“Raise our prices? No thanks, I actually want to keep my customers!”
For most companies, just the thought of raising prices is nerve wrecking. They don’t have a proven method – and this creates uncertainty.
And raising prices is a delicate matter: on the one hand, it is a necessary element of doing business over time. On the other hand, most fear the risk of unpleasant conversations with existing customers and the threat of lower market share as a consequence of customer churn.
While I understand the reluctance, reality tends to be a bit more complex than that – and at times even counterintuitive.
Because one of the best ways to increase customer satisfaction might just be through higher prices.
How?
By putting a higher price tag on your products or services than your competitors, you might well be doing some price-quality signalling.
Price-quality signalling
For some products and industries, price-quality signalling can be a moderate overpricing of your products or services – e.g. Apple compared to other brands – or a radical price increase – for instance black pearls compared to classic white pearls. But in both cases, you signal to your customers that what you offer has a higher quality than what they can get elsewhere.
The question is then just how the price-quality signalling increases your customers satisfaction?
Although it’s an economically irrational statement that your customers get more satisfied the more they pay for what you have to offer, there’s something to it. According to a study by Kalita, Jagpal and Lehmann, higher prices not just signal higher quality to customers; they also result in greater satisfaction with the choices that your customers make.
Contrary to what most of us think, customers don’t automatically reject higher prices – they often pause to take a closer look at what justifies them. What are you offering that’s worth that price tag? What was it that they didn’t notice immediately, but might give them higher value or satisfaction? This happens due to a psychological phenomenon called the confirmation bias that urges us to look for confirmatory reasons for – in this case – a higher price tag.
So we believe the more expensive bottle of wine is better than the cheaper one – and we actually experience that it tastes better the more expensive it is!
We state that the more expensive consultant is more effective or skilled than the one who charges less; and we feel that a more expensive medication works much more effectively. The list is long, but all end with the same bottom-line: A higher price tag might actually be just what you need to increase your customers satisfaction.
We value expensive more
Higher prices not only result in higher satisfaction, they also enhance our experience of how efficient and useful the product is.
In one study, Baba Shiv and his coworkers gave a very low dose of electrical shock to test participants and subsequently gave them a pain reliever under the pretext that the aim was to test how efficient the pain reliever was. The pill was, of course, a placebo. The primary objective of the study was to test for the effect of price on experience.
Some of the participants received a pill they were told was sold at $2.50 and others were told that the pill would cost $0.10. As it turned out, when the participants thought the price was $2.50, 84.5% experienced pain reduction, while only 61% experienced pain reduction when they believed the pill costed $0.10.
In another study, the participants were told that the aim of the study was to measure an energy drink’s effect on endurance. After drinking the content, they subsequently had to solve as many math puzzles as possible. The group told that the energy drink was sold at $1.89 solved an average of 9.9 puzzles, while the other group believing the cost of was $0.89 on average solved 5.8 puzzles.
In absence of other clues, we use price to estimate value
Most customers are more than often unsure what the true value of a product or service is. In lack of better valuation assessment the readily available price tag serves as the best clue to what value your product represents.
Our brain simply tells us that because the price is higher, the quality must be better. And the confirmation bias kicks in to line up all the reasons why the service or product is in fact superior.
And mind you, the confirmation bias works the other way as well: When faced with a cheap price, the confirmation bias encourages your customers to look for reasons why your products or services are priced lower than competitors. They are more alert of potential shortcomings and think that cheap signals that it's probably not among the best in class.
Your customers are willing to pay significantly more than they think
In one Harvard Business Review article, researchers Bertini and Wahtieu described an experiment where the test participants stated that they were willing to pay 20% extra for organic salad and fair-trade coffee compared to regular coffee.
Then the researchers presented the participants with products priced 80 percent over the standard products – and something remarkable happened: the participants would take the time to come up with twice as many positive informations about the products, and the sheer amount of positive information made them better able to argue in favour of buying the products!
Overpricing also triggered a more passionate response - for example, how important organic and fair trade products were at all and for them specifically - and ultimately increased their willingness to pay more for the products.
In comparison, when the test participants were exposed to a price relatively close to their stated price – about 10% above the 20% they were willing to pay – or an absurdly expensive price – 190% above their stated price – they acted in accordance with their stated price without reconsidering their price sensitivity and choice.
What this study tells is that for every purchase decision your customer is facing, there is a price range above what they say they are willing to pay. And this positive range encourage them to ask “Do I need this or not?” a question you much rather want them to ask instead of the usual and more harmful “What is the cheapest solution available to me?”
Stop reducing prices!
Unfortunately, many companies often respond to price competition by pushing prices down to a point where your customer's important consideration about added functionality or benefits are ruined by overfocus on price – and their expectations hit rock bottom!
