There was a time when pricing was almost a consequence of other decisions made by a company. Companies used to figure out their cost and tack on a few pennies. Today, companies reverse engineer their solutions based on a price point.
In his book Priceless: The Myth of Fair Value, MIT professor William Poundstone shared a discovery that rocked the consumer goods industry and set a standard for how companies think about price.
He famously offered consumers various choices for beer. When presented with two choices, people chose the more expensive option 80 percent of the time. When a third, pricier option was added, they selected the middle-priced beer 85 percent of the time.
So what does this have to do with the cost of tea in China? As our economy migrates to end-to-end solutions and service bundling, marketers are rethinking how they price products. Price does not only impact revenue and profit; it shapes buyers’ perceptions of a brand.
While many industries are changing seemingly overnight, a stodgy old pricing theory is still relevant. “Good-better-best” is proliferating online. Providing options implies we respect our customers enough to give them choices. The shrewdest marketers have figured out machine learning will offer opportunities to influence buying decisions in ways they never could before.
Here are keys to utilizing a good-better-best strategy to optimize margin and profit:
Anchor from the beginning.
Imagine you want a Zipcar in Los Angeles. As of this writing, you are offered three options:
- No monthly commitment
- $7 per month plan
- $50 per month plan
The “anchor” of $50 sets the bar for other offers. A new customer will associate $50 a month with significant value. With a $50 option, $7 feels like a bargain. Marketers should A/B test various pricing thresholds to identify the optimum spread among prices. Often, the threshold where a “difference” is perceived starts at about 10 percent.
Keep your offer simple.
Poundstone’s study revealed the law of threes. It’s not hard to understand the underlying psychology. We innately want the best life has to offer and also want to feel we are getting great value, so our inclination is to choose the middle option. When given too much information, many buyers will opt for nothing at all. Restrict your offer to three options, or include a fourth offer: Free.
Simplicity gives you the opportunity to guide the customer to the offer you prefer.
Provide a clear standard of comparison and a path to upgrade.
Marketers utilize packaging to swing buyers to a service bundle that is profitable and scalable. That’s why the difference between the base offer and the middle offer has to feel overwhelming. In other words, provide a side-by-side comparison for all three and seek to load up the middle offer with what feels like a nominal price increase. By doing so, the provider almost guilts the buyer into choosing a solution that feels complete enough and is not perceived as “cheap.”
Be strategic about numbers you use.
For years marketers assumed they should use 5/9 pricing (such as $595 or $9.99) for everything, and such pricing does keep a buyer below a psychological threshold. However, in a good-better-best scenario, a price like $1,000 may provide better anchoring than $999.
A $59 monthly subscription fee feels much more digestible than a $600 annual fee, although the ideal frequency may also have a lot to do with client retention and customer lifetime value.
Test, test, test.
Online providers have the opportunity to pivot based on consumer behavior. Machine learning is providing more opportunities to gather data about customer demographics, psychographics and profiles so marketers can make informed choices on how to market to them. One of our clients who sells a travel product found their online pricing strategy needed to be radically different than in stores. The only way to gain such insight is to measure actual behavior. Test, test and test some more.
Manage your business around the service bundle.
Companies fall into a trap where they fail to set expectations about how to serve clients based on various price points. You may stay at Courtyard by Marriott or The Ritz-Carlton (also owned by Marriott), but you do not get access to Ritz amenities at Courtyard.
Realizing this, one of our clients completely reorganized their company; they provided a segregated sales and operations team for each client type, so they could service them appropriately and profitably. Build your company from the ground up to service offers that optimize return. Make sure your team understands these differences so they do not over-serve customers in a way that cuts into your profit.