The Psychology of Price

by Leigh Caldwell

  The main challenge is the time it takes to draw up a customised quote. Fully analysing the situation and deciding which pricing techniques to apply could take a few hours, days or even weeks. You may want to draw up one formula that you can apply in many different situations. An example might look like this:

  Estimate the number of hours required for the service, and your standard hourly rate Standard option 100 hrs × £120/hr = £12,000

  Add 60% to the hours and 30% to the rate for a ‘high-service’ option: the client will receive personal attention from a senior person, extra project management and other additional services Premium option 160 hrs × £156/hr = £24,960

  Add 30% to the hours and 20% to the rate for a middle option Advanced option 130 hrs × £144/hr = £18,720

  Offer a subscription option: divide the Standard Option price by 15 to give a monthly price over two years; this includes standard service plus some followup meetings and additional support Subscription option £800/month over two years

  Offer a value-pricing option which ties your rewards to the number of new customers they win, or the productivity saving they make, or some other measure. This will nearly always work out much more expensive than all the other options, so they won’t choose this one, but it shows that you’re willing to take a risk and work with them Partnership option (e.g.)£2 per hour of staff time saved

  The details will vary according to your industry, but this is one example of how to construct a bespoke quote without going through a time-consuming analysis every time.

  When it is time for a face-to-face negotiation, the psychology has a lot in common with pricing approaches, but some of the subconscious messages that you usually convey through pricing can also be put across directly in the negotiation. After all, your pricing structure conveys your confidence in the quality and value of your product; it shows that you are willing to be reasonable and tailor the price to the budget of your client, as long as they accept the appropriate tradeoffs in features or benefits; it allows you to defer the client’s pain to the future or shift it onto someone else; and it demonstrates that you can walk away from the negotiation because you have other clients who are willing to pay for your product or service. All of these factors apply in a negotiation, and your actions and demeanour should be consistent with them.

  This means that you go in confidently with your price, making no apologies for it. If the customer asks for a discount, you only offer it to them in exchange for some reduction in the benefits of the service. The reduction in benefit may not be exactly proportional to the reduction in price – you need to judge how important saving money is to the client relative to the other benefits you offer. You should be creative with offering solutions that delay payment to the future or tie it to pain-free events like increasing the client’s market share. If they push you too far you need to be willing to say no (though you can play safe by saying no on a small point, to gauge how much they are willing to bend, before taking the risk of walking away from the whole project).

  You might even find some of the same techniques apply when you’re negotiating a raise or a bonus from your employer.

  There are whole books on negotiation, both with your customers and with your boss, so I won’t attempt to provide a full treatment of the different techniques. But the basic psychological points are the same as for pricing: understand and take control of the expectations of the other party; give them a choice between several options on your terms, not theirs; and make the payment distant – emotionally or in time – but make the benefits close, visible and highly salient.

  Chapter 11

  The tea party

  Inspired by a visit to the USA during the Congressional election campaigns, Maggie launched her range of luxury products in May with a new marketing campaign: the Chocolate Tea Party.

  Having gradually built up a mailing list of several thousand loyal customers over nine months, the company announced a competition to select the top 100 influencers. They each received a visit from someone in the sales department and a gift of the new luxury tea range. This combined an exclusive high-cocoa chocolate with a range of Japanese and Chinese teas, served in a handmade pottery tea set.

  The range was not designed to be enjoyed alone, however. The tea set came with eight small cups and saucers, and the quantities were made for sharing. This was the launch of the Chocolate Teapot Company’s first social marketing experiment.

  I took a trip to Liverpool to visit an early summer tea party hosted by influencer number 37, Joanne Spiers. Joanne was a charming lady of indeterminate age (let’s be polite and call it 45) whose house by the river had a beautiful, secluded garden. She had set up a tray for tea and cakes before I arrived, and invited me to sample a little before the party proper got started.

  We sat together on the grass, with a small table in front of us, and Jo opened a packet of luxury Cho-Chai. The tea was sealed in a thick parchment packet and the chocolate, disc-shaped, wrapped in a cacao tree leaf. She placed the leaves in a porcelain pot and poured some boiling water over them. A timer chimed after 90 seconds and she dropped the chocolate discs in. Another minute and she poured the tea out into two small china cups. We could almost have been in Kyoto instead of Liverpool. I brought the tea to my lips, anticipating something special.

  It had a lovely flavour, more delicate than the normal teapots and with a sweetness that was more subtle. Instead of the normal strong black tea, which needed a fair hit of chocolate to balance it out, these teas tasted more herbal, with only a hint of chocolate providing some warmth in the background. I savoured it for a few moments before taking a bite of sesame-infused rice cake.