This means that if you are giving away your products or services cheaply – meaning that its perceived value exceeds its cost – your pricing strategy can both harm your profits as well as your ability to maximise your customers’ satisfaction.
And if you find yourself in an industry where prices have taken a round in the harmful downward price spiral, a deliberate overpricing can help reverse the trend. Think for instance of Starbucks who took a beverage that many companies gave away almost for free and instead put a significantly higher price tag on it.
Millions of cups of coffee later it is clear that founder Jerry Baldwin, Zev Siegl, and Gordon Bowker did something quite remarkable. Not because Starbuck's customer base was more wealthy or because the quality of Starbucks coffee was that much higher. What Starbucks did was consciously putting a price point that made people reconsider the importance of a coffee break in their lives.
Tactics to raise your prices
So does this mean that you can yank up your prices from one day to the next and your customers will cheer with joy?
As the Danish mortgage lender Nykredit's disastrous attempt to increase their fees in 2016 illustrated, then of course not.
I’m only saying that your old belief that higher prices authomatically generates angry customers isn’t necessarily true. You can employ different tactics to manage your price increase in a customer friendly way.
#1. Customers love fair prices, not necessarily low prices
First and most important, you need to consider what price range your customers feel is fair. Several studies conducted by Sandra Rothenberger, Leslie John and other scholars show that customers are more likely to develop a loyal and satisfactory relationship with a company when they feel that the products or services are priced fairly.
Only when customers regard the price as fair are they more likely to develop positive attitudes towards your products’ and services’ performance, your company and your brand.
The key point here is the price customers perceive as fair and not necessarily whether the price is high or low. And it is this perception you need to take into account and handle through different frames.
For instance, several studies show that we perceive price increases as legitimate and fair if they are due to added external costs that are out of your span of control. On the other hand, your customers will perceive price increases as a result of increased demand – or even worse, if you forget to communiate why the prices increase – as very unfair.
So if your prices rise due to external costs, communicate this again and again. Furthermore, other studies show that if you in addition to providing legitimate reasons for your price increase also attach it to another high price anchor with real value to the customer, then you have more influence over your customers perception of what a fair price for your product or service is.
Ultimately, your customers’ perception of a fair price increase depends a lot on the quality and amount of your communication, the frames and anchors you apply and whether your arguments are believable and true. And finally, if you have the luxury of price transparency, this goes a long way in increasing your customer satisfaction and loyality.
#2. The January Effect
Another way to increase prices – a reframing strategy – is to increase your prices at the beginning of the year, often in January, where customers are not surprised to see a rise in prices but consider them a necessary evil.
Perhaps your first thought is that annual price increases are tied to inflation and that inflation has been very low the past 4-5 years, but you shouldn’t feel too restricted by the actual inflation rate.
Consider this: Yours truly is enrolled in the Harvard Kennedy School's mid-career MPA. If you take a look at the tuitions and fees site for international students, it says that prices increase by 3-4 percent a year. Right off the bat this doesn’t give any reason to be sceptical as most of us intuitively accept this as a consequence of inflation, without considering that the average US inflation rate hasn’t been more than 1.5 percent a year the last 4-5 years.
This type of price increase may work quite well when you only sell one product or service. But if you have a variety of products or services then a flat price increase across all of your offerings is a waste of opportunity. A better way is to use inflation to adjust the relative price differences between your products or services. For example, if you experienced that demand for some of your products or services has increased and others have fallen, inflation gives you a good opportunity to increase prices a little more on your most popular products or services compared to those less popular.
You can also choose to freeze or reduce the price of those products that have not sold as well - in that case, be sure to advertise the products that are hedged against inflation. It not only creates awareness about them, but also signals why the price of other products has risen.
And last but not least; if you at the end of the year communicate to your customers that the price of a product is increasing, there is a good chance that they will rush to buy before your prices go up.
#3. Packaging Cycles
If you are truly unwilling to increase your prices out of fear that your customers will turn you back on you, but your costs are still increasing and eating away your profits, what do you do then?
Here, another effective price increase is to resize your products or services packaging or composition. Instead of thinking like an economist, this kind of reframing requires you to think like a magician.
Let’s say that you want to increase the price of a yoghurt without increasing the price tag. Then the old magic trick is to look for creative ways to reduce the size. You can for instance create a rounder arch in the bottom of the container to reduce the content, effectively increasing price per liter while holding the price per item constant.
You can slim down the package of cornflakes or leave more air to hide the content reduction, knowing that reducing the package size from 500g to 450g effectively gives an 11% price increase.
If you sell services, you can cut the number of expensive consulting hours and replace them with junior analysts (a fancy word for students).
This works because your customers are often more aware of the price, while it is harder for them to remember if the can of corn used to be 350 or 330g, if the package of wet wipes had 80 or 72 pieces in it or if the number of senior consulting hours was 21 or 23. It would require them to walk around with a pen and paper in life and business, registering all the compositions, sizes or numbers they encounter with.
