The compilation of 33 pricing lessons for startups
Dreamers and Executors is a non-formalized group, where we create interesting things together, learn business related stuff and share our learnings.
Over the last 5 weeks of our meetups, we’ve covered a lot of material on pricing and customer psychology.
We’ve studied hefty research papers, browsed through tons of online resources, read a few books, watched Youtube videos, and had a few really good discussions on that topic.
If you don’t have time to go through the whole article, we’ve prepared this slideshare summary just for you:
But remember, that
half baked knowledge is worse than no knowledge at all.
Now let’s dive deep:
The Fundamental Lessons in Pricing and Psychology
In this first part, we’ll list out some fundamental lessons on the verge of psychology and pricing.
Some of them may sound obvious, but stay humble, stay foolish :). Things will stop being obvious around lesson # 9.
Lesson # 1: Understanding the customer psychology makes business and marketing a bit more predictable.
Business is about influencing the decision making processes of your target consumers, says Michael Fishman, a customer psychology expert, in Forbes.
Here’s a chain of reasoning which explains why it’s wise to dive deep in to the psychology of your customers:
In order to alter the decision making patterns, you have first diagnose and understand them. Since most of the decision making drivers lie in the subconsciousness of your target consumer, and since you cannot really analyze it a priori, your best bet is to be knowledgeable about its internal dynamics, that is, knowing on average how people respond to certain marketing attributes.
This is equivalent to saying that:
all human beings essentially have the same mental triggers that drive actions.
Lesson # 2: Sally, the owner of your mobile app, is not rational.
People are able to say which of the two goods they want, but they don’t know why, again says Michael Fishman in Forbes.
As a consequence, the best marketing method is observation, with a huge emphasis on its subset: experimentation. Do experiments that have a very small risk of failing, observe, implement the insights, adapt. And then experiment again.
Lesson # 3: Value your prospects and make them feel significant.
In short: give massive value.
Whether it’s Gary Vaynerchuk’s jab, jab, jab & right hook analogy to give, give, give & then ask, or Alex Ikonn’s no one cares about you or your success, just focus on giving value, the best business minds agree:
giving value is your best bet to win the eyeballs and hearts of your customers.
Lesson # 4: Highlight your strenghts by admitting shortcomings.
Admit the problem and show improvement in action. According to social psychologist Fiona Lee, customer were more trustworthy of companies that admitted strategic failings, over those who blamed the externals for various circumstances (taken from Leo Widrich from Buffer).
It can also be called commitment-consistency bias, as stated on the Shopify blog:
This principle says that people will go to great lengths to appear consistent in their words and actions.
Lesson # 5: Tailor your marketing messages to the personality traits of your target customers.
The results of the research on effectiveness of marketing campaigns says that advertisements were evaluated more positively the more they cohered with participants’ dispositional motives. [Source]
The consequence of tailoring to particular personality traits and being very clear who you’re for exactly, is that sometimes it will result in you making an enemy, which, if played strategically, can increase the loyalty of your customers.
It always pays to have a clear value benchmark and stand for something at times. For example, of customers who have a strong relationship with a single brand, over 64% said it was because they had shared values with the company in question.
According to one of our members, Eugene, the key thing to execute this lesson well is to create a buyer’s persona. He says:
Many businesses often start their marketing campaigns without truly understanding their target audience.
By creating a persona of the target audience, businesses can create better ways of reaching the target audience.
Referencing the work of Ewa Wysocka & Samuel Cook, the persona can be built in 7 steps:.
1. General: Name, age, gender, marital status, location, job, annual income
2. Goals and Values
3. Lifestyle and personality traits: Likes and dislikes
4. Challenges and Fears
5. Interest and Hobbies
6. Keywords the persona will use when searching for information on the web
7. Objections and decision making.
Lesson # 6: Understand what the buyer wants.
In order to influence someone, you need to know what already influences them.
Lesson # 7: Remind customers how easy it is to get started and achieve their goals with your solution.
Professor Robert Cialdini reported that adding a minimum to a request increased donations for the American Cancer Society by 78%.
Remind your customers how easy it is to get started to help them break through action paralysis.
But getting them through the beginnings is just the start.
What happens next?
You should use the A-Z technique, as described by the Kissmetrics blog:
Your customers want to get from point A (where they are now) to point Z (where they want to be).
In your marketing message, your goal is to teach your leads how to move as close as possible to Z before you ask for their money. The closer you get them to Z, the more likely they are to buy from you in order to go the final few steps needed to arrive at their desired end result.
By doing this, in their minds, they start to associate your business with the pleasure they get from the results produced as they arrive at all the milestones between A and Z.