  With hindsight, I realised how strongly my experience of the flavour was affected by the power of the ritual and of all the extra attention I paid to the flavour as I tried it. The very fact that I knew this tea was expensive made me enjoy it more.

  Jo’s guests arrived soon after, and I watched their reactions to the tea as well as the interactions across the table throughout the evening. I’ve never been to an Avon or Ann Summers party but I imagine they might be a little like this, if more risqué – some gossip, some trying out different products and comparing them, and all the while a careful social comparison of who’s buying what.

  The social dynamic was fascinating. Everybody clearly felt they had to buy something. Jo told me she had invited only people who would be comfortable with spending a certain amount of money, but I wondered whether some might just make a token purchase. It seemed, though, that they all wanted at least one luxury tea set and a range of cakes to go with it. When someone reached the £100 mark the others all added enough extras to take them over £50.

  The distinction instead turned out to be between those who were interested in hosting a party themselves and those who chose not to. Three of the guests also placed an order for stock and all the required items to host their own tea party – which they did not need to pay for until after they had hosted it. Jo was to receive some kind of commission on whatever her guests sold at their own parties.

  I noticed an intriguing effect halfway through the party. A series of luxury porcelain teapots had been provided with the party pack. Each matched one of the cups from which the guests were drinking. Jo passed the teapots around during the evening, and everyone had a chance to pick out the teapot that matched their cup and see how they looked together. The people who had physically touched each pot were more interested in buying them at the end of the party. Each guest, once she had looked at the pot and handled it, seemed to put a higher value on it than did those who had not touched it.

  In the end, people were sufficiently unwilling to give up the teapots they’d tried that Jo sold over £600 of products at the party. Two more parties were booked and one more was to be arranged. Rolled out across the country, this marketing channel looked like a good bet as a sales source in itself and also as a way to introduce newly launched products to the market.

  Two powerful effects are at work tog
ether in this chapter, as well as a few more minor ones.

  The first is the peer effect. In situations where we have little past experience or guidance as to the appropriate way to behave, there is a strong pull to follow the example of other people like us. Part of this is because we use their behaviour as a cue to tell us what a sensible strategy might be for ourselves. And part is because we don’t want to look silly in front of our peers.

  The peer effect can even override our own reasoning capacities. In one experiment, subjects were shown a series of lines on a screen and asked to say which was the longest.

  Diagram 6

  One of the lines was clearly longer than the others, and when shown the lines unprompted, 100% of subjects got it right. On a second test, new subjects were placed in a room with several other people, who unbeknownst to the subjects were actually part of the research team. The researchers all pointed to a line which was clearly shorter than the others, claiming – against the evidence of everyone’s eyes – that it was actually longer. In about half of cases, the subjects went along with this and pointed to the wrong line too.

  When there is no clear right answer – for instance, how much tea should I buy, how much should I spend, or how much should I contribute to sponsor my colleague’s marathon run? – the effect is even stronger, especially when our decision is visible to our peers: we have an interest in behaving like them, to reduce the risk of embarrassing ourselves or them.

  This can be seen clearly in social marketing contexts such as the chocolate tea party, or to some extent through social media such as Twitter and Facebook. It also works in retail environments: when a person sees other customers buying a product, they consider it to be a justification of both the price and quality of the product. Recommendation engines on websites work on this principle – ‘other people who liked X also bought Y’ – although it is not clear whether they use price as one of the criteria for their recommendations.

  A related effect is reciprocity – where people who have been given some unconditional gift or assistance are likely to reciprocate by spending more money in return, or making a purchase they might not otherwise have made. In many party marketing contexts there is an expectation that the guests will buy a product as a gift for the host. The purchase of this gift may also help wary customers to get past their inertia: once the first purchase is made, others will follow.

  The subjective quality effect was also seen in this chapter. The fact that the luxury tea set was priced higher than a standard tea led to a direct improvement in the experience of the customer.

  This is a well-known effect with wine. Subjects tasting a wine which they believed cost £40 per bottle enjoyed it much more than the same wine which they were told cost £7. The reasons for this effect are not fully understood, but they may be related to the length of time and attention the drinker spends savouring the wine; it may be fulfilment of an expectation of high quality, if the drinker starts with the assumption that the wine will taste good (or bad) and then adjusts slightly upwards or downwards based on its actual taste. Drinkers may even take particular identifiable flavours – for instance a high tannin level – as a sign of high quality in a good wine, and simultaneously as a sign of low quality in a bad wine. The same principle applies to many other products.

  The second main phenomenon demonstrated in this chapter – also related to inertia – is the endowment effect. Researchers have discovered that people put a higher value on things they already possess than equivalent objects that they don’t own or have not touched.

