Here are 3 key pricing mistakes to avoid.
Using cost-plus pricing. This is where we decide that the best price is 20% or 8.5% or some percentage above ‘the costs’. The problem is that we don’t actually know what the true cost is since figuring out the overhead can be quite difficult. I’ve seen many examples where the overhead value that was used is to high (so that a price ends up too high, and nobody buys the product) or the overhead value is too low and the price that is set results in an actual loss on the product. The other end of the spectrum is where by adding only the 20% or 8.5%, we have not extracted the full value of what our customers are willing to pay since we are basing our price solely on the costs incurred.
Forgetting the importance of reference pricing. Reference pricing refers to the price consumers expect to pay. It’s essentially the price that a customer thinks is ‘fair’. And the person who decides the ‘fair’ price is the customer. And sadly, their idea of a ‘fair’ price may not match yours. Consumers are generally more willing to accept price increases relative to the reference price if they know that the actual cost of goods sold increased. Alternatively, by bundling products or focusing on the net benefits to the consumer, marketers can obscure the cost of goods sold or change the reference price itself.
Increasing or decreasing prices incorrectly. Customers evaluate price differences proportionally rather than in absolute terms. This means a $5 discount on $20 is felt different by the buyer than a $5 discount on a $200 item even thought its the same $5. At the same time, generally losses loom larger than gains with both having diminishing effect as they grow larger. See value vs gain/loss plot to right, Source: Sri Venkataraman. Therefore, for price increases, a series of small steps is more effective whereas for discounts, one large one works better. This comes from Prospect Theory.
Pricing strategies, especially with the use of pricing analysis tools such as those taught by Professor Sri Venkataraman of UNC Kenan-Flagler, can dramatically increase the revenue brought in by products and services. But it can also be a dangerous pitfall that leads to everything from products that are leaving money on the table to products that are actually losing money.
Pricing can be a gold mine for increasing revenue, but it can also be a landmine for those who ignore key customer pricing pitfalls.