Alex Ikonn calls it The Super Mario Technique: how does your solution help people become the best version of themselves?
Lesson # 8: Use urgency the smart way.
Using urgency is tricky. It can work, but it tends to be blocked out by the users if they don’t have a clear follow-up direction.
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That’s about it when it comes to fundamentals. It’s always good to review them. Now let’s turn to some really tactical pricing lessons.
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Exploiting pricing cues
The following lessons are based on the article from Harvard Business Review titled “Mind your pricing cues”.
Lesson # 9: “Sale” can increase demand by more than 50%.
Using the word SALE beside the price (without actually varying the price) can increase demand by 50%.
However, please note that if your customers sniff an overuse of this sign, or any other pricing cues for that matter, they will become absolutely immune to them.
Importantly, sale signs reveal what in economics is called the diminishing marginal returns, which means that:
there is a point at which adding more SALE signs yields fewer sales.
As showed in the lesson # 2, you have to find this point by experimentation.
Lesson # 10: Products with prices that end in 9 still have remarkable power, but not when they are already on sale.
Response to this pricing cue is still remarkable.
Here’s the experiment that confirms it:
In one study performed by HBR, researchers were able to increase the demand for a woman’s catalogue by third by increasing the price from $34 to $39. By comparison, changing the price from $34 to $44 yielded no difference in demand.
Importantly, this reasoning was proved to be correct at cents levels too.
Lesson # 11: Pricing cues should be implemented systematically. You should mindful of their long-term implications.
Always take into consideration long-term effects of the strategies you employ. Some studies show that inflating demand with short-term pricing policies can harm your company in the long term. The general rule found in the literature is that:
cues like signs or prices ending in 9 become less effective the more they are employed, so use them only where they pack the most punch. In particular, use them on the items for which customers’ price knowledge is poor.
Lesson # 12: Pricing cues work best if: customers purchase infrequently, are new, if product designs vary over time, prices vary seasonally, quality or sizes are not standarized.
In general, those who are least informed about price levels will be the most responsive.
Lesson # 13: Pricing optimization should be balanced with efforts to cultivate brand image.
Have you ever seen Apple bragging about massive discounts for their products?
The reason you probably didn’t, at least on a larger scale, is the following:
customers often interpret discounts as a signal of weak demand, which may raise concerns about quality.
In general, research shows that price cues always have a negative impact on a brand. The question is then:
how often do you actually apply those cues and if that negative effect can be offset by brand-enforcing efforts.
Finally, it’s always wise to ask yourself: what will my customers think of my brand if I blast them with massive discounts and sales?
Here’s an example of short-sightedness in this area:
The owner of a specialty women’s clothing store in Atlanta offered a [similar] rationale for why she does not use sale signs to promote new items. Her customers interpret sale items as leftovers from previous seasons, or mistakes, for which demand is disappointing because the item is unfashionable.
Lesson # 14: Customers do use price as an indicator of quality.
Since price is concrete and measurable, the customer views it with much confidence. He trusts it more than most cues directly concerned with quality.
Lesson # 15: Consumer satisfaction with a product depends, at least in part, on the amount of effort in which the consumer expends to obtain the product.
Here’s the key finding by Richard N. Cardozo in An Experimental Study of Customer Effort, Expectation, and Satisfaction.
Customer considers how she will feel about it [the product] after buying it […]. [Therefore] the more she spends for a product, the more she has invested in it, and the more she probably will like it.
Lesson # 16: Sometimes customers pick higher-priced brand as a way to reduce the risk of choosing a product of significantly poorer quality.
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Now let’s see how to capture value more efficiently with pricing experiments. By the way, spread some love and heart the article!
Now back to pricing.
Capturing more value with prices
Sometimes the optimal move isn’t to set the highest possible price.
Why?
Get a bit more sophisticated and you can grow the pie with your pricing, keeping a larger share of it for yourself.
The lessons in this section are based on the article from Harvard Business Review titled “Pricing to create shared value”.
Lesson # 17: Switch your focus from transacting your customers to building relationships with them.
Lesson # 18: Be proactive in your pricing.
Set prices in ways that encourage customer behaviour that benefits both the firm as well as the customers.
In other words, encourage pie-growing behaviours on your customers’ side.
Example?
HBR cites Amazon Prime, which for $79 annual fee, provides two days shipping on all orders. Seen via fixed-pie lens, it looks like a way to reward high-volume customers. However, seen via increasing-pie lens, it is a strategy encouraging people to do more shopping with Amazon, or even invite their friends to join them. In addition,
observers attribute Amazon’s 300% increase in share price and 30% increase in sales during the recession years of 2008 to 2010 in large part to Amazon Prime.