  If you give out small objects like mugs or chocolate bars to individuals and ask them to look at and hold the objects for a short time, their valuation of those objects will increase. People on average will assign a 20%–50% higher value to the object they have been given than to similar objects that they have not been ‘endowed’ with. Thus, if offered the chance to trade these objects with the others in the room, they will be less likely to swap if they have held onto the object for a while.

  This endowment effect is stronger if the objects have been physically touched, but it works even without that. It is related to the phenomena of loss aversion and the status quo bias. All of these effects arise from the fact that people prefer things how they are, and want to hang onto what they’ve got rather than taking the risk of swapping them for something uncertain.

  Whether you can use these effects in your business depends on the nature of how you sell. In a retail environment, if you have sales staff who spend time personally with the customer, they can physically place an object into the hands of the buyer before asking whether they want to purchase it. This will increase both the likelihood that the customer will buy, and the price they are likely to pay for it.

  If you sell by mail order, you may find it worthwhile to offer customers your product on a sale-or-return basis. Of course you may lose some when a few people do not return the product and do not complete payment (although by taking card details you can now eliminate much of this risk), but the chance that a person will want to keep the product once they have had it in their possession is much greater than the chance that they will want to pay for it before they have seen it.

  If you offer a service rather than a product, the endowment effect suggests that you should consider encapsulating the service in a physical, tangible version. Customers who can ‘hold the service in their hand’ are more likely to think it is legitimate to pay for it than those for whom it is completely intangible. You do not want customers to become too focused on the likely cost of the physical object itself, so ideally it should be symbolic of a larger experience rather than encapsulating the whole service fully in itself. A good example is that, alongside a physiotherapy service, you can offer exercise equipment which the customer can use to practise what you have done with them. Some objects can be very cheap to provide – a rubber strip or ball, for example – but can offer a lot of intrinsic value in complementing, and providing a reminder of, your service.

  How to apply it

  Social effects have the most powerful effect when you can bring together people who are loyal and regular purchasers of your product with those who are not yet committed to it, or not willing to spend so much.

  Look at your customer segments and see which of your customers have the highest willingness to pay. Can you identify any social context where those people are likely to be in the company of others who do not fit that segment? If not, can you create this context yourself (as CTC did with the tea parties)? You may be able to set up seminars where existing or likely customers can meet with others who have not yet started to buy your product or service.

  At these events, provide products at a range of different price points, but try to incentivise your high-spending customers to make a visible purchase from the expensive end of the range. You could do this by directly offering the host a commission on sales, or by simply asking them in person to do it. Customers who rate your product highly are often quite happy to help you out if you ask.

  The subjective quality effect is most useful when you remind customers of the high price they have paid during the experience of consumption. Try providing cues in packaging or in the way a service is provided which reinforce the price message. This might involve investing in some services or features which are technically unnecessary – for instance a dentist might provide a private waiting room for their patients or a personal followup call after an appointment to ask whether the tooth still feels OK – but which are designed to remind the customer that they paid more than is standard and that they are being indulged accordingly.

  The endowment effect is easier to apply with a product than with a service, but symbolic objects can be provided as part of a service offering too. Look at your value chart and determine which objects would most clearly encapsulate the values that are most important to your customers.

  Consider whether you can find a mechanism to give customers the object before they make the decision to buy it. In a face-to-face sale
s environment this is usually straightforward. You can also let them select their preferred product and then offer them a slightly more valuable version – a higher-quality product or one with more capacity or features. The customer will often perceive that there is no downside in trying out the upgraded version of the product. Once they have tried it, they will experience a strong resistance to downgrading to the version they originally intended to buy.

  Chapter summary

  • If people are unsure about a new product, or whether they should pay a certain price for it, social approval is a powerful way to reassure them.

  • You can promote this by bringing different customers into contact with each other – those who are less price sensitive and already willing to pay a higher price with those who have not yet been willing to try it.

  • Giving people a product to hold physically will increase their attachment to it and make them more likely to buy it.

  Chapter 12

  Bundling

  One Sunday in June I realised that I’d grown to rather depend on my chocolate teapots. I felt like drinking one, but opened the cupboard to find there were none left. At 10pm it were too late to go out and buy one. But I realised that there were a couple of squares of white chocolate in the corner, and some teabags. It was time to carry out an experiment.

  I boiled the kettle and picked out the tea which seemed most similar to the Assam variety that CTC uses. I poured the water into a cup and, while it was still boiling, dropped in both a teabag and a square of chocolate. I had to keep stirring for a while before the chocolate would dissolve, but eventually it worked. Cautiously I raised it to my lips to see how closely I had managed to replicate the chocolate teapot experience.