Paul Skah

The Psychology of Crafting a Great Pricing Strategy

By: Paul Skah | August 1, 2018 | 
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The Psychology of Crafting a Great Pricing Strategy“How much should I charge for my product or service?”

If you’re among the people asking themselves this very question, I must break it to you—there is no easy answer.

I am, however, able to guide you through the results of research which will help you establish a good pricing strategy.

In Your Pricing Strategy, Your Price is Too Low

Let’s start with the basics.

If you’ve put your services (products are less often the case) on the market, you’re probably pricing them too low for two reasons:

  1. You’re doing what you love. Therefore, you consider what you do as “pleasant.” Imagine you love mowing your lawn and absolutely hate doing the dishes. You are willing to pay more to have someone do dishes for you (because you loathe the chore) rather than mow your lawn for the same fee, right? And in turn, if someone asks how much you’d charge for an hour of lawn mowing… you’ll name a lower price.
  2. You’re good at what you do. When deciding how to price of our services, we often look at time as a key factor. A lawyer who charges $1,000 for a document which takes him 10 minutes to prepare is ripping you off. Now if the same document took two days to prepare, then it could easily cost $1,000. Try to remember how mad you were when the doctor charged you some ludicrous sum for a visit. And when it was over, all you could think was that it took only 10 minutes! Hence, you have misgivings about charging $1,000 for updating a customer’s website, knowing it will only take you 20 minutes to complete.

Negotiating with Yourself

These two factors coalesce into what psychologists describe as “negotiating with yourself.”

Before setting out for a client meeting, you convince yourself to drop the price at least a little bit.

Then, you begin the conversation by offering a discount. Or quite simply, your prices are lower than they should be to begin with.

How should you go about rectifying this?

  1. Ask someone else to negotiate the prices for you. If you can do this, it’s by far the most comfortable option. An “outsider” who knows what your services are worth won’t have the strong emotional reaction towards customers as you do.
  2. Negotiate with a note in hand. Be honest with calculations on how much your services are worth, what your costs are, and how much you want to earn. Write the results on a sheet of paper and take it with you when sitting down to negotiations. Let it play the “bad accountant” role—you can even set some sort of punishment for yourself if you go below the sum you jotted down. If you’re dropping prices too often, go back to the drawing board and review your calculations.

Customers are More Elastic Than you Think

Do you know what “price elasticity of demand” is?

It doesn’t sound appealing, but it’s an incredibly important factor.

Price elasticity of demand shows how demand changes should you change your prices.

In other words, if you raise your price by X percent, what percentage, less clients, will still buy from you?

A staggering majority of entrepreneurs (the task doesn’t belong solely to marketing) don’t measure and analyze the price elasticity of demand.

The effect? They earn less than they could with the same amount of work.

Take a look for yourself:

  • You run a language school. One term costs $1,000, and you have 80 customers. You earn $80,000 per term. What happens if you raise the price to $1,200 per term?
  • If no more than 13 customers leave, you have to raise your prices. This is due to the fact you’ll earn more with 67 customers paying $1,200 than with 80 customers paying $1,000.

Do you know what the most interesting part is? In many cases, the drop in customer levels will be exactly… zero.

If you don’t operate on the border of price elasticity (you price yourself lower due to the reasons above), customers will be ready to pay you more.

What Fee Amount to Include on your Price List

Do you charge a nice round $500 or $499? Or something else entirely, maybe $473?

The price of your products and services influences price elasticity.

And if that wasn’t enough, the way you present the price also matters.

Let us move on to the issues of the pricing strategy psychology.

A “Pretty” Price

Take prices with the number nine at the end.  The number nine itself doesn’t matter. The most important number is that last number on the left.

During a price reduction, if the price drops from $430 to $390, such a reduction is perceived as more attractive than the price where the first digit remained unchanged (i.e., $450 to $410).

Keith Coulter did research showing that the effect is amplified if the cents are in fine print.

Now, we’re off to redo our price lists!

Note, however, the effect of a pretty price works mainly on things we buy for rational reasons. These are necessary products, for example,  bread, milk, a new school backpack, or a winter jacket.

If you’re selling things people purchase on a whim, you’re better off using prestige prices.

Prestige Pricing

When shopping for luxury items (gaming consoles, sweets, dinner in a fancy restaurant) rounded prices such as $500, rather than $499, work best.

Why?

