Second article about Behavioral Science and how it affects companies ability to price for profit.

This is the second article about behavioral science and how knowledge of this science should affect how you can best price your product and service.

In the first article, we covered these subjects:

Emotions: All purchase decisions are emotional; therefore, a seller can influence those decisions and customers’ willingness to pay with the “right” marketing, leading to higher sales volume, often at higher prices. This also means that with the right marketing, customer satisfaction will increase.  

References: All purchase decisions are made in relation to references, and companies can drive higher sales volume at more profitable prices by providing the “right” references in the “right” order. Details such as the layout of a website’s pricing page, or a proposal, or quote make a difference here.

Recall: It matters how often a buyer is exposed to a brand, logo, or product or service name. Familiarity lessens sales friction by reducing the perceived risk of a purchase, even if it is not necessarily the “optimal” purchase choice. But still a reasonable choice.

Remember that companies that use behavioral science, specifically behavioral economics, in their pricing practices will see substantial increases in sales volume, be able to increase prices without losing sales volume, and increase customer satisfaction. This is the Paradox Of Price. So leveraging behavioral science in your pricing and go-to-market strategy is really quite important.

Expectation bias: This second article on the topic will only cover expectation bias, as this is one of the most important and influential aspects of behavioral economics, and confirms what I mentioned in the first article - that buyers are malleable. Everything a company does around its selling sets expectations in the buyer’s mind about the value, benefits, and quality the buyer expects from the purchase. This is important, as value perceptions drive customer satisfaction, willingness to buy, and willingness to pay.

There are several aspects of expectation bias, and I will cover them one by one.

The first aspect is when a buyer is presented with a price below what they expect. What then happens in the buyer's mind is that the low price itself sets an expectation of inferior benefits from the product or service the buyer is about to purchase. That could be because the buyer believes the product or service itself will be of inferior quality. Or it could be that the low price creates a lack of trust in the seller, in the support the seller may provide, or even that the buyer doesn't believe the seller will stay in business very long. Or it can be all of the above, and for that reason, the buyer simply decides not to buy.

The same applies to discounting, except in some specific cases. A buyer exposed to a higher-than-expected discount will have the same effect. Too high a discount will make the buyer believe there's something wrong with the product or service, or that it's something wrong with the company that sells it, or that the seller won't be able to support the product or service, or even that the seller is about to go out of business. So again, a too-deep discount will make the buyer decide not to buy. It is all about the buyer’s expectations, set by the deep discount.

And I'm sure we've all been there. We're holding our hands on a product, either physically or metaphysically, and we look at the price or discount and say to ourselves, "I really wanna buy this, but at this low price, or high discount, I won't." As an exercise for yourself, please think about when this last happened to you. I'm sure it was only a few days, or maybe weeks, ago.

Yet, I talk to CEOs on this topic all day - and then many go back to their companies telling sales they need to drop the price to sell more. Marketing to develop discount campaigns to sell more. Go figure!

There are, however, cases when deep discounts do not generate these negative expectations. For example, end-of-season sales in clothing stores or of food that is about to expire. Cases where the seller wants to clear inventory and the buyer accepts the drawbacks of the purchase.

But we also need to consider that not all deep discounting will lead to the same results. There are companies that flourish on continued and deep discounting. They have educated their buyers that, despite ongoing discounts, the products or services they sell are of adequate quality, and so is the support, should it be needed. Some companies raise prices a couple of weeks before Black Friday or Prime Day, so they can offer deep discounts while maintaining a reasonable margin. Discounting around events like these is not perceived as nearly as negative as when done at other times of the year. In fact, once I had a conversation with the CEO of one of the dollar stores. He said: “Despite our low prices, we have to provide high-quality products; if not, customers don’t come back.” Or the flip side - when Ron Johnston took over as CEO of JCPenney, he adopted the pricing and discounting strategy he learned at Apple, where he was responsible for the retail stores. So he stopped all discounting, all specials, all coupons,  all “pile ‘em high and sell ‘em cheap“ and raised the prices. Since JCPenney's customers specifically appreciated everything he removed, they stopped buying. Resulting in a more than 35% decrease in same-store sales. Almost killed the company; it now has about 1/3 of the stores it used to have, is nowhere near profitable, and store closings are still continuing.  

We also have to recognize that the point at which the price of a product or service is too low to sell varies widely across products and services. It is also the case that, as I mentioned in the prior article, a brand's strength can mitigate the negative feelings a too-low price generates. Meaning that a strong brand can sell at lower prices, or a higher discount (if this is their chosen business model or market positioning) than a brand that is not so strong. Generating high sales volume. That’s because a brand is a promise of quality and consistency. What can be consider a too low price point also is widely depending on if the product or service is a pure commodity, where that “too low” price point is very low (as commodities are sold on low price only), or if the product or service has a level of uniqueness or complexity, which typically means the price  point that an be considered “too low” is much higher.

