The Psychology of Price Read online

  I nodded.

  “The point is, the positioning of the product makes a huge difference to how much people will pay for it. If we put it next to the teabags, people will compare it to the price of a teabag or a cup of coffee, which is between 3p and 10p. £2.79 for six seems hugely expensive. But if it’s next to a freshly made cappuccino, you’re willing to pay £2.89 for just one. A vast difference. We think the sweet spot for the supermarkets is in the fresh snack drink range, similar to a smoothie or a yoghurt, or a packaged hot chocolate. This lets us charge around £2. But there’s clearly a market in the café sector too, so we will try to distribute it there as well.”

  As it turned out over the following months, the café market was a big one. It wasn’t clear right away whether it was more valuable as a sales channel in itself, or as a way of creating product awareness for future purchases at the supermarket. In any case, once Maggie got one chain to sell the chocolate teapots, the others followed within six months.

  When customers first encounter a new product or service, they usually have only the vaguest idea of what it is worth to them. In a few cases the product may have quantifiable material benefits – this is true of some financial services, and some business purchases. This gives a clear rationale for the price of the service – if something will make you £10,000 in profit, it is probably worth paying up to £9,000 for it.

  Mostly, though, it is hard for us to know what we should pay for a product. We might try to predict the enjoyment we will get from consuming it. However, that is intrinsically difficult to guess – and even if we can, it doesn’t naturally translate into a sum of money. Instead, we are likely to compare it with something similar we have encountered before and use that as a benchmark.

  Imagine your friend from Estonia is visiting, and discovers that one of your neighbourhood pubs serves her favourite drink, which is made in Tallinn from local ingredients. You offer to buy her a glass of it. How much would you expect to pay?

  Imagine it is poured from a bottle into a wine glass. You might compare it with wine, and expect to be charged £4 for 175ml. If it’s poured into a champagne glass, it might be £7 for the same amount. If you instead discover that it is sold by the half pint, you are likely to compare it with beer, and £2 for the half pint will seem reasonable. If it is served in a shot glass, you would probably think of it as a liqueur and be happy to pay £2 for 25ml. That’s a price difference of 11 times, just based on how the drink is presented. Of course the alcohol content is also a factor – but not a factor of 11.

  Whichever products we most closely associate a new purchase with are the ones we are likely to use as a price guideline. Most products could potentially be compared with a number of different alternatives. The supplier therefore has the opportunity to shape our expectations by creating an association with a more expensive product.

  Chocolate teapots might be seen as similar to teabags, or to freshly made cappuccinos from a coffee shop. The Estonian local tipple might be more like beer, more like whisky or more like champagne. And a service to complete your tax return could be compared with paying £5.50 for registered post, £95 for a software program or £2,000 for a bespoke service from a highly qualified professional.

  The benefit matrix

  Every product benefit can be seen in terms of something deeper.

  Think about your product or service and all the benefits it provides. You should think hard to work out all the reasons somebody might buy from you. Then look in turn at each of those reasons and see if there is something more basic behind it. For instance, the taste of a drink might provide sweetness – which is a basic biological desire – and it might also provide familiarity, comfort and reminders of pleasant memories. These memories in turn can be broken down into something even more basic. Ultimately, every benefit is based on two fundamental emotional drives, pain and pleasure, and two fundamental material benefits, time and money (you can ultimately consider money and time also to be enablers of pleasure, but adding this extra level is not much help in practice).

  For example, here’s how it works for the Chocolate Teapot Company:

  Primary (level 1) drivers

  Level 2 drivers

  Level 3 drivers

  Basic drives

  The taste of chocolate tea

  Sweetness

  Pleasure

  Energy from sugar

  Memory associations

  Quenching thirst

  Preventing pain

  Satisfying a caffeine habit

  Reducing tiredness

  Productivity at work

  Pleasure Increased wealth

  The camaraderie of sharing a drink with someone

  Social bonds

  Pleasure

  And here’s an example for an accountancy firm:

  Primary (level 1) drivers

  Level 2 drivers

  Level 3 drivers

  Basic drives

  Compliance with regulation

  Reduced likelihood of fines and penalties

  Direct cost savings

  Money

  Reduced stress

  Reduced pain

  Feelings of order

  Doing the right thing for society

  Sense of community

  Management information

  Increased sense of control

  Reduced pain

  Better planning

  Profits

  Money Pleasure

  Improved firm strategy

  Reduced tax bills

  Cost saving

  Money

  Cash flow improvement

  Reduced stress

  Reduced pain

  Greater ability to grow the business

  Money Pleasure

  At the end of the chapter there is a blank version of this table for you to fill in yourself.

