In our July 11th show we discussed The First Law of Marketing: The Value of Value. The Second Law of Marketing is just as critical to help your organization communicate value, and help convince your customers to pay for that value.
One of the most customer-centric strategies your company can deploy is to offer an array options to your customers. It is very “outer-directed,” rather than just offering a one-size-fits-all, take-it or leave-it option.
Customers prefer options, especially in today’s world where they face a plethora of choices regarding who, when, what, and how to patronize a business. Contemplate these examples:
- Universal Studios Theme Parks standard admission price is $80, but for $139 you can get a “Front of the Line Pass” and for $299 a “VIP Experience,” giving guests behind-the-scenes access.
- When the final book in the Harry Potter series was released, the publisher offered the regular version for $34.99 and the deluxe version for $65. They were ranked number one and two, respectively, on Amazon and Barnes and Noble websites.
- Tourists in New York can avoid the long lines to get to the observation deck of the Empire State Building for double the regular admission price, guaranteed to take no longer than 20 minutes.
We simply must get over the false idea that there is one optimal price for a customer. There is a range of optimal prices, commensurate with the value being created. Dutch psychologist Peter van Westendorp developed the van Westendorp Price Sensitivity Meter (PSM) by posing these five questions:
- At what price would this service be so expensive the customer would not consider buying it?
- At what price would the service be expensive, but the customer would still buy it?
- At what price would the service be perceived as inexpensive?
- At what price does the service become so inexpensive the customer would question its value?
- What price would be the most acceptable price to pay?
The Magic of Three––Goldilocks Pricing
There is strong empirical evidence—from both the rational and behavioral schools of economics—that offering customers at least three options can often times result in them purchasing more, at a higher price, than merely offering one take-it or leave-it option.
In his book, Predictably Irrational, Revised and Expanded Edition: The Hidden Forces That Shape Our Decisions, behavioral economist Dan Ariely illustrates the utility of offering options by illustrating The Economist magazine’s offerings. First, he presented the following two options to 100 students at MIT’s Sloan School of Management:
- Economist.com subscription $59: One-year subscription to Economist.com, including access to all articles from The Economist since 1997—68 students chose this option.
- Print & web subscriptions $125: One-year subscription to the print edition of The Economist and online access to all articles from The Economist since 1997—32 students.
Now compare those results to the actual ad that The Economist offered, which contained three options, not two:
- Economist.com subscription $59: One-year subscription to Economist.com, including access to all articles from The Economist since 1997—16 students chose this option.
- Print subscription $125: One-year subscription to the print edition of The Economist—0 students.
- Print & web subscriptions $125: One-year subscription to the print edition of The Economist and online access to all articles from The Economist since 1997—84 students.
Ariely concludes that there is nothing rational about this change in choices. The mere presence of an option that was not desired—known as the decoy or dominated option—affected behavior, leading to a potential 42.8% increase in incremental revenue for The Economist.
When two options are presented, the decision is mostly made on price, yet when three options are offered it becomes a decision based on value.
The Anchor and Framing Effects
Offering options creates the anchoring effect, whereby the customer is now comparing prices to your highest offering. This is why Victoria’s Secret offers a diamond ornamented bra for $6.5 million that no one probably ever bought; and Prada stores always display one incredibly high-priced article that acts as an anchor for all the other products.
All of these high priced items act as an anchor, even if the customer never buys them—throwing a halo effect over the other offerings, allowing for prices to be higher, while increasing average per customer sales.
The first lesson from the above is if you do not offer a high-end premium package, how could you customers ever select one? Second, list your most expensive option first. The third lesson is that by offering three options, you almost always sell more of the middle option, and less of the cheapest offering.
This confirms what most pricing experts know: people are not price sensitive; they are value conscious.
Another behavioral phenomenon is the framing effect. What you compare something to will determine an acceptable price to pay. If I offered to sell you my Unicorn, you’d have no idea what to pay since no one has ever purchased one. But you’re happy to pay for coffee in little pods—which are more expensive than coffee purchased in bulk—because you are comparing it to Starbucks.
This is why brands pay so much attention to what you’re comparing their offerings to: Red Bull is packaged in a skinny can so it will not be compared to a Coke or Pepsi, and Woolite is in a bottle so it’s not compared with Tide, but rather dry cleaning.
When you present three options to the customer, you are also subtly changing their psychology. Rather than thinking about whether or not they will do business with your company, the options nudge them in the direction of thinking about how they are going to do business with your company.
Pay close attention to the context in which your prices are anchored and framed. It will have an enormous impact on your profitability.
Additional Resources and Books Mentioned
For more on why are we in business, Peter Drucker’s Marketing Concept, and the role of profit, see Pricing on Purpose: Creating and Capturing Value, by Ronald J. Baker.
Minding the Store: A Memoir, by Stanley Marcus. Ron believes this is the best book ever written on customer service.
Positioning for Professionals: How Professional Knowledge Firms Can Differentiate Their Way to Success, by our VeraSage Institute colleague Tim Williams, who will be a guest on a future show.
We referred to Rory Sutherland TED.com talk, and his example the breakfast cereal Shreddies. Here is the video. Rory will be a guest on our August 29th show.
The infamous Wendy’s commercial from the Cold War era, about offering choices.
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