This too-low price has another, unexpected effect for some companies. In my company's case studies, many clients had their products or services so underpriced that when we advised them to raise prices, they saw sales volume increase. Secondly, it's important to realize that the price point where prices start to have a negative impact on sales volume and revenue can be accurately measured, which, spoiler alert, is the activity of my business.

Bottom line, however, is that companies need to realize that low prices are not the only driver of sales volume increases; often, it is the strength and effectiveness of their messaging and so forth that enable them to drive higher sales volume.

In fact, research has shown that 81% of buyers choose what they consider the best value, not the lowest price. And “best value” comes from a range of different product or service attributes and buyers’ perceptions:

Hard facts:

   • Technical data

   • Features/functions

   • Availability

   • Warranties

   • Price

   • Your product/service and competition

Soft emotions/opinions

   • Prior experience

   • Expectation of service

   • Expectation of benefit

   • Brand value

   • Expectation of quality

   • Your product/service and competition

Expectation bias also works the other way on the scale. If the price for a product or service that is not a commodity is relatively high, or very high,  the high price itself sends a message of uniqueness, quality, and benefits.

In the consumer space, the high price of luxury goods is a major reason a product is considered a luxury. The high price itself excludes the vast majority of potential buyers, leaving it to the much smaller group that can afford it.

In businesses, buying certain high-priced goods or services is less about luxury and more about risk aversion when the purchase is substantial. There was a well-known saying that "Nobody gets fired for buying IBM." IBM is not as dominant in B2B sales as it once was, but the saying still applies to other products and services. I know from my interactions with CEOs that they sometimes purchase services advertised as similar to the service of my company from one of the large global consulting firms at much higher prices than what we offer (5 to 10 times higher), despite the fact that the CEO knows the services the large consulting firm will provide will be inferior to what a boutique company like mine can offer. Using a large, well-known consulting firm is the perceived safe choice. Should that CEO be challenged by the board, he or she believes it is possible to justify the expensive purchase.

High price also affects customer satisfaction. A buyer who purchases an expensive, unique product does so because of its uniqueness and the specific value it delivers. Moreover, because the price is high, it sets an expectation of the level of benefits the buyer will experience, but those benefits occur only because the buyer expected them. Let me give two examples.

We all know that the active ingredients in generic Aspirin and generic Tylenol are exactly the same as in the branded versions. It is the same chemical compound in the same amount. But despite this, some buyers choose the brand Bayer, which invented the drug in 1923; likewise, some buyers choose the branded Tylenol rather than the generic version. In both cases, the branded version is substantially more expensive than the generic version. And in both cases, buyers of the branded version say it simply works better. It is more effective as a painkiller than the generic version. But this cannot possibly be the case! So in this case, what makes the expensive branded version of these drugs unique is the brand itself. Nothing else.  

In a B2B case, the history of Intel and AMD is interesting. Microsoft created its operating system for Intel’s x86 CPUs and went on to dominate the market. A duopoly. But computer manufacturers wanted a second source for the CPUs and pressured Intel to license its CPU designs to AMD. So both Intel and AMD manufactured identical CPUs. (There is much more to the story, but for the purpose of this article, this summary is sufficient.) Companies thus had a choice of buying computers with identical specifications, using either Intel- or AMD-manufactured CPUs. Despite being about 1/3 of the price of the identical Intel CPU, the AMD CPU's market share hovered in the teens or low twenties. Computer manufacturers simply said that buying the “brand” is the safe choice, even if it costs more.  

So expectation bias has five sides:

A price that is too low, or discounting too high, sets an expectation of inferior quality and benefit, leading to loss of sales volume and, further, a decrease in sales volume should prices be reduced.

Price can be high, setting expectations for high quality and value, but it might also be too high, excluding some buyers who cannot afford the purchase for various reasons.

A high price affects the buyer's satisfaction with the purchase. er

A high price lowers the perceived risk of a purchase.

A company’s marketing and sales strategy and effectiveness (or lack thereof) strongly affect buyers’ willingness to buy and willingness to pay, thereby influencing the price a company can set for its products or services.

And it all goes back to understanding the balance point of price; any selling organization must know the price that is neither too high nor too low. That price leads to the highest sales volume for any business.

But not everything is sales volume. The price that generates higher revenue and the price that generates higher margins are both higher than the price that leads to the highest sales volume. These three price points can, and should, be accurately measured. The price that leads to the highest sales volume, the higher price that leads to the highest revenue, and the even higher price that leads to the highest margin. With this information, companies can decide to trade sales volume for revenue or profits. Or trade lower revenue and profit for higher sales volume. The right choice is based on the company’s strategic position and business model.

This is already a long document (I trust you see its value), and I will continue the discussion of behavioral science and pricing in my next article.

Per Sjofors
Founder/CEO
Sjofors & Partners Inc