From The Object (The Product) To the Deal – Part One
There are many consumer behavior studies that provide a psychological profile of how consumers think, feel, reason and choose from an array of products and brands. Retailers can adopt anyone of the many pricing strategies (over and above the traditional cost-based or targeted gross profit, economy, penetration, skimming and premium strategy), depending on the brand, targeted customer profile, the nature, demand and scarcity of their product. When establishing a price, retailers must consider their customers’ price sensitivity in order to maximize sales and profits.
WHEN IT ALL STARTED
In 1867 when Karl Marx’s Das Kapital was first published, he wrote ‘The wealth of capitalist societies presents itself as an “immense accumulation of commodities” ‘. In 2009, Ellen Rippel Shell, author of Cheap, completed the picture by stating that ‘In a market awash in increasingly similar – even identical – goods, price is the ultimate arbiter, the lower, the better.”
It has become more and more unthinkable today for many consumers to pay full price for most of the products that they purchase. Besides the commoditization of goods and services, there are many other reasons why this is happening and if you know what they are you have a good chance of being able to create a strategy that addresses this problem.
For one, most consumers link price to perceived profit and they grossly over estimate profit margins. Don’t blame them for that, though! Between 2000 and 2007 the median family income dropped $1,175 and their spending on basic expenses grew $4,655, and the fact that, in this same time frame, corporate profits doubled was not missed by the public.
The truth of the matter is that consumers feel that they are getting ripped off when in fact buying lower quality products priced affordably is what’s really ripping them off. And yet they believe that they are getting a bargain, at least until they need to go and buy a new pair of shoes because the ‘good deal’ shoes fell apart after a few wearings. The irony is that most of us can’t resist the appeal of a good deal and yet, as I once heard someone put it “only rich people can afford to buy cheap products.” Ultimately, retailers and their associates had better remember and remind their customer of what Cosmo Castorini, the plumber character in the movie Moonstruck, said to the couple in need of plumbing repair “There are three kinds of pipe. There’s aluminum, which is garbage. There’s bronze, which is pretty good, unless something goes wrong. And something always goes wrong. Then, there’s copper, which is the only pipe I use. It costs money. It costs money because it saves money.”
IS THE PRICE RIGHT?
We are all familiar with the game show ‘The Price Is Right’ in which contestants compete to identify the pricing of merchandise to win cash and prizes. It is a guessing game not much different from the guesstimate game we all play every day when we decide whether to buy something or not based on how we feel about the price of those things. Do we know what the price of a couch that we are trying to buy should be? We definitely know what others might be selling the same couch for, since today we are all trained to do comparative shopping. But we don’t know what couches in general should cost. At best, we remember what ‘couches are supposed to cost’ and mistake that for a definite sense of value, the value of the product that we want to buy. This is called compensation. As William Poundstone writes in his book Priceless, it is like a sight-impaired person who can navigate familiar surroundings not because they can see, but because they compensate with their memory of where everything is. The truth of the matter is that we don’t know what the price of the couch should be and, more in general, we don’t know how much things should cost. Yet, every choice we make is shaped by the price options in front of us. Prices determine actions and, as Poundstone puts it ‘evoke a complex set of emotions. Depending on the context, the same price may be perceived as a bargain or a rip-off, or it may not matter at all.’
So, if the absolute price of things is a mystery to consumers, there is hope for the people in charge of setting prices (manufacturers and retailers) by filling in the blanks and creating convincing pictures in the mind of their customers of what things should cost and how they should spend their money.
There is a little known profession called Price Consultant, whose main job is to advise companies how to price products that the customer will want to pay. Not just the price amount, but also how to assort and display products with different prices so that the customer can choose from multiple options and, God forbid!, not end up picking the lowest price product. Or, how to create promotions that the customer perceives as a deal that bring sales and profits to the retailer. And the way they do it is by tapping into the psychology of consumers and their reaction or response to numbers and prices in particular. And there are quite a few ideas that you can borrow from them to help convince your customers that your prices are right, and even embrace the “the more you ask for, the more you get” philosophy described by psychologists Gretchen Chapman and Brian Bornstein’s from a paper they wrote on the suggestive power of anchors.
