Unit K.03 – Pricing Impact on Value of Products or Services

What you’ll learn to do: discuss how price affects the value of an organization’s products or services

Price determines how much revenue a company is going to earn. It determines whether the business is covering the costs to create and deliver its products. Price drives the financial health of the business.

In out initial discussion of pricing, we’ll start with the perspective of the customer. If the customer doesn’t see value in the product offering—and that includes pricing—company objectives won’t be met. Customer perceptions of value must be the central consideration in the pricing process.

Demonstrating Customer Value

Rent the Runway is a company that lets customers borrow expensive designer dresses for a short time at a low price—to wear on a special occasion, e.g.— and then send them back. A customer can rent a Theia gown that retails for $995 for four days for the price of $150. Or, she can rent a gown from Laundry by Shelli Segal that retails for $325 for the price of $100. The company offers a 20 percent discount to first-time buyers and offers a “free second size” option to ensure that customers get the right fit.

Do the customers get a bargain when they are able to wear a designer dress for a special occasion at 15 percent of the retail price? Does the retail price matter to customers in determining value, or are they only considering the style and price they will pay for the rental?

What does value really mean in the pricing equation?

The Customer’s View of Price

Whether a customer is the ultimate user of the finished product or a business that purchases components of the finished product, the customer seeks to satisfy a need through the purchase of a particular product. The customer uses several criteria to decide how much she is willing to spend in order to satisfy that need. Her preference is to pay as little as possible.

In order to increase value, the business can either increase the perceived benefits or reduce the perceived costs. Both are important aspects of price. If you buy a Louis Vuitton bag for $600, in return for this high price you perceive that you are getting a beautifully designed, well-made bag that will last for decades—in other words, the value is high enough for you that it can offset the cost. On the other hand, when you buy a parking pass to park in a campus lot, you are buying the convenience of a parking place close to your classes. Both of these purchases provide value at some cost. The perceived benefits are directly related to the price-value equation; some of the possible benefits are status, convenience, the deal, brand, quality, choice, and so forth. Some of these benefits tend to go hand in hand. For instance, a Mercedes Benz E750 is a very high-status brand name, and buyers expect superb quality to be part of the value equation (which makes it worth the $100,000 price tag). In other cases, there are tradeoffs between benefits. Someone living in an isolated mountain community might prefer to pay a lot more for groceries at a local store than drive sixty miles to the nearest Safeway. That person is willing to sacrifice the benefit of choice for the benefit of greater convenience.

When we talk about increasing perceived benefits, we refer to this as increasing the “value added.” Identifying and increasing the value-added elements of a product are an important marketing strategy. In our initial example, Rent the Runway is providing dresses for special occasions. The price for the dress is reduced because the customer must give it back, but there are many value-added elements that keep the price relatively high, such as the broad selection of current styles and the option of trying a second size at no additional cost. In a very competitive marketplace, the value-added elements become increasingly important, as marketers use them to differentiate the product from other similar offerings.

Perceived costs include the actual dollar amount printed on the product, plus a host of additional factors. If you learn that a gas station is selling gas for 25 cents less per gallon than your local station, will you automatically buy from the lower-priced gas station? That depends. You will consider a range of other issues. How far do you have to drive to get there? Is it an easy drive or a drive through traffic? Are there long lines that will increase the time it takes to fill your tank? Is the low-cost fuel the grade or brand that you prefer? Inconvenience, poor service, and limited choice are all possible perceived costs. Other common perceived costs are the risk of making a mistake, related costs, lost opportunity, and unexpected consequences, to name but a few.

Viewing price from the customer’s point of view pays off in many ways. Most notably, it helps define value–the most important basis for creating a competitive advantage.

The Psychology of Pricing

You will notice that when we discussed the value equation in the previous reading, we referred to perceived benefits and perceived costs, rather than absolute/actual benefits and costs. Every customer perceives benefits and costs differently, and many of these perceptions aren’t even conscious. There are very few buying decisions in which a customer meticulously lists and weighs the benefits and costs in order to determine value. More often than not, the buying process involves snap judgments and decisions, and psychological factors likely come into play.