Lesson # 19: Flexibility is value.
There’s always an underlying assumption that there’s this one price you have to arrive at, the perfect number.
What if there just isn’t anything like that?
What if I tell you that subjective value assigned to your product differs not only across customers, but also across the situations they find themselves in.
Example?
It’s a Friday night and you’re drunk.
As a result, based on your current circumstances, the value you assign to a convenient vehicle that will take you from a bar back to your home is immense, much higher than on your regular Monday 3PM. And on average, so do others. Of course, that’s why Uber is more expensive at those days.
Allow yourself not to assume that there is this one, homogenous customer on the other side of the screen. It’s (hopefully) tens of thousands of different life stories, circumstances, and as effect, different value levels assigned to the product you provide.
Lesson # 20 : When choosing pricing, focus on simplicity.
Many of the sectors with the worst customer satisfaction scores also have the most complicated pricing plans.
The more complex pricing interface you have, the less trust you’ll elicit in your customers. It also maps back to treating your customers like partners and not like walking wallets.
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Innovations in pricing
If you’re into startups, you probably know that building a better mousetrap is often as good as innovating on the product side.
Better mousetrap can be defined as an improved business model dynamics that captures more value than incumbent solutions.
Money is the fuel of business model and pricing mechanism is the money transmitter. Since you can’t much innovation on the money side, building better moustrap is best done with improved pricing mechanisms. In this section, we’ll reveal a few lessons on how to innovate on the pricing side.
But let’s start with a case study.
Do you know LifeStraw?
It removes 99,99999% bacteria and 99,9% of protozoan cysts from contaminated water.
Without a doubt, that’s a massive innovation. That’s the innovation all of us would like to come up with. But here comes the question: how would you price it? Think for a few seconds and try a guesstimate for yourself.
Now how would you price it if I told you that the cost of LifeStraw is beyond the means of most households in developing countries, which is essentially your target group?
Finance guys would say that such innovation doesn’t make sense. But entrepreneurs are glass half full people, and pricing wouldn’t stop anyone with a vision to improve living conditions for 780 million people, who currently don’t have access to clean water, right? So here’s the innovation in value capture that made this innovation possible to exist in the first place: carbon offset credits.
We won’t go into the details because this article is not about LifeStraw, but let me just say that seeing pricing mechanisms as an innovation channel appends another dimension to your innovation.
You can have a 2-D innovation if you innovate both on the value creation and value capture.
So, now let’s have a few lessons in value capture. The following lessons are based on the article from Harvard Business Review titled “Capturing more value”.
Lesson # 21: You can innovate on the price-setting mechanism.
This occurs when a company stops setting prices by simply marking up production costs or calibrating against competitors’prices and instead charges according to the offering’s worth to the customer.
HBR names a few value capture innovations of this kind:
- Value based pricing.
- Auctioning.
This model works for Google. As HBR says:
[…] auctioning can yield prices the seller would never had had the audacity to name.
- Demand-driven pricing.
The basic idea that price is the result of fluctuations in pricing. It can work really well especially when coupled with predicitive models. Uber.
- Name your own price.
- Pay what you want.
Lesson # 22: You can change the payer.
Perhaps the most familiar examples are in media business where content is expensive to produce and consumption is subsidized by advertisers — an arrangement known as a two-sided market model.
Many types of businesses have relationships with consumers whom others would like to reach; they could probably succeed as two-sided markets selling access to valuable networks they have assembled.
Lesson # 23: You can change the price carrier.
First things first, what is the price carrier?
Price carrier is the part of the experience you hang the price tag on.
Ways to capture more value here?
- Moving the carrier.
It’s Nespresso’s changing the price carrier from the bag of beans to the perfectly brewed beverage.
Or:
It’s Netflix changing the price carrier from charging discretely per each rented DVD to the subscription service.
- Bundling and unbundling.
Bundling elements into a package with one overall price allows sellers to assemble varying solutions that appeal to different customer segments; it also staves off price wars by making comparisons between vendors more difficult.
Examples?
Airline industry.
And the final strategy in this lesson is:
- All-inclusive offering.
Think of it as an ultrabundle.
While a bundle offers a combined price for the sake of convenience or to induce customers to buy more elements, an all-inclusive offering combines elements that customers might not normally regard as components of one solution but that they are obliged to buy because of the time frame or setting.
Lesson # 24: You can change the timing.
A few strategies here too:
- Installed base pricing.
Think razor-and-blades model.
