The rational way to handle pricing is to declare your price, tell customers everything you’re going to do for that price, list all the wonderful benefits, then ask for a purchase decision. That works in a rational world, but as it turns out, people aren’t rational when they spend their money. In Predictably Irrational, behavioral economist Dan Ariely dives into the forces and thought processes that guide purchase decisions. From his book you can glean three pricing strategies that will not only help customers decide to purchase from you, but also be willing to pay a higher price.
Contextual Pricing Strategy
When customers buy, they judge in terms of relative advantages, not in absolutes. For example, a customer considering a purchase with you does not look at your product and its price tag, and then vote yes or no.
“most people don’t know what they want unless they see it in context.”
– Dan Ariely – Predictably Irrational
Let’s say you’re an interior decorator (insert your profession here) and you present your bid to a potential client: $699. You think it’s a great deal. In fact, you’ve knocked $100 off your normal price to make sure you get this client. Does the client think it’s a good deal? The answer is, they don’t know…unless they’re able to put it in context.
This is why people get bids from multiple vendors. They really don’t know how much they should pay for something. People want to be able to compare to make sure that they’re not spending more than they should. So what should you do? Adopt a contextual pricing strategy.
You should never present just one option with one price to a potential customer. Give customers choices. But the key of contextual pricing is to offer related choices so that customers feel comfortable making decisions. You already know that given three choices, customers will most likely take the middle choice. So offer three related price variations, with the middle option being the option you want them to buy.
This is especially important for service businesses selling an intangible product that is not easily comparable. It’s an easy fix to add two additional choices to the mix. But what about retail businesses? Avoid one-of-a-kind items sitting on shelves isolated from comparable products. Give customers three related choices at three different prices.
Decoy Pricing Strategy
Decoy pricing: Offering a slightly less desirable version of the product you really want customers to purchase.
When you have contextual pricing in place, you’re ready to tackle decoy pricing. Decoy pricing is giving customers three choices; 1) The product you want them to buy at the price you want them to buy, 2) A slightly less-good product at a slightly lower price (the decoy), and 3) a similar product but not quite the same as what the customer wants.
Take a floor covering store, for example. A customer has asked for a quote on laminate flooring. You present them with three choices, 1) The laminate product you want them to buy, 2) a laminate product that is a little cheaper, but is not as resistant to scuffs and moisture (the decoy) and 3) a new vinyl flooring product that looks like laminate and costs about the same, but it’s not laminate.
You know the customer won’t choose option (3) and you don’t want them to choose it anyway. You include this choice in the mix for two reasons, to give the customer a third choice, and to focus the customer on the choice you want them to make between option (1) and (2).
Why do this? Ariely found that people…
“tend to focus on comparing things that are easily comparable, and avoid things that cannot be compared easily.” And remember, “people don’t know what they want unless they see it in context.”
Offering customers three choices allows people to put things in context. Ariely also surmised that decoys help people make decisions, and his experiments showed that when faced with a decision between two similar products people will most often choose the slightly better product, even if it costs slightly more.
Anchor Pricing Strategy
Anchor pricing: when we encounter a new product (and new business) we accept the first price that comes before our eyes and from then on that price becomes the anchor for what we are willing to pay for that product.
Ariely found that “once we buy a new product at a particular price, we become anchored to that price.”
This why the elevator pricing strategy does not work. A common business practice is to entice new customers with lower prices, thinking that once customers are on the ground floor, they can be taken up the price elevator to higher profits. That elevator never gets off the ground because the customer’s price anchor won’t let the elevator go up. The anchor pricing strategy is to set the customer’s anchor at a higher price.
When you first come in contact with a customer, set the anchor high. Introduce them first to higher priced options. They will judge all future purchase decisions by that anchor. Later you can give them lower-price options, which they will judge against the higher price. This is really important and the point is driven home by Ariely:
“But price tags by themselves are not necessarily anchors. They become anchors when we contemplate buying a product or service at that particular price. That’s when the imprint is set. From then on, we are willing to accept a range of prices but as with the pull of a bungee cord, we always refer back tot he original anchor. Then the first anchor influences not only the immediate buying decision but many others that follow.”
Be careful even talking about price with a customer on the phone, if you mention prices lower than what you want to sell, you are setting a price anchor in the customer’s mind.
So how do you price things? Are you using any of these pricing strategies? Check out Dan Ariely’s book: Predictably Irrational, Revised and Expanded Edition: The Hidden Forces That Shape Our Decisions
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