3
£1–£1.50
Regular drinkers, sometimes a few cups a day
4
£2–£3.50
Luxury teas – chai latte or specialist herbal/fl oral teas
“For now we’re going to focus on these top two segments. Looks like there are different product types that will work for each – we may use different kinds of chocolate and definitely different kinds of tea. There’s no point in going for the lower end right now. Maybe later we can work out how to develop a product for them, but at the moment, anything we offer at those price points will probably just lose sales from segments 3 and 4.”
Segmentation of this kind is an important step in any pricing strategy. You want to know the range of price sensitivity, or willingness to pay (WTP for short) among your potential client base. Often, as in the teapot case, this range will divide into several clear categories based on what alternatives people compare your product or service with.
It is hard to span distinct WTP categories with a single product. If you are able to attract a customer base at £2.50, it’s dangerous to also offer a 30p version of your product – customers might trade down, and the profits you lose on the £2.50 client will be hard to make up unless you can sell huge volumes of the cheaper version.
The more unusual your product is, the more you should aim for a premium price segment; if you have close competitors you may have to hit a particular price point to capture a volume market, but if not, the cons usually outweigh the pros.
Determining the segments of your potential customers is important but not easy. If you rely on looking at existing customer behaviour, you don’t measure whether people would really be willing to pay more. If you speak to people who aren’t your customers at present, you are asking them to think about a hypothetical situation and this makes it hard for them to give you accurate answers.
This is why questions like 7 and 8 in Maggie’s questionnaire are important. Question 7 puts people in a situation which is relatively similar to the real buying environment, and asks them to make a real decision. This prompts the customer to go through at least some of the same mental processes that they go through when buying a real product. Having done that, the price point they think in response to question 8 is more likely to be accurate, and to reflect what they might really be willing to pay for the product.
It’s risky to ask direct questions such as ‘How much would you be willing to pay for this?’ Apart from the difficulty for the consumer of trying to predict their potential behaviour in a hypothetical situation, many people will deliberately give you an underestimate – in some kind of strategic attempt to influence you to lower your prices. As far as you can, you should structure your questions to replicate the real process and mindset of a consumer buying a product.
How to apply it
You can use the following questionnaire as a starting point, but feel free to modify it. Identify different groups of people whom you think might have a different attitude to your product, or use it differently. Then speak to as many individuals as possible. You should target at least 10 in each group, though you can probably benefit from talking to more than that if you have the time and patience to do so.
Remember the David Ogilvy quote at the opening of this chapter. Your customers do not necessarily know, and will not necessarily say, what they would do when presented with your product in a real environment. Therefore, try to ask the question in such a way as to make the scenario as realistic as you can. Some techniques for doing this include the following.
• Ask the person to place themselves in the shoes of a third party – for instance, to predict what their friend would do instead of what they themselves would do. This creates distance, takes away a source of bias and a degree of subjectivity that might result in a false answer to the question if they tried to imagine their own behaviour.
• Give them some money and ask them to spend it on products in your category. Although this isn’t perfect – because people treat newly acquired money in a different way from their own money, and because they might feel a moral obligation to buy a product they wouldn’t normally want – it makes things much more realistic than simply asking the consumer to imagine how they might behave.
• Put them in a physical environment which is appropriate to the decision you want them to make. For example, when interviewing people about a luxury housekeeping service, I booked the interviews in a five-star hotel in central London in order to convey the brand values that I wanted to present. When interviewing about a new coffee product, try asking people in a café.
Questionnaire template
You should modify this to reflect your particular product or service. See the teapot questionnaire above for an example of how to do this.
• How often do you buy (or use) this type of product or service?
• What variety, or which brands, do you normally buy?
• Where do you buy it?
• What are the experiences or feelings you most associate with using this product?
• If you decided not to buy this particular product today, what might you buy instead?
• What do you buy, or use, alongside this product?
• If I gave you £10 [or an appropriate amount] and asked you to go and spend some of it on buying this product, where would you go?
• How much would you expect to pay for it when you got there?
Chapter summary
• Asking questions of your customers or potential customers is an important way to get insight into what they will spend money on.
• However, you can’t take the answers literally. The responses customers give will indicate what they really think, but you have to read between the lines.
• One of the most important insights you will gain is what kind of questions or what context will change the answers that people give. This gives you a clue to how you can influence their decisions.
In focus
Does 99p pricing work?
Many of the prices in the examples so far have ended in 9. Does this really matter?
We all know that lots of products, from the sandwiches you buy for lunch up to a stereo, are priced with a 99p ending. Sometimes even a £24,000 car is priced at £23,999. Even this book is at a price point of £14.99. Surely this must make a big difference to sales?