Research by Kuangije Zhang and Monica Wadhwa shows rounded numbers increase the “cognitive ease of processing.”

Simply put, rounded numbers feel better and are easier to wrap our heads around.

Talking about ease of processing—prices with fewer characters or symbols (1400 instead of $1,400) are also easier to absorb.

And my favorite part of the research, which price sounds “cheaper.”

One thousand, five-hundred or fifteen-hundred?

We perceive prices with fewer syllables as lower.

Perhaps we should charge $28.50 (five syllables) instead of $27.70 (seven syllables)?

And then there is my favorite: the price matches your age!

A consumer celebrating his thirtieth birthday will choose a selection of products for $30!

Before you decide to round your prices, there’s one more thing to note concerning very expensive products.

Unit Prices

There are products which customers perceive as “units”—bought individually, in small quantities, and quite rarely.

A house, a customized website design, or a car with custom equipment.

In such cases, the price shouldn’t be a template, either.

Website design for $3,990 sounds a lot cheaper than a website for $4,130.

Unit price offers the impression of uniqueness—for which customers are willing to pay.

It suggests we took into account a few modules or elements and that neither the product nor the price is a template. And speaking of packages and modules…

Increase Shopping Cart Worth with Package Deals

When buying a car for $134,000 (you know, unit price), it’s much easier to justify throwing in that winter package for an extra $9,000 rather than “winter tires for $3,000,” “heated seats for $3,000,” and a “towing hitch for $3,000.”

In the second case, the customer must make three individual decisions about whether to buy something or not.

In the first, all it takes is one decision—and the price of $9,000 doesn’t seem so high when compared to the price of the whole car.

It doesn’t seem so high due to the Weber-Fechner law, which states, that even if price changes are fluid (raised by a single dollar), customers will still notice changes in segments.

Initial changes won’t affect them at all, but if you exceed the segment’s threshold, the price starts to sting.

When it comes to price changes, the average worth of a segment is about 10 percent.

If you increase your prices by an amount within 10 percent, chances are your customers won’t even notice the change. All that’s left is the matter of anchoring.

Comparing Prices

A $90 “Shrimp Feast” at a restaurant (luxury item gets the prestigious price, remember?) looks expensive…until we pit it against a “Shrimp Extravaganza” for $290.

Our brain has issues processing numbers without context.

That’s why instead of assessing the worth directly, it often tries to compare it with something.

“Anchoring” is an effect in which we compare something with things in the closest vicinity.

Make the comparison easier and reap the rewards.

The Shopping Channel hosts like to say, “But that’s not all!”

So what if we were to add a third option to our menu?

  • Shrimp Feast $90
  • Shrimp Feast Premium $120
  • Shrimp Extravaganza $290

What do you think will happen? People will start choosing the “Shrimp Feast Premium” more often.

Aside from anchoring, we observe something that Daniel Kahneman pointed out as an “A-rule.”

When comparing three products, our brains tend to cast aside the one that is more difficult to compare with the rest and directs the choice to the remaining two.

(In this case, the “Shrimp Extravaganza” seems something completely different than the other two “feasts.”)

In the case of luxury items, the more expensive ones win far more often.

Time Over Money

Do you want customers who purchased your shrimp feast to come back for more?

Then don’t mention money!

In her studies, Jennifer Aaker proved people are willing to buy more if we remind them about the time they spent using our product or service rather than the money they saved on it.

That’s why “Remember the fun you had with your friends sharing our shrimp feast?” is a far better pitch than “Remember the 30 percent you saved on the shrimp feast?”

Speaking of time, a higher price spread over a period works better, too.

Would you prefer to spend $168 for a year of premium Netflix access, or $14 per month?

That’s why certain companies inform customers about a monthly subscription plan but charge them for a full year when they make the purchase.

Crafting a pricing strategy isn’t an easy task.

Knowing how people react to prices and how they assign worth will enable you to increase your income.

Photo by Fabian Blank on Unsplash

About Paul Skah


Paul Skah is CEO of MIDEA branding agency, which specializes in consumer psychology, with the main focus on the decision-making process. Paul helps companies craft their brand stories and come up with better strategy. His clients range from large multi-national corporations such as HBO and SONY, to successful startups such as Brand24 or LiveChat, to small businesses. Paul does most of his work in Polish but Iis dipping his toes in other markets as well. His articles have appeared in “Forbes”, and he is a columnist for “Brief” (the oldest Polish marketing magazine).

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