Setting a price for your product or service can be difficult to get right. We think we’re rational when we assess the value of something. But there’s actually a lot of factors, including the prices of competitors and our own emotions. Understanding behavioural science is key to setting the right prices and improving your profitability.

2015_JULY_ALL_MONEY - How to boost profits using behavioural science

What is the right price?

It’s in our nature to be irrational when attributing value to the products and services we buy every day. Take an unlabeled bottle of orange juice as an example. If you were told it cost £2.50, that would probably seem like a lot for what it is. But if you were then given a bottle of Tropicana orange juice at the same price, you may suddenly think that £2.50 is fair price. Even if both of those bottles were the same size.

On the other hand, your choice could also include a budget brand of from-concentrate orange juice for £1. You know it’s not the same quality, but you may feel that £1 is a fairer price for orange juice than £2.50, and go for the cheaper option instead.

Both of these are examples of how emotions affect our purchasing decisions. “We like to think we know what price is the right one. But the fact is that we make relative comparisons,” Bill Poundstone, author of Priceless: The Hidden Psychology of Value, says.

So how can businesses take emotions into consideration when setting prices? “Perceptions of price are like those of physical attributes. Like is something dark or bright, heavy or light,” says Poundstone. “If you don’t have a benchmark for price, your willingness to pay is fluid and contextual. This is something companies can use.”

Many businesses set prices on a formula such as “x percent over cost”. However, this doesn’t take into account what the customer thinks the value of the product or service is, which can depend on a variety of factors.

Who are your competitors?

Knowing what your customers compare your products and services to shows you who your real competitors are. Which may be different to who you think. Your competitors are not necessarily other local businesses that offer the same services as you. For an accountancy firm, the competition might be hiring an in-house accountant instead of outsourcing it. Similarly, a competitor for a local accountant serving small businesses may be an online accountancy service, rather than a rival firm down the road.

Knowing your actual competitors will help you set your prices. You will also be able to better demonstrate your value in your marketing campaigns and sales meetings. Your customers may believe your service is comparable to more expensive rivals, meaning you have the option to increase your prices.

You may also find that you’re missing out on customers who need a smaller service. Maybe you offer a bundle, but some customers only need a single service. By unbundling these services you could gain new customers you wouldn’t have otherwise.

Presenting prices

Once you understand who your true competitors are, you can work on presenting your prices to maximise profits. To do this you need to use methods like decoy pricing and “Goldilocks pricing”.

These methods create different price points, while subconsciously telling customers which option is the best. As the name suggests, with Goldilocks pricing it’s usually the middle option.

An example of this in action is a test run by Kucher & Partners, a price strategy and marketing consultancy in Munich and Milan. The test was run to see whether banking customers would pay for an account that had extra features.

To start, only a free account and a €2 option were presented, with 60 percent choosing the free option. A third product priced at €4 was then added. As a result the number of customers choosing the free option dropped dramatically, while sales of the €2 increased. Next, a €6 product was introduced. Again, customers opted for a higher priced product. The test raised the average price of their products. They did this without losing customers because they still offered the zero-priced product.

This method is used by businesses all over the world. It’s also very common in SaaS companies, such as email marketing software, but can be used in almost any situation. With three pricing tiers, customers can self-segregate into different spending levels. Each level can then be priced alongside other competitors your customers are looking at. With accountants, a lower tier price might be priced to compete with online accountants as well as local rivals. A higher tier price would then compete in value and price with hiring an in-house accountant.

Wrapping Up

While adjusting your prices to take advantage of behavioural science, it’s important not to lose sight of the bigger picture. Companies that succeed in the long term are those that help their customers get the most value by helping them make decisions. No one wins by forcing customers to do something they don’t want to.

Ashleigh Lambert Xero

This content is provided courtesy of Xero Accounting Software - used by hundreds of thousands of businesses all over the world.