Adapted from Nagle, Hogan, and Zale’s The Strategy and Tactics of Pricing, 5th Ed., Chapter 4
Value-based pricing strategies fail unless potential customers recognize and understand the value of your products and services and how they differ from those of your competitors. Clear value and price communication can protect your value proposition from competitive encroachment, improve willingness-to-pay, and increase the likelihood of purchase. Effective messages cater to both different types of products and different stages of the buying process.
Value Communication
Value communication is important when your product or service creates value that is not obvious to potential buyers. Less experienced customers will not fully appreciate your value and may need to be informed or relieved of risk to try the product.
Adapting the Message for Product Characteristics
The first step in developing a value message is determining which drivers motivate a customer to make a purchase. The goal is to help the customer recognize the linkages between a product’s differentiated features and what is important to them. There are generally two types of goods: search goods and experience goods. Their main difference lies in the relative cost of search: the financial and nonfinancial cost relative to the expenditure in the category that a customer must incur to determine differences in features and benefits across alternatives. Search goods usually have a low relative cost of search; experience goods demand higher search costs.
Search Goods
Most consumer goods fall into this category: light bulbs, batteries, cosmetics, groceries, etc. These products usually have objective features that allow buyers to find information and choose among them with relative ease. Value messages can be quite explicit about the linkages between product features and relevant value drivers.
Experience Goods
Experience goods have differentiating attributes that are more difficult to evaluate across options. Customers must invest substantial time and effort to evaluate the products before purchase. Examples include most services such as consulting, auto repair, investment services, and cellular contracts. The complexity of these goods makes it more difficult for marketers to establish clear connections between features and expected benefits. Instead, marketers of experience goods will focus on broader assurances of value to reduced the perceived risk of purchase and to increase awareness of the potential benefits.
The type of benefit sought by the customer should also influence the value message. Measurable monetary benefits such as profit, cost savings, or productivity motivate many purchases. For other purchases, especially consumer products, psychological benefits such as comfort, style, status, or personal fulfillment play a large role in customer choice.
For messages that focus on monetary value drivers, value quantification can call to attention any gaps between the customer’s perceptions of value and the actual monetary value of the product. When the important value drivers are psychological, it is best to avoid incorporating quantified value estimates because value is subjective and will vary from individual to individual. Sending a message that causes the customer to disagree with the proposed value will create a negative impression of the product.
CASE STUDY
In many cases, you will need to communicate both economic and psychological benefits to the consumer. For example, Johnson & Johnson was forced to justify its premium-priced drug-coated coronary stent when it entered the market. The stent, used to keep clogged arteries open, was priced at $3,500, or 250% higher than traditional uncoated stents. The premium was well above the cost of the drug used to coat the stent. The high price drew criticism from the medical field and the public press. J&J responded by explaining the economic benefits to medical professionals. Stent implantation surgery costs upwards of $30,000. But in 20% of cases, uncoated stents reclog in less than a year, requiring a repeated procedure and an additional $30,000. With J&J’s new stent, the likelihood of reclogging falls to around 5%. Thus, the objective differentiation value from the smaller reclogging rate was $4,500 (15% rate reduction x $30,000). In addition, patients received substantial psychological value from avoiding the risk and discomfort of a second procedure. Compared to these benefits, the original $3,500 price was justified.
Adapting the Message for Purchase Context
Value-based messages must also be adjusted to the purchase context. A buyer will go through four basic stages: origination, information gathering, selection, and fulfillment. Effective messages will address the buyer’s specific needs at each stage.
The Customer Buying Process
Origination
Origination is the stage at which the customer becomes aware of a need and begins the search for a suitable offering to satisfy it. The objective for messaging at this stage is to use value as a lever to encourage customers to consider a purchase within the category. During the 2008-09 recession, Hyundai created the “Hyundai Assurance” campaign that enabled a customer to purchase a new car and then return it with no penalty if he subsequently lost his job in the next year. Hyundai identified a new value driver, uncertainty about future income, and developed a promotion to address the need. As a result, tens of thousands of customers initiated the buying process for a new car because it was less risky than continuing payments on an existing car.
Information Gathering
This stage is critical for complex goods with a high cost of search. It is the seller’s burden to provide accurate and relevant information to the customer. This can include easy access to product specifications, sizing, and descriptions. The communication objective is to increase the importance of the value drivers for which your product has an advantage.
Selection
Selection involves winnowing the alternatives to a manageable number to conduct a more detailed product evaluation. Here, the seller’s goal is to create awareness of the brand and its superiority in terms of the most important value drivers.
Fulfillment
Fulfillment involves the selection of the purchase channel and then the actual purchase. The value communication goal at this stage is to justify the price. For goods in which monetary value drivers are most relevant, marketers can use quantified estimates of value to create a favorable framing for the price. For goods that are driven by psychological benefit, the goal is to develop message that clearly demonstrate high value relative to price. This can be accomplished in many ways such as benchmarking against other products with well-understood value propositions. For example, Glucofast is a drug that helps diabetics stabilize blood sugar levels. The value of the product was high but intangible. The company reframed the value by comparing it to the cost of a cup of coffee, implying that better health was worth at least the price of a hot drink.