  This matrix of values shows all the different reasons – conscious and unconscious – that influence somebody to buy your service or product. In any given situation the customer will only consider a small number of these reasons, which is a powerful opportunity for you.

  For each of these buying reasons, you have a different set of competitors. A customer has a number of choices they can make to satisfy each of these needs.

  For example, a customer who wants to taste something sweet has various options apart from a chocolate teapot. They could also buy a packet of wine gums, or an ordinary cup of tea with sugar, or a dessert. Someone who just wants a hot drink could choose tea, coffee or hot chocolate. And someone who wants the social bond of sharing a drink could go to a café and share a coffee; they could go to the pub for a glass of wine; or they could even go to the cinema.

  Each different set of competitors has its own price spectrum. If you make the right choice of competitor and choose your positioning accordingly, you can choose a completely different price point. This will transform your profitability.

  The accounting firm described above might choose to focus on one key group of values: compliance (which largely covers doing the annual accounts and tax returns for small firms). If it did so, it would be stuck in a low-value market, being compared with self-employed bookkeepers and high-volume accounting ‘factories’ that have a low cost base and can undercut a traditional accounting firm. This is likely to be a low-profit option.

  Alternatively, it could focus on tax consulting: a higher-value market and one where the price charged is easier to tie to the value generated (see the case studies in Chapter 15 for details). Tax consulting perhaps calls for more creativity, and as a result is a less price-competitive market.

  The firm could position itself as a business adviser, offering strategic input into its clients’ commercial and investment decisions. This decision can unlock high value, because some business decisions can make a difference of many millions of pounds in value; and if the firm plays an integral part in helping its client make the right decision, it can charge a price commensurate with the difference it makes.

  Howe
ver, this last option brings with it a different set of positioning considerations. The market for business advice services is much smaller than that for compliance services. The way a business advice firm needs to present itself to earn confidence from clients is very different from the way an accountant should behave. The firm needs to show the right kind of experience to gain credibility to provide such a service. And most businesses will resist the high fees that come with this service – at least they will if those fees are quoted in the traditional way.

  Thus, a firm following this route should instead choose a pricing strategy that does not confront the client immediately with the cost of the service. The best way to do this is to charge a share of money the client doesn’t yet have: the benefits of future growth. Firms should look at structures whereby they enter into a joint-venture or revenue-sharing arrangement with a client; where the firm’s advice contributes to the success of a new growth market, the firm will end up with a stake in a far more valuable asset than they could ever have persuaded the client to pay in cash.

  Many accountants hate this idea. It is more risky to enter into an equity-based or revenue-sharing relationship than to charge a fee in advance, since many client ventures will fail, or stagnate, and will not make much money for the accountant. It requires an investment of time up front while the return, if it ever comes, will be far in the future. It is an unusual approach, with few examples to copy from, and requires an entrepreneurial commitment from the professional that may not come naturally. But those who do it will make far more money than they could have done in the traditional way.

  How to apply it

  In the ‘How to apply it’ section of each chapter I will show you a process you can go through to use the insights of that chapter in your own business. The benefit matrix exercise in this chapter is the most important in the book, because the benefits and values of your product or service will then provide the basis for most of the other techniques in the later chapters. You can download more copies of this matrix from the website www.psyprice.com.

  First, fill out the benefit matrix by analysing the benefits or value that your customers get from you. Write these benefits into column 1. Each direct benefit is likely to have something deeper underlying it, as shown in the examples above. Put these in column 2, and so on. Ultimately you will get down to the four basic drives: avoidance of pain; pleasure; time; and money.

  You may find that there are either more or fewer than four levels of benefit; for example, you might go straight from level 2 drives to avoidance of pain and to pleasure. If you don’t need column 2 or 3, just leave them blank. If you need more columns there are other versions of the table on the website.

  Use the value comparison chart on page 14 to choose one of the key benefits (values) of your product, and write down as many other products as you can think of that provide the same benefit. Write down the typical price of the other products. You can then choose which of these competitors you want to position yourself against, and whether you would rather be seen as a teabag or as a freshly made cappuccino.

  The ‘units’ column may be hard to fill in. For some products there is a clear unit of value. For example, with transport services it is the distance travelled; for accommodation, the number of nights stayed. Other products or services do not have clear units: for example, the brand value provided by a BMW definitely provides a benefit to the customer, but it is hard to imagine what units this could be measured in. You may be able to think of a way to represent it – perhaps the number of friends and acquaintances who will notice the brand? – but if not, then just leave the units column blank.