Think printers and ink-jet cartridges.
- Futures contracting.
If your business has a future-anticipation component, that can be a way to go.
Lesson # 25: You can change the segment.
The tactics are:
- Target costing.
Target costing uses market analysis to gain customer insights and then determines the price at which a certain segment of the market will buy a certain product.
- Self-segmented fencing.
First, customers self-segment by choosing either high- or a low-priced offer.
Next, the firm creates a fence in order to prohibit arbitrage, such that customers with a high willingness to pay are prevented from buying the low-priced product.
Coupons are an almost perfect example of a fence.
Instead of selling groceries at low prices to everyone, retailers offer coupons that discount specific products for specific periods of time.
The hassle of finding a coupon, checking its validity, search for the exact item offered, and presenting the coupon at checkout fences off customers who prioritize saving from those who are more interested in convenience.
Neat, isn’t it?
Also, remeber that the lessons and strategies listed above can be combined together to create a combo strategy.
Remember to follow us if you want to receive more compilations like that.
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Pricing and the psychology of consumption
The following lessons are based on the article from Harvard Business Review titled “Pricing and Psychology of Consumption”.
In this section, we’ll discover how pricing affects consumption. In this section, we define consumption as:
the extent to which customers use products or services that they’ve paid for.
This section can be very useful especially for startups, because the nature of online products is that customers can almost always consume at least a portion of the value before they pay. Pricing policies that you adopt can encourage or discourage consumption. In general, the following lesson applies:
Lesson # 26: People are more likely to consume a product when they are aware of its cost.
This effect is known as sunk-costs effect.
It’s well documented that consumers routinely consider sunk costs when deciding future courses of action.
In addition, this lesson sheds another light on the tactical pricing lessons covered earlier. Consider for example the tactic of bundling. Here’s the problem with this tactic:
Common pricing tactics such as advance sales, eason tickets, and price bundling all serve to mask how much a buyer has spent on a given product, decreasing the likelihood that the buyer will actually use it. And a customer who doesn’t use a product is unlikely to buy that product again.
So here’s another lesson for you:
Lesson # 27: When employing your pricing tactics, always consider their impact on long-term consumption.
And if you don’t apply this lesson, the following can happen:
[You] may be trading off long-term customer retention for short-term increases in sales.
The next lesson may be counterintuitive, but it’s of crucial importance:
Lesson # 28: Higher consumption means higher sales.
Here’s the punchline:
Research has repeatedly shown that the extent to which customers use paid-for products in, say, one year determines whether they will repeat the purchase the next year.
And here goes the example:
One health study, for example, found that health club members who worked out four times a week were much more likely to renew their memberships than those who worked just once a week.
Lesson # 29: Consumption helps establish switching costs, which can drive the value of your business through the roof.
Transitions between systems are painful, and even more so if you regularly use something, of course.
Next lesson gives you additional reason why sometimes it’s wise to go a bit creative with your pricing:
Lesson # 30: Pricing drives perception of cost.
Consumption is driven not so much by the actual cost of a paid-for product as by its perceived cost. This perception is influenced greatly by the manner in which the product is priced. Some pricing policies highlight the perceived cost of a paid-for product while others mask it.
Lesson # 31: Get the payments and consumption in sync.
Of course there are many variables at play when choosing the optimal payment moment, like financial or demand-driven, but in general,
the more payment and consumption are synced, the more cost-aware will be the customer, and therefore, you may have a chance to increase your sales in the future.
The final lesson is sort of a warning:
Lesson # 32: Price bundling may increase short-term demand, but decrease long-term consumption.
The previous lessons provide the logical justification of why that it.
Lesson # 33: People don’t have an internal value meter. Rather, they focus on relative advantages and baskets of goods.
Advanced Ranking Blog gives an example of Apple selling in pricing series that frame your beliefs into thinking that buying the cheapest version of the product is a deal compared to the high-priced one.
It’s also called the decoy effect.
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That’s it for now.
But we’re not stopping.
Here’s what we have on the agenda for the next week:
- Update this compilation with 10 more lessons, taken from blogosphere.
- Publish next compilation. Topic: Lessons in Psychological Biases.
Don’t want to miss it? Then follow us.
And remember that it’s a living document.
You can improve it by:
- linking up valuable resources in the comments,
- giving examples to the lessons,
- giving special cases and contradictions to the lessons,
- rewording, improving,
References can’t wait to be made ;)
Thanks…
Finally, massive thanks to the following members for their work:
and
- Tomek,
- Wojciech,
- Norbert,
who provided massive feedback, and
who supported us.