The Seller’s Messaging Objective
Price Communication
Research in behavioral economics has demonstrated that people do not necessarily evaluate prices rationally. Customers can perceive the same price paid for the same value differently depending on how it is communicated. There are four aspects of price perceptions that have implications for price communications: proportional price evaluations, reference prices, perceived fairness, and gain-loss framing.
Proportional Price Evaluations
Buyers tend to evaluate price differences proportionally rather than in absolute terms. For example, one study asked customers if they would leave a store and go to a nearby one to save $5 on a purchase. Of respondents who were told that the price in the first store was $15, 68% said they would go to the other store to buy the product for $10. Of respondents who were told that the price in the first store was $125, only 29% would switch stores to buy the product at $120. When the $5 difference was proportionally more (33% lower in the first case), it was more motivating than when it proportionally smaller (4%).
Psychologists call this tendency the Weber-Fechner effect. This can explain the appeal of “free” services, which represent a 100% reduction in price, over other lesser discounts that have the same or even greater value. The most important implication of this effect is that price change perceptions depend on the percentage, not the absolute difference, of change in price. This goes on to imply that there are thresholds above and below a product’s price at which changes are noticed or ignored. A series of smaller price increases below the upper threshold is more successful than one large increase. Conversely, buyers respond more to one large price cut below the lower threshold than to a series of smaller, successive discounts.
Reference Prices
A reference price is what a buyer considers a reasonable and fair price for a product. The creation of product lines often uses this concept to the seller’s advantage. Many lines offer bargain, standard, and premium versions of the product. Adding a premium product to the product line may not necessarily result in overwhelming sales of the premium product itself. It does, however, enhance buyers’ perceptions of lower-priced products in the product line and encourage low-end buyers to trade up to higher-priced models.
Marketers also influence reference prices by suggesting potential reference points. For example, buyers’ reference prices can be raised by stating the MSRP, a higher price charged previously, or a higher price charged by competitors. Research indicates that advertisements suggesting reference prices are very effective in influencing consumer durable product purchases (e.g. electronics), particularly among less knowledgeable buyers who rely more on price to determine quality when making buying decisions.
Promotional deals such as coupons, rebates, and special package sizes can influence reference prices strategically. Some marketers have argued that new products should be priced low to induce trial and build a potential market of repeat purchasers; prices can be raised later. However, if the low initial price lowers buyers’ reference prices, it can affect repeat sales adversely. The seller should clearly establish a product’s regular price and then promote the discount as a temporary price cut. Otherwise, initially low promotional prices will undermine the product’s perceived value at regular prices later on.
Perceived Fairness
Fairness is, as one would suspect, subjective. However, because of this, it is also more manageable than one might think. In a famous experiment, people imagined that they were lying on a beach, thirsty for a beer, and that a friend was walking to a nearby location and would bring back beer if the price was not too high. Researchers asked the subjects the maximum amount they would pay. Half of the subjects were told the friend would go to a “fancy resort hotel” while the other half was told that the friend would buy from a “small grocery store.” The product would be the same. The median price of those who expected the beer to come from the hotel, $2.65, was much higher than the median price given by those who expected it from the grocery store, $1.50.
Companies that frequently adjust prices are careful to set the “regular” price at the highest possible level, rather than at the average or most common price. This enables them to “discount” when necessary to move product, rather than having to increase prices when demand is strong.
Gain-Loss Framing
Ask yourself which of the following gasoline stations you would rather visit, assuming both brands are equally good and you always pay with a credit card:
- Station A sells gas for $2.20 a gallon, but gives a $0.20 per gallon discount if the buyer pays with cash.
- Station B sells gas for $2.00 a gallon, but charges a $0.20 per gallon surcharge if the buyer pays with a credit card.
It is more likely that you chose Station A. This illustrates the phenomenon of loss aversion, where people weigh losses more heavily or equivalent gains. This effect, part of prospect theory, has several implications for price communication:
- To make prices less objectionable, make them opportunity costs (forgone gains) rather than out-of-pocket costs. For example, people find it less painful to pay for things such as insurance or retirement plans with payroll deductions instead of buying them outright.
- When a product is priced differently to different customers and at different times, set the list price at the highest level and give most people discounts. To those who pay at or near the full price, the failure to receive more of a discount (a foregone gain) is much less objectionable than if they were asked to pay a premium.
- Unbundle gains and bundle losses. To maximize perceived value, the seller should identify and value each benefit but bundle the loss into the price. If the buyer objects to the price, the seller can take away an element, which will then make that element appear as a stand-alone “loss” that will be hard to give up.
Some of these tactics may seem overly complex or farfetched. However, prospect theorists make the claim that buyers also frame the same transactions in many different ways, each implying somewhat different decisions. Researchers have shown that changing how people think about their gains and losses in otherwise identical transactions consistently changes their behavior.
Summary
An effective pricing strategy depends on more than just value. Buyers are also influenced by how that value is presented and communicated through the price. Most customers lack the time or the incentive to fully inform themselves about their alternatives. If you want them to recognize your value, you have to make the process easier for them by supplying them with information about your offer and what you think it should mean to them. When communicating prices, you should actively minimize customers’ adverse feelings about paying it. By controlling price progressions, reference prices, and perceptions of fairness, you can reduce negative reactions without reducing your margins.
K Does Cases 