Since we are talking about consumer psychology, we need to first understand a very important psychological concept introduced by Amos Tversky and Daniel Kahneman, two Israeli American Psychologists, called anchoring. Anchors act as mental references that we use to decide on what’s right whether it’s a quantity or value. Put in other terms and applied to prices, it means that ‘internal prices are ‘constructed’ as needed from hints in the environment.’ Tvrsky and Kahneman proved that concept with an experiment. They spun a wheel of fortune marked with numbers up to 100 and when the wheel stopped at 65, they asked a group of students two questions:
1. Is the % of African nations in the United Nations higher or lower than 65?
2. What’s the % of African nations in the UN?
The average guess was 45%. However, when the same wheel was spun with another group and it stopped at ten and the questions were now:
1. Is the % of African nations in the United Nations higher or lower than 10?
2. What’s the % of African nations in the UN?
the average answer was 25%. In essence, the answer with a specific number to the 2nd question was influenced (‘adjusted to’) by the number cues (65 in the first case and 10 in the second case) or what are called the ‘anchors.’
Time to see anchoring at work and its suggestive power and see how you can use it to your advantage.
Idea #1: Cheap products next to high price products don’t sell and vice versa.
Try selling a pair of shoes at $45 in a store where most of the other shoes sell for an average of $300. What do you think happens in the consumer’s mind when they see the $45 pair of shoes? They most likely find the price attractive but a second later an alarm goes off in their head with a clear message: “you get what you pay for.” Maybe yes, maybe not! There are plenty of shoes that sell for $45 and they are perfectly fine. But in a store where everything else is about $300 (the anchors), they must be junk! Of course, the opposite is also true. If $45 is the anchor, i.e., most shoes in your store sell for that price on average, try selling a shoe for $300!
Idea #2: Scaling from high price makes the customer feel like they are getting a deal.
Think about the same shoe store. When the average price is $300 and you have shoes that sell at $170 and even $200, customers trained to expect prices in the $300 range, feel like they are getting a deal. Not that a pair of $200 shoes is such a deal per se! Again, with the $300 anchor, maybe it is!
Idea #3: Add a third choice that few, or no one wants, to increase market share of what you do want to sell.
Suppose you have a wine store and sell two types of Bordeaux wine: A. a cheap bottle ($12) and B. a medium price bottle with a good Wine Spectator rating ($21). A customer comes in and wants to get a bottle of Bordeaux to bring over to his boss’ house who has invited him for dinner. Unless, budget is a real issue, the customer who is buying a bottle of Bordeaux wine for a dinner at his boss’ house will most likely choose B, the better bottle at $21. Or, maybe not! Now, suppose you have three choices, A., B. and C. Choice A being a super-cheap bottle of Bordeaux at $7. Now, the customer might feel that the $12 is not too bad of a choice after all and might go for that one. It is almost as if the existence of a cheaper alternative to the original cheap bottle legitimized it. Now, what if A., B. C. are a $12 bottle a $21 bottle and a $48 bottle respectively? Now, the customer might go for the $21 bottle (unless they really need to impress their boss and would do whatever it takes!). Obviously, decisions on what to buy are influenced by many factors not necessarily tied to the way the customer perceives value in the things they buy. Things such as, how much money the customer can spend, how much they want to impress their boss, how much they know about each product that they are considering (they might know that the $21 bottle is actually overpriced in spite of the WS ratings). However, what these different scenarios stand to demonstrate is that by anchoring a product to a cheaper or a more expensive one, you are able to sway a customer’s decision to buy the products you want to sell them. If you wanted to sell more of the $21 bottles, you would be better off presenting them with a much cheaper and a much more expensive option. Middle options tend to work as safe, compromise choices – neither too cheap, and possibly terrible, nor a rip-off. The super expensive or super cheap options work as anchors or a ‘decoy’ to increase market share for a product we want to sell. Need another example? In my days in the department store industry, I discovered that it was easier to sell the higher priced ‘bridge’ sportswear (the better option in a good, better and best assortment) when we also carried a few higher priced designer pieces (best options as the anchors).
Idea #4: Don’t be afraid to carry products at ridiculous prices (anchor). The anchor is for sale but it is ok if nobody buys it.