The research literature says yes, but there are conflicting stories about how the practice originated and why it works. One story that goes around is that this originated not to increase sales, but to protect shops against embezzlement by their staff. If a customer paid $1 for a 99 cent item, the cashier would have to open the till to make change. In order to do so, they would be required to ring up the sale, preventing them from pocketing the dollar.
There is little evidence for this story, but it has the appeal of sounding plausible.
A more convincing psychological explanation is that people group prices into rough bands and apply very crude pattern-matching rules to make their decisions easier. Therefore a £2.99 sandwich falls into the ‘£2ish’ band, while a £3.05 sandwich would be placed in the ‘£3ish’ band and might be subconsciously excluded from the buyer’s consideration. Supporting this, one experiment by Robert Schindler asked people to compare two products priced at $20 and $25; the difference in value was perceived as small. When the prices were reduced by one cent to $19.99 and $24.99, the difference was perceived as much greater and people were much more likely to choose the cheaper option.
There is some support for this in the evidence that people can subconsciously recognise a number without knowingly registering it. An amusing example is an experiment by Katherine Hahn at Michigan Business School. She presented subjects with two very similar options, for instance two erasers which were almost identical except for a few random marks or a corner that had been rubbed off. Unprompted, people were equally likely to choose either option. But when the two erasers were placed on either side of a large number 9, people were much mor
e likely to choose the one on the right. When the number was 1, they chose the eraser on the left. Nothing else was changed except the number – and the hypothesis is that people subconsciously map the world onto a left-to-right one-to-10 number line, with digits providing cues for us to look left or right on this line. It is not known whether the effect is reversed in cultures where the language is written from right to left!
Overall, experience suggests that 99p price points do work. When your product is likely to be compared with a competitor’s, cutting that extra penny off the price could make people more likely to buy it. When the customer is choosing between different options within your product range (such as on a menu in a restaurant) the 99p may be more likely to bias them to pick one of your cheaper options, which could be counterproductive.
Chapter 5
New launches, belief and fairness
Consumers were easy compared to the next group Maggie had to persuade: the buyers in the supermarket and café chains.
I was allowed to sit in on two of those meetings, and – though I’m not free to talk about the negotiations in detail – I can report my surprise at the cynicism of some buyers.
“You’ll never sell them at that price,” was the most common message. “It’s a tea, it has to be priced in line with our teas,” said the cafés. “We can’t put this on the same shelf as a box of 40 PG Tips for the same price as one teapot,” said the supermarkets.
The consumer research data helped but did not entirely persuade them – it is hard to change a person’s firmly held beliefs with mere information.
The supermarket buyer claimed he could only sell a four-pack of teapots for £1.20, which would require CTC to price them at less than 20p per teapot. The café chain was a little more ambitious, suggesting a retail price of £1.40 for a single teapot, but with the higher margins that the café insisted on, this would still have forced CTC down to a 35p wholesale price point.
Maggie decided to take some risks. When one of the big four supermarkets refused to stock any teapots without a 50% cut from the original asking price, she stood up and left the room. It was clearly a tough decision so early in the life of the business, but doing it put her in a powerful position to negotiate with the other chains.
She went back into those negotiations and promised to take back unsold stock if it didn’t sell at the listed prices. That, combined with an agreement to participate in several sales promotions during the first six months of the launch, did the trick. Once the first supermarket placed an order, the two others soon followed.
The following week, the first café chain, a subsidiary of consumer products giant Leverkraft & Gamble, agreed to add teapots to their menu in six stores.
1 September was chosen as the launch date, and everyone held their breath.
Persuading people in your industry that you are worth what you say can be one of the hardest tasks. Typically, they think they know more about pricing than they do. The typical mindset is to remember the last time they had a tough price negotiation with a client, and focus on that as if it represents the whole market. However, the very fact that it was a tough negotiation means the client was probably at the most price-sensitive end of the spectrum.
People do tend to assume that their most memorable experiences are the most typical ones (this is known as the availability bias). You would like them to look dispassionately across the whole market, but it is hard to persuade people to do that.
Negotiating with someone like this is especially difficult, because they will claim (and usually believe) that they are not negotiating on their own account, but simply reflecting their understanding of how much their customers are willing to pay. The supermarket that insists that their customers won’t perceive your teapot as a premium product and the consultant who says that the client will pay no more than £600 a day for your expertise are probably both basing their opinion on the same lack of hard data.