  The example shown at the top of the chart is for a supplier of health drinks, who has found that its key customer benefits are refreshment, self-image (through the branding of its product) and health (through the vitamins and herbs infused in the drink). Please use the blank rows underneath to fill in your own examples, or download an electronic version from www.psyprice.com.

  Once you have come up with a list of services or products that provide the same benefits as yours, you should be able to see which ones have the highest per-unit price. Consider how you can position yourself as an alternative to those: this is where you can probably achieve the highest price for your product.

  The benefits or values which you choose to focus on – those which will position you against the highest-value competitors which therefore enable you to achieve the highest price – are called your critical value dimensions.

  Bear in mind the likely sales volume of the products you are positioning against. If you position your new car model against Ferrari instead of against BMW, you can probably achieve a higher price per unit, but you will not sell as many cars. The next chapter shows you how to analyse the volume you need to sell.

  Benefit matrix

  Level 1 drivers (benefits)

  Level 2 drivers (features)

  Level 3 drivers (emotions)

  Basic drives

  Value comparison chart

  Benefit or value (taken from any column of the benefit matrix)

  Competitor

  Units of value

  Price per unit

  Refreshment

  Lager in pub

  Minutes spent drinking

  10p

  Sparkling water in café

  Minutes spent drinking

  12p

  Tap water at home

  Minutes spent drinking

  0p

  Self-image

  Alternative therapy session

  Per session

  £50

  Competitive health drinks

  Per bottle

  £2.50

  Reading a magazine

  Per issue

  £4

  Health

  Gym membership

  Per session

  £8

  Salad (in restaurant)

  One salad

  £6

  Salad (from supermarket)

  One salad

  £2

  Benefit or value

  Competitor

  Units of value

  Price per unit

  Chapter summary

  • The value that customers place on your product is subjective, and influenced strongly by context.

  • You can increase this value – and the price customers are willing to pay – by positioning your product alongside a more expensive alternative.

  • understand what alternatives customers might perceive as legitimate comparisons for your product, analyse the benefits it provides.

  • Each time you identify a benefit, ask yourself what deeper need that benefit fulfils, until you get right down to basic pleasure and pain.

  • These benefits will be a key tool in understanding the psychological pricing and marketing of your product or service.

  Chapter 2

  Cost-based calculations

  Your baseline, not your price

  The factory wasn’t up and running yet, but Maggie took me to the food laboratory where the prototype teapots were being put together. I had to put on gloves, a protective hat and even disposable shoe covers for hygiene. Somehow the outfit seemed to suit her much better than me.

  The manufacturing process was painstaking but not immensely complex. The plastic teapots were made in an injection mould, with the bowl of the pot emerging from the mould first and the spouts fitted and sealed in place afterwards. Then something that looked like a garden sprinkler sprayed a layer of liquid chocolate onto the inside of the pot. Leaves were sealed into a small teabag, which was dropped into the teapot once the chocolate had cooled down, with a thread attached and a tag hanging out of the lid.

  Maggie was cautious when I asked her about the cost of the teapot.

  “It depends on what you include in the cost. The individual ingredients are not too expensive once we have the equipment in place: the teapot costs about 5p, the chocolate 6p and the teabag about 3p. Plus another 5p or 10p depending on how we
design the packaging. But it has cost us at least £30,000 to put all this equipment together just for the prototypes. And the real factory will be 10 times that – just to get a single production line running.

  “The big question is marketing. If it catches on, we might get away without spending too much. If not, we may have to spend three times as much selling it as we do making it. It’s all quite unpredictable, which makes it hard to answer your question.”

  “So what’s the least you could sell each teapot for?” I asked.

  She paused. “That’s not the kind of question that has a meaningful answer. If we sold just a pot on its own, perhaps about 20p … but then we have to make enough profit to pay back the cost of the equipment and marketing. That depends on whether we sell 10,000 or 100,000 pots.”

  “At least you can get a reliable 50% markup if you sell it at 30p, then …” Maggie shook her head, frowning, and I tailed off. Clearly she was reluctant to discuss it any more. The conversation left me wondering whether this company was going to be wildly profitable or struggling to pay the wages. With hindsight, I realise Maggie had no better idea of the answer than I did. What was clear was she was working as hard as I’d ever seen anyone work to get these products developed and sold.

  In this chapter, we don’t look much at psychology; rather, this is an analysis of some financial aspects of your business which will provide the baseline for psychological strategies in future chapters. So if you already know all about your fixed and variable costs, and your breakeven volume, you can just skim this chapter.