This idea is closely related to the previous one. Remember that episode of The Sopranos where Tony Soprano receives a Williams-Sonoma $2,000 espresso machine as a gift for his ‘good deeds’? Well, that coffee machine was not just in the show, it was actually in the WS stores and selling for that ridiculous price. I don’t believe that they were selling that many of those machines. However, I am pretty convinced that the $2,000 machine made all the other espresso machines at $400 or even $800 quite affordable by comparison, shall we say a bargain? Also, with this kind of situation, the customer is probably thinking, wow if these are for sale, somebody must be paying that kind of money! According to Dan Hill Marketing Consultant of Sensory Logic, ridiculously priced products can generate in some consumers a feeling of “anger and happiness”. They get angry because they can’t buy what costs too much, but then they get happy by buying something else.
Idea #5: Deals do sell… a lot.
In his book, Poundstone talks about a restaurant in Amarillo, Texas called Big Texan Steak Ranch known for its flashy proposition of a free 72-ounce steak if you finish it in an hour or you pay $72 if you don’t. Why does this promotion work? From the customer’s perspective: what do you have to lose…until you can’t finish it and then it’s $72 that you have to pay! It’s a little unreal: it is the thrill of the deal at work here, i.e., zero price is an end and a victory in itself (just like low prices are, whether you need it or not!). The customer does not know if he/she is going to get the steak for free. Also, in theory it’s a better deal than the 2-pound steak priced at $1.25 per oz. The deal works on what’s called a nonlinear pricing structure – meaning that the price is not a straight line and the price per oz. diminishes as the quantity grows. The same model is used by cellphone companies with their billing plans (the customer is lured to buy more minutes – meat in the above example – than they actually need to get a low price, although some are now offering ‘rollover minutes to compensate). From the restaurant’s perspective, the deal works because first and foremost, it earns it great publicity and bragging rights. The customer also has to pay $72 for the single meal – $1 per ounce. Then, $72 works perfectly as an anchor indicating that Big Texan Steak Ranch is the place where you can eat 72 oz. steaks which in the end raises the diners’ perception or estimate of how big should their steak be (not 72 oz. but possibly higher than at other places, i.e. their prime rib is 10 oz. and 16 oz. where many restaurants offer 8 oz. and 14 oz.) and most importantly, how much they should or should be willing to pay for their steak. Even the use of 72 oz. instead of four and half pounds changes the perception of the steak actual cost: $1 per ounce sounds a lot more ‘appetizing’ than $16 per pound!
Idea # 6: Raising prices by toying with packages, i.e., by creatively shrinking them.
This is very common with products that are bought regularly, when customers know how much they have been paying all along. Because if it is true that consumers don’t know how much things should cost (absolute prices), they notice the difference between what they used to pay and what they are paying now (relative differences) in frequently purchased items. Products that need to be priced higher are sold to the consumer with a new, supposedly more attractive or functional packaging. This is very often done to raise the price of the actual product without actually raising it. They are just putting less product into the package, thanks to the redesigned shape of the container, and get the consumer to pay the same that they have always paid for slightly less product (of course, they are not told that there is less product in the container). Manipulative? Maybe. Pervasive? Absolutely! Tropicana orange juice’s new packaging: a design makeover or a way to charge the same for less juice?
Pricing strategies are a fundamental component of your business. A small change in price can make a huge difference in profitability, either positive or negative. Optimizing prices typically increases profit margins by about 2%, which can be huge. Just like coming up with the right strategy to price your products can be huge. And so far we have just touched the surface. Stay tuned for more.
James Dion BS, MS, PhD(abd)
Determining the optimum price is not an easy task. Retailers often rely on competitors’ price comparison and predetermined markdowns throughout a product lifecycle. We also know that some continue to use the classic but outdated “cost-up” or “targeted gross margin” strategy. Sales may go up 3%: but how sure are you to have maximized your sales and profits on any given item? Maybe the price was set too low or marked down too soon, shorting your profits by 10%. Inadequate pricing can seriously impact your bottom line with high inventories and lower profits. Having experienced merchandisers with flair of their market is essential but so are the optimization tools that improve their accuracy and efficiency.
A2R consultants can help you improve your pricing strategy, optimize your inventory and align your marketing efforts in order to maximize your profitability. Why leave money on the table?
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James Dion, an internationally known Retail Speaker and Author, sensitive to cultural and global issues, offers insight on consumer behavior towards low prices and pricing strategies.