the customer towards the feeling of 'missing out' on a product or a deal. This involves highlighting the potential 'loss' that the customer might experience by not making a purchase decision immediately.  

The pitfall of overusing loss aversion strategies

The strategic use of loss aversion can be a powerful tool for marketers, but relying too heavily on playing up potential losses can diverge into manipulative territory, reducing trust in your brand and sacrificing long-term customer loyalty.

The ultimate goal shouldn’t be manipulation of your customers’ emotions but aligning with their needs and expectations in a way that builds trust and nurtures meaningful relationships.  

In conclusion, tapping into loss aversion through the lens of prospect theory is a potent method on its own, however by combining this approach with a focus on building strong customer relationships, businesses can create a winning strategy that drives long-term success.

Using psychological communication techniques to maximize your sales is one thing, but setting the right price at the base, considering your brand strength and customer expectations, is something entirely different. Both are important.  

If you're looking to take your business to the next level, you need to nail your pricing strategy. At boobook, we understand this and are committed to helping you navigate the complexities of pricing. Our approach combines robust consumer-based data analysis topped with insights from behavioural economics to create pricing strategies that align with your customers' decision-making processes.

Don’t miss our upcoming final article in this series on psychological pricing techniques, delving into cognitive biases and decoy methods with explanatory examples.

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