Despite tremendous advances in brain research, the factors involved in perception and decision making are still not well understood. We do know that perception is highly individual and complex. If you, as a marketer, are trying to understand how consumers perceive something abstract like the “value” or “benefit” of a product, it’s important to know that there is certainly a psychological dimension to that perception, but there isn’t a scientific formula that can give you all the answers or accurately predict whether someone will buy. Still, you can avail yourself of the interesting work that has been done in this field and be aware of some of the factors that might affect buying decisions.

Studies of Psychology in Pricing

Most of our understanding about the psychology of pricing comes from research studies that explore buyer behavior.

The Case for the Number Nine

Many studies show that customers are more likely to buy products whose price points end in the number nine. That is, they prefer products that cost $99 over identical items priced at $100. Somehow the brain perceives greater value from a small price change that ends in nine.

A study in the journal Quantitative Marketing and Economics validates the benefit of using nines in pricing—with a few important qualifiers, noted below. The study compared purchases of women’s clothing discounted to $35 and the same clothing discounted to $39. The study found that 24 percent more consumers purchased when the clothing was priced at $39, even though the price was higher.

The study found that if a product has been available at a different price for a long time, then changing the price to end in nine will have a smaller effect than if it’s a new product that starts out with a price that ends in nine. It also found that if a product is marked “on sale,” the nine will have a small impact.

The researchers conclude that the nine has more power in situations where the buyer has limited information. If there is enough information for the customer to suspect that the nine is being used to manipulate the sales decisions, the customer is less likely to buy.^[1]

Providing Pricing Options

Anchoring is a cognitive bias that describes the common human tendency to rely too heavily on the first piece of information offered (the “anchor”) when making decisions. During decision making, anchoring occurs when individuals use an initial piece of information to make subsequent judgments. Once an anchor is set, other judgments are made by adjusting away from that anchor, and there is a bias toward interpreting other information around the anchor.^[2]

In the presentation of pricing, anchoring has a powerful impact on buyer behavior. In negotiated pricing, the first price offered becomes the anchor. For example, the initial price offered for a used car sets the standard for the rest of the negotiations, so that prices lower than the initial price seem more reasonable even if they are still higher than what the car is really worth.

On company Web sites, on restaurant menus, and in the layout of retail stores, anchoring is used to adjust perceptions of price. The prominent presentation of a higher-priced item lifts the buyer’s price expectations in a way that makes other items seem more reasonable, even if their prices are also high.

Inviting Price Comparisons

Are there limitations on the impact of anchoring? Another study examined the impact of providing price comparisons on buying behavior.

First, researchers listed popular music CDs on the auction site eBay flanked by CDs of the same title with different prices. In one auction, CDs with an opening bid of $1.99 were positioned next to CDs of the same title with a starting bid of 99 cents. In a second auction, those with a starting bid of $1.99 were positioned next to CDs with a starting bid of $6.99. In an auction, the buyer sets the top price, but the cheaper CDs positioned next to the $6.99 CDs sold at much higher prices than the same CDs presented next to those with an initial bid price of 99 cents.

Researcher Itamar Simonson explains, “We didn’t tell people to make a comparison; they did it on their own, and when people make these kinds of comparisons on their own, they are very influential.”

Next, the research team ran the same auctions but in this case explicitly told the auction participants to compare the $1.99 price to the price of the other CDs presented. This explicit instruction to compare prices adversely impacted buyer behavior in a number of ways. The price of the adjacent CDs ceased to have a statistically significant impact, buyers waited longer to make the first bid, submitted fewer bids, and were much less likely to participate in multiple auctions simultaneously. Simonson explains, “The mere fact that we had asked them to make a comparison caused them to fear that they were being tricked in some way.”^[3]

So while pricing comparisons can be a value presentation strategy, they are not without risk.

As you can see, pricing has a profound impact on buyer behavior, not only in determining what the buyer can afford, but in the deeper perceptions of value and the marketing exchange process.

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