As a business owner it is always difficult to know exactly what price your consumers will go for. This is especially true for big ticket items like homes, websites, and other business services. For those of you that know me well, you will be aware that if I don’t know how to do something I spend hours, days and even weeks researching it. After all, this is how I became an expert in web design and online search.
When I started this business (ImYourBiz) I went out and researched tons of articles and study papers on pricing. I wanted to make sure that once I start getting tons of traffic; my pricing will do exactly what I wanted it to do. So here is what I found out:
Under-pricing your service or product is a terrible mistake to make and I have often been guilty of this. Laura Willet, a small business consultant and lecturer at Bentley College in Waltham, states that you have to price your products correctly, especially during tough economic times, otherwise you will lose out to your competitors in a big way. Consumers want to know that they are getting value for money. In many instances your products will look inferior to your competition’s.
“Yeah I got the better version” – says your competitor’s customer with a smug face to your customer.
We have all heard of the term ‘market penetration’ whereby Wal-Mart comes in and price out everyone else and wins market share. This doesn’t always work for the smaller guy. Wal-Mart’s products are easily comparable. They have the same brands as other stores. Unless you are selling a commodity product that is easily comparable, then you will find it difficult to justify your value over the more expensive competitor’s.
Then of course there is overpricing. You all know the terrible effects of this. Too expensive = too few sales. It is really as simple as that which is why I am not going to elaborate on it.
Golden rule: charge what consumers are willing to pay, not what you can afford
Tim Harford, an economist and columnist for the Financial Times, was asked the following question by a head teacher from a private School:
A child can come to my private School at 5 years old and will be charged more for each year they progress. By the time they are 16, they will be paying double. I would like to award loyalty. How will I go about achieving this?
Tim Harford is pretty plainly spoken and anyone who has read his book, The Undercover Economist, will know what I mean. He told the head master to suck it up and forget about rewarding loyalty. Don’t charge what you think is fair, charge what you think customers are willing to pay. Only then will you find the equilibrium between under pricing and over pricing your services.
If you think about it, it makes perfect sense. Your pricing has to meet demand or one of two things will happen. If you think it is fair to charge less, (1) then your demand will go up, or (2) it will look like your competitors have a better product. If we take the more optimistic option, then you will have to hire more workers to cope with the demand, but your margins will be lower. Why would you want that? Your variable and fixed costs will go up whilst maintaining roughly the same revenue.
Optimizing your pricing strategy
I am going to assume that you already have products and they all have a price. So how would you go about optimizing them? The obvious choice would be to do a questionnaire, but I have found that what people say and do are two different things. I did a survey with LegacyForex.com to find the optimal pricing level for that business and it didn’t lead me down the right path.
Perspective – most of the time people have no clue what things should cost, even when it comes to stuff we hear about all the time on the news, like the cost of housing. People need something to compare your product to and if they don’t know what it should cost they will stick to first number they hear as a comparable. If you say a really high number like “it is normally $4,500 for a website, so you should really be looking to spend that…”, people will be shocked, but they will now have that high number in their thoughts. Then when I say “I personally will do this, this and this, to make it $1,497” it seems completely reasonable to them. I have reset the price anchors – read more about this study
Options – the more options you have the better right? Of course not and we all know it. Steve Jobs came back to Apple in the early 90s and eliminated about 30 products until they only had one laptop and one desktop. However, a number of studies have shown that have a few pricing options really does improve your sales.
Let’s take The Economist as an example. They have three packages, each with a different value proposition. They really only have two products: 1) online only subscription, and 2) their print subscriptions. Have a look at the image below.
Their third subscription is print and web combined – a 2 for 1 offer – but as you can see, it is the same price as the print subscription without website access. When you look at it you think, “Whoah! Do they think I am stupid? Of course I am going to go with option 3.” You almost feel lucky that the third option is available. Well actually, they want you to go for option 3, because they always offer the web for free with the print. They just added the second option to make you feel like a clever clogs for buying option three.
When they tested the pricing here is what they found. When they didn’t have the middle option, 68% of people chose option one, but when they added the second option, 84% of people chose option 3. See image below:
So how can you structure your pricing to optimize it?
From all the research I have done in this area I found one particular pricing strategy the simplest to understand and implement. So whether you sell a product or service, here is what you should do:
1. Offer three options
The first offer is going to have the lowest price, but also the lowest value. The second option will be the one you want to sell. It is only going to be slightly more expensive, but offer tons of extra value. The third option is going to be a super ‘premium’ offer which offers the most value, but is also much more expensive than the second option i.e. if you are selling socks
$13.99 for 1 pair of Darn Tough socks
$17.99 for 2 pairs of Darn Tough socks
$39.99 for 3 pairs of Darn Tough socks + water bottle
Even if you sell the second sock at break-even, the number of transactions will increase. More importantly, they will definitely come back to your store for their next purchase.
A study, which can be found in W. Poundstone’s book called Priceless, experimented with this concept. They found that nobody went for the first option, 90% went for option two, and 10% went for option three. You can see the same concept at work on my website:
Note: I have since removed the pricing from my website, but this still serves as an illustration.
This could work with anything
Even if you build homes and someone comes to you with a $500,000 budget – give them three options. $475,000, $500,000 or $650,000, but ensure that they know about the extra value you are going to give them. It is worth a shot for an extra $150,000 and there will be a small minority that only want the best and will fork out the extra money. Some of you must be thinking what happens if they go for $475k (the lowest option). Well, you have to ensure that the value goes down, which means your costs will go down too. Now you will make the same dollar value (or more) than option 2, but with less effort.