The Future of Pricing: No, Every Customer Should Not Pay the Same
The following is adapted from Price by Cactus Raazi.
Price is the fulcrum of every customer interaction. A number of elements influence a consumer’s decision-making process — from perceived value, to geographic location, to the smell of a store, to marketing — but no single aspect has a greater impact than price.
Price is one of the most obvious and important aspects of a sale, yet the way we think about and set prices has not evolved in decades. It’s primarily a process of guesswork, focused on maximizing revenue.
As we move into a world of increasing price competition, though, we’re going to need new strategies. Instead of maximizing revenue, we’ll need to maximize customer loyalty, by using dynamic, personalized pricing — or, in other words, by giving different customers different prices, based on their loyalty.
How Prices Are Currently Set
Let’s say a fashion company wants to sell a new wool coat. The design is complete, and production is ready, but how do they decide how much to charge for it? In most businesses today, a single person or group of “domain experts” gather in a room, discuss how much they think people will pay for the coat, and then come to an agreement on the price.
Obviously, these experts will consider several factors, especially the input costs, because no astute business would deliberately sell its products at a loss. They will consider the costs to design the item, the costs of labor and raw materials, and all the other direct and indirect costs of producing the coat. They also might take into account the season and current trends, the price of competitors’ coats, and what the market will bear. With all this information, they settle on a price.
This is the way prices have been set for decades, so why change now?
The answer is simple: Because there’s a better way.
Informal committees of domain experts can settle on good prices but not the best prices. The first issue is that the traditional pricing method is largely an arbitrary process. I’ve been on such committees determining price, so I know firsthand how much guesswork is involved. While the domain experts consider many factors, it is ultimately their human opinion that determines the final price.
The second issue is that this process does not treat customers as the individuals they are. The same price is not the right price for all of your customers. Your customers exhibit different behaviors, so you need to be thoughtful about engaging them on an individual basis. If your customers are individuals, shouldn’t they have individualized prices that reflect their relationship to your business?
How Prices Should be Set: Maximizing Loyalty With Personalized Pricing
Most academic work about pricing defines the optimal price as the highest price you can charge at any moment in time — that is, the price that will maximize revenue. This generalized pricing theory has been the standard for decades, but it begins to break down in the face of increasing price competition.
In a world of pure price competition, the only way to compete on the transactional level is to have the lowest prices. But slashing margins in order to have the lowest prices is a slippery slope.
Instead, businesses should move their attention away from individual transactions to the creation of recurring revenue streams. The best way to do this, in my opinion, is to build long-term loyalty through positive customer relationships, with individualized price as part of that relationship.
The more you build loyalty, the less customer churn you will experience, and the less energy and resources you’ll need to dedicate to marketing and gaining new customers. Your focus should be the creation of a steady revenue base over the long term.
There are many ways to foster good customer relationships, but I believe that price, as the fulcrum component of the purchasing experience, is the most important one. Loyalty should be rewarded, and the clearest, easiest way to do that is through dynamic, personalized pricing. This kind of loyalty pricing is founded on the ideas that (1) the right price today might not be the right price tomorrow and (2) the same price is not the right price for all your customers.
Preparing for the Future
The world is changing — quickly — and you need to start thinking about the future today. The concept of different people paying different amounts for the same item may appear to be fundamentally unfair, but this practice already exists, in the form of loyalty programs that provide discounts or offer lower prices for subscriptions.
The old one-size-fits-all pricing paradigm will not last forever. If you want to best reward and inspire customer loyalty, you need to engage them on what matters most: price.
For more advice on the future of pricing and how to maximize customer loyalty, you can find Price on Amazon.
Cactus Raazi is the founder of Elefant Inc., a startup building smarter marketplaces through AI-powered pricing, which was acquired by Exos Financial. In more than three decades in sales, Cactus has developed an acute sense of how price affects the commercial transaction (and how we get it wrong). He has a graduate degree in business analytics from NYU, and now focuses on applying data analytics to personalized pricing.