Of course, this strategy only works for a while. At some point and before the cornflakes package becomes thin as an envelope or only students do the actual work in your business, you need to change your pricing strategy.
This is where you introduce a new economy-size package or an add-on product or service together with the old one. This type of repackaging is harder to compare with previous versions, as it differs in size, price and design. It makes it difficult for your customers to assess whether it is a good purchase or not. So they buy it. And then a new cycle of shrinking begins.
It's an absurd price-value dance and most of your customers would rather pay the inflation-adjusted price if they were confronted with this head on – at least, this is what they say.
Your problem is that there is a big difference between what customers say they want and what they actually do, and a remarkable price increase especially on elastic goods and services is a turn-off.
Fortunately for the manufacturers, customers' memory around packages and sizes is very short. And although size reframing has the disadvantage that it does not directly increase your revenue, it creates room for you to introduce a bigger and more expensive package at a later date.
#4. Product Changes
You can also try to influence your customers’ memory of what prices you carry. Here, the solution might just be to replicate the British fast-food chain, Pret A Manager, and change the product range several times a month at different price points, thus introducing price increases without it being visible to customers.
Another approach is to change prices as often as possible with discounts until the customer completely forgets what the base price was. The next few times you visit your local supermarket, notice the prices of Coca Cola. I often shop at Nemlig.com, and during the past few months I’ve witnessed the price of a 1.5 liter Coca Cola change from 10 to 25 kroner, including combinations such as 5 for 50 kroner, 2 for 25 kroner, 1 for 10 kroner, 1 for 12 kroner, and so forth. And then you have all the other versions such as 0.25 liter, 0.33 liter, 0.5 liter and 2 liters with their own fluctuating price levels that completely blurs my memory of what the price of a Coke is. This means that when a 1.5 liter Coke hits 25 kroner, I don’t feel the same aversion to the price increase. I might still find the Coke expensive, but the negative emotional response to “price increase” is greatly reduced.
#5. Netflix’ Pricing Strategy
In 2011, a large part of Netflix's business was still to send physical DVDs and BlueRay movies to customers on a subscription solution. Streaming service was becoming an important part of the business, but the number of movies available was far fewer than the physical formats.
In an effort to make an indiscrete price increase, Netflix divided its subscription in 2. Instead of paying $7.99 a month for free streaming and rental of 2 physical movies, customers now had to pay 2 separate subscriptions of $7.99 each for respectively unlimited streaming and unlimited rental of physical movies.
Suffice to say it created a veritable rebellion amongst their customers and Netflix lost thousands more subscribers than assumed. 2011 was a bad year for Netflix.
Wise from harm, when Netflix a few years later wanted to raise their subscription price by 25% - from $7.99 to $ 9.99 – the transition was so smooth that it was almost art: they announced their price increase no less than two years in advance! As early as May 2014, Netflix annonced that prices would increase in May 2016 for old subscriptions, while the price of new subscriptions would rise immediately.
You might think that when it comes to the old customer, to agonize over a $2 price increase you have to be a tighwad; but to agonize over the $2 price increase for 2 whole years you have to be an extreme pennysaving version of Scrooge McDuck!
But in fact, the beauty of the Netflix price increase is that it uses a number of psychological and behavioural finance biases to make the process much less painful.
Netflix’ pricing strategy takes advantage of our inability to value time and utility in a rational way – a bias behavioural economists call “hyperbolic discounting” - but Netflix cleverly wedged the bias between two other psychological phenomena: On the one hand the “status-quo” or “default bias”, which is our tendency not to act but let things stay as they are. On the other hand the “escalation of commitment bias” that encourage us to escalate our commitment to our previously chosen path of action - a bias that has ruined many a poker players.
The effect of this finely spinned web of biases can also be utilised for other products and services that cost far more than what Netflix charges, but is, however, particularly effective for business models with customers in subscription plans, or customers who buy regularly. This is because it is this regularity that creates the default situation and “stickiness” in your relationship you’re your customers.
An example involving more than a few dollars is in wealth management and financial services. In every asset managers’ customer portfolio there are a number of “legacy customers” who still pay the cheap prices and fees from the beginning of their customer engagement, simply because the asset manager fears losing them if prices were to be increased.
Here, the Netflix pricing strategy will be a massive help to level out the price differences as long as the price increase is sufficiently far into the future and is announced many times during the interim period. When the day finally arrives and prices increase, the customers feel that they have implicitly accepted the increase simply because they didn’t protest or leave earlier when the price increase was announced.
Or returning to mortgage lender Nykredit: When the company looked to increase their spread, just imagine how a pricing strategy similar to Netflix’ could have hