Although pricing is the key to higher profits, setting the right price for a product or a service is often underestimated or left to chance, which leads to missed opportunities. As a remedy, sophisticated tools for pricing analytics & research have been developed, focusing on cost analysis, historical data and competitor’s pricing.
Atenga Insights’ founder Per Sjöfors was already an established pricing expert when he saw a gap in the industry. Combining world-class proprietary tools with deep market experience, he developed a ground-breaking method for predictive pricing which is fast, accurate and highly actionable. [source: Atenga.com]
He joins DirecTech Labs today to talk about his method to obtain the optimal price that will generate higher sales and profit.
Per Sjöfors: The story here is that I had a chance to run a couple of companies in Europe; Switzerland and UK. And then when I came to the US, I ran a few companies, and I also headed divisions of large public companies. And all through these experiences pricing has always been an exciting area for me.
For years I thought I had the perfect formula on how demand and price should work to influence each other. And now, of course, I know that that formula was utterly wrong. Because of my interest in pricing, we did experiments in these companies, and some of those experiments were very successful. Things like the next quarter revenues were up 25 percent. Others were complete disasters. And what I had learned in business school and what I read on pricing were just too theoretical. It was nothing that I felt that we could use in these organizations.
So a dozen years ago I set out to make pricing practical. And I devised a process that would have given me the answers to make all of these experiments successful. And the bottom line of this is to measure willingness to pay, which you can do and then correlate those measurements with value drivers and decision drivers. Those drivers are anything that a company will do to influence a customer’s willingness to buy at a particular price.
When you have the information on how these value drivers affect willingness to pay and buy, you have a recipe for making those pricing strategies successful every time.
Per Sjöfors: Think about how the majority of companies set their prices. They set their prices primarily based on three things: competition price, margin goals and gut feel. The interesting thing is that the competitor probably guessed that price too. So you follow a guess with another guess. If you are still in business, you’ll know you made a good guess.
Per Sjöfors: Yeah. I mean first off over the years we’ve been engaged about 600 times, and from those engagements, we have 598 references. So I would say that the process that I devised works every time. And these are roughly split equally into B2B and B2C. The underlying theory is the same. And it is about measure and willingness to pay and correlate that with the value and decision drivers. Pricing is the most powerful message of quality and benefit. If you price yourself too low, people don’t believe that whatever value your product is going to give them is true and therefore they won’t buy it.
Per Sjöfors: You don’t want to experiment before you measure and this has to do with some of the fundamentals of the psychology of pricing. There is a thing about the psychology of pricing called price walls. Price walls are psychological price points where a small price change will affect sales volume significantly.
So you don’t want to experiment until you know where these “price walls” are. Between the price walls, the demand or the sales volume will not change very much with the price changes. And so you say you have a product priced at $18.25, if you drop the price to maybe $16, you may see very little change in volume and of course you leave more money on the table. If you increase the price to $19.50 and again see very little difference in sales volume. This is the result of A/B testing.
In many cases companies A/B test their prices, and they see very little difference simply because they’re on that price plateau between two price walls. Should they cross a price wall, they will either see a dramatic increase or decrease in sales. So you don’t want to do these experiments without knowing what these price walls are and how severe they are.
Per Sjöfors: Yes, correct. And so what it also really means is that you want to make sure that your price is as close to a price wall as possible. But on the right side of it.
Per Sjöfors: The process is we use online panels. We use a lot of qualification both internal and external to make sure that the people that we poll are the appropriate people for our client. We then analyze this data, and we most importantly not only develop the pricing charts which are demand curves but also how we correlate those demand curves with these value drivers and decision drivers. In many cases when companies tell us they have a pricing problem what we find is that their bigger problem is not pricing, it is that they use value drivers marketing messages that don’t drive a higher willingness to buy at higher prices. So, of course, they have a problem with pricing.
Per Sjöfors: There are no differences because this is all about human behavior. What we do when we measure willingness to pay in this way and the psychology of pricing is that we will lean on a fairly new academic field called the behavioral economics. Nobel Prize winner in economics, Richard Thaler worked with some of my colleagues here in Los Angeles. So they studied under him, and the human purchase behavior is the same no matter whether it’s product or services.
The difference, of course, is that services could in some cases mean that you don’t have a hard or as significant cost of goods sold whereas in of course when you sell products you don’t want to sell below your cost or below some minimum margin. And that obviously can put some limits on where the price should go.
Per Sjöfors: They have the commissions. But on the other hand, they don’t have the cost of infrastructure that a regular retailer may have. But there’s a strong need for the prices to be high enough so that there is enough margin for everybody. That’s why it becomes so important that the company knows not only how to how to set their prices right but how to teach these sellers how to defend prices.
Per Sjöfors: There’s a couple of things to remember when it comes to discounting. First of all a discount is not the same as a low price. And what I mean with that is that when the customer look at the product and compared to the price, in their minds there is a correlation between the perceived value and price . Now if you provide that with a discount it becomes a better deal. So people are more likely to buy it because the value perceptions are still anchored with the original price, not the discount. But if you discount too much then instead of anchoring the value perception with the original price people sort to anchoring the value perceptions with the discounted price.
And that means that more and more people will start seeing the product as a lesser valuable product simply because it’s cheaper. So too much discounting and too aggressive discounting are something that over time detract from the value of the product. When that value is detracted, It’s tough to go back and sell the products at the original price.
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