Old Pricing Theories Put to an End by Behavioral Science
Old Pricing Theories Put to an End by Behavioral Science
As old pricing theories go, there is a business saying that goes like this: “Low prices will get more customers and high prices will get fewer customers.” This alleged “old” truth is something that the business economy lives by and has done for a very long time indeed. But this saying doesn’t capture the reality of customers’ buying behavior, as there are many facets attached to it, some complicated. On the contrary, higher prices can actually increase a company’s sales volume.
A traditional way of thinking in business economics would follow that price and demand have an inseparable linear relationship. Marketing strategy regarding pricing becomes simplified by the “normal” practice of setting the price, which will optimize the total earnings.
However, modern research has now further complicated this well-known business practice. Humans have many internal/external influences that affect their behavior, for instance, psychological and other non-rational factors, these also affect buying behavior too, so the whole picture is not given through this established economic theory.
People make their purchasing decisions based on an estimation of the value of a specific product or service. Of course, that valuation will differ for various situations, as it is individualistically based. What one person sees as value for a product or service may have little or no value attached for the next person—it’s subjective.
However, there is a correlation regarding the estimated value, not only concerning the current and personal needs but also its interrelationship with other products or services of a similar kind. Before making a purchase, a potential customer will ask a couple of quickfire questions: “Is this product or service of good quality?” and, the big one, “Is it worth the asking price?” If the customer’s answer is “Yes,” then a purchase is likely to take place, but if it’s “No,” then it’s highly unlikely a purchase will occur.
In most cases, the customer has little knowledge of how good the quality is for a specific product or service, and thus, they take the price as a sign of quality, a quality indicator. So, when looking through the customer’s eyes, a price increase will be seen as a value increase. This has little to do with showing off wealth or status, but that could be used as a determining factor for some customers. This principle is applied in a general way, especially for products or services that don’t have any status attached to them.
An everyday example can be choosing a pair of winter shoes. While in the shoe store, it is very difficult for the customer to be able to look at the shoes in-depth, to get the full picture, to see whether the shoes are of high quality or not. Only prior research, looking at reviews, etc. can do that, before going to the shoe store. However, if the price is seen as high, most people will assume that the quality, and thus, the value is higher. It’s a risk buying low-quality shoes for the winter season; you don’t know whether they’ll start to leak or deteriorate quickly. They may only cost a fraction of the more expensive shoes, but are you willing to take that chance?
Here lies the problem – most people don’t know this in advance. The cheaper shoes are probable as capable, in some cases, more capable, of keeping your feet dry and warm as the more expensive ones, but this is where the uncertainty lies. Only time will tell whether you’ll get good value for your money from your purchase or not. So, price becomes the deciding factor when estimating the value of winter shoes.
When you know how your customers make their purchasing decisions, this information should become integral to your pricing strategy. Low-priced products and services can be perceived as having low value because of the price attached to them. So, it’s not always the case that a low price will give a higher sales volume. It can also have the opposite effect, having prices that are deemed “too low” may reduce sales volume because the message the prices are giving is one that is perceived as cheap, attaching poor quality and lack of value to it, so your potential customer may not buy it because of these factors.
Therefore, price is an important factor in itself. What companies need to fully understand is that a correctly set price is not about placement on a linear graph, but it’s about finding that place where their consumers' perceived value is the greatest.
So, where is that optimal price? This is the question that needs to be answered if companies are going to get their pricing strategy right. Getting the answer may seem rather obvious – you ask your current and potential customers. When you ask your customers to put a value on your different products or services as well as indicate what they’re willing to pay for them, those results will give you precise price indicators for a specific product or service. Having this information, you’ll be able to uncover the true balance between the price and sales volume of your products or services. Also, by using a number of different variables, this can be refined, as well as it is possible to work across various markets.
What happens next is that the results are analyzed and processed and after these processes are completed, a graph is produced that will look totally different from a “standard” graph analysis. You see, instead of just a linear relationship being presented, it now becomes a two-way staircase, where various price plateaus and price walls appear in the data. These are the places that’ll aid your pricing strategy.
So, as it now becomes abundantly obvious, humans very rarely act according to the traditional and classical economic theory mentioned earlier. But in a psychological way, we will perceive a low price as having lower quality, and thus, placing a lower value on it. People are only prepared to pay the asking price, if, and only if, they think it’s “worth the money” When this is factored into the situation, a higher-priced item may hold a sales advantage that is too good an opportunity to miss. Never look a gift horse in the mouth!
It’s estimated that 95% of companies today still use a “simplified” model when deciding prices for their products and services. They use guesswork (never an effective way), use predetermined marginal goals, or cost-based pricing. What’s amazing is that if the actual willingness to pay is included in their calculations, an increase in the profit margin of between 25–40% can occur. In some cases, even more!
All this means that the price of your products and services can be improved significantly. For those traders and businesses who are hard-pressed under small margins, you can, through such analysis, provide yourself with the information to provide a solid foundation for your pricing strategy, as well as the potential to increase profitability across the board and gain opportunities that will help you develop your business.
Of course, all of this is based on the fact that your products or services are totally genuine. You’ll definitely get no success by trying to pass on substandard products or services for a high price to your customers. This will only backfire and your business will reap the consequences of such underhand practices. Be warned!
It may not be very revolutionary to see the importance of customers’ perceived value for your products and services; however, the process of investigating and analyzing this value is a new concept—one that works. Both psychological and behavioral science factors play a much greater role in customers’ purchasing behavior, more so than the traditional and classical economic models. When you really know what your customers are willing to pay for your products and service, then you’ll see pricing strategy in a whole new light. It’s a whole new ball game—one you can win!
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