A related argument you will sometimes hear is the just price – the idea that the prices you charge should be some kind of fair balance between your costs, the time you spend sourcing and distributing a product, and the demand for it. This concept goes all the way back to St Thomas Aquinas in the 13th century. We all want the prices we pay to be fair; but many people are unwilling to confront a supplier directly and suggest that they should be charged less. However, a third party who places themselves in the position of defending the end customer’s interests, and who is probably more informed than the consumer about the margins you are likely to be making, might try to argue for fairness on the customer’s behalf.
Modern economic theory puts little stock in the idea of fairness, but customers do like to be treated fairly. Therefore it is always worth having a rationale for your prices which you are happy to defend to customers. This will also be useful in negotiations with third parties or resellers. They may feel reassured to have ammunition in case their customers ask them about the basis of your prices. In reality, few customers will, but you may as well help assuage your partners’ worries if you want to keep working with them.
A final danger for many new companies is the risk that their belief in their own value is undermined. This is the most common pitfall for individuals who set up as consultants or freelancers: they find it hard to believe that their time could possibly be worth hundreds or even thousands of pounds per day. This isn’t the place for a seminar in self-confidence, but you can remind yourself of a few key facts.
• The value you offer to your client for a few hours of expertise could be immense – you are entitled to a fair share of it.
• By charging too little, you signal to your client that your advice is not worth much – this makes them less likely to follow it. Is that in their interest?
• There are always people in the market more expensive than you, and there is always somebody cheaper. Place yourself where you think you deserve to be – are you in the top 20% of people with your expertise? (You probably should be.)
Ultimately, you need to be willing to take responsibility for your prices: if you are firm in your conviction of your worth, you will be able to persuade customers to pay for your value and your positioning. You might need to help your partners to communicate that value with marketing support, or by giving them a clear script to follow when selling on your behalf. If you take control of that process, they are more likely to go along with you.
Case study
A specialist consultancy and its reseller
A specialist leadership training consultancy, McComb Associates, sometimes sold its services directly to clients but was more often used as a subcontractor by a larger management consulting firm, which I’ll call Excisient. The large firm had its own standard pricing approach, based on charging its clients for their consultants’ time at between £600/day and £1,000/day.
One of Excisient’s clients was an international bank which brought in the consultants to help launch a new venture in China. Part of the work involved training top European executives to manage Chinese staff and communicate with Chinese government officials, and Excisient asked McComb to help with this.
McComb realised that the value to the bank of doing this work really well was immense. A successful launch in China would be worth billions. The MD, Victoria McComb, wanted to dedicate some of her top people to the job, and to be rewarded accordingly. So she approached Excisient with a quote for the training services based on the value that would be created for the bank. The price was partly contingent on successful delivery of the project, and if fully successful would have worked out to about £240,000.
Excisient understood the logic of this value-based price, but insisted that the client would only pay for services on a day rate, and that the maximum rate available was £700 per day. Since McComb had been planning to spend only 80 days on the project, this would work out to no more than £56,000 – a tiny fraction of the value that the client would gain. At £700 a day it would be unprofitable to use their senior consultants on the project. U
nable to persuade Excisient to raise the day rate or pay a lump-sum project fee, McComb was resigned to assigning junior staff to the project and doing a low-quality job.
Victoria McComb asked what the overall budget of the project was. Excisient gave a figure just over £1m, but indicated that the client was willing to throw vast quantities of resources at the project if necessary. This gave her an idea.
McComb realised that the total price of the project was not a barrier at all; the problem was merely a bureaucratic limit on the day rate paid to consultants. If they could spend more days on the project, and make it profitable, they could increase the total price and capture a fair share of the value the client would gain. She proposed a research exercise, in which McComb’s student researchers would spend 300 person-days at £600 per day researching the Chinese market in endless detail, in order to create briefing reports for the trainers and the bank’s staff. The trainers would do their job at £700 per day and the total project value would reach £236,000. The students would cost McComb a small fraction of the price being charged, and the extra profit would allow the firm to use its top people for the training.
Both Excisient and the bank were able to see that the value of the project would far exceed the price paid, and this structure helped bypass the day-rate limit that had been imposed in the procurement contract.
How to apply it
Revisit the benefit matrix you drew up in Chapter 1. For each of the benefits, work out the highest price that you could imagine anyone paying for that benefit.
Think about it in terms of the most expensive service or the most over-the-top luxury goods you can imagine. If the benefit is that the customer gets to look beautiful, imagine the most expensive haute couture dress or diamond-laden necklace you can think of. If the benefit is that your corporate client makes £5m in additional profits, imagine a financial deal in which they pay £4m to a bank to gain that £5m benefit.
The Psychology of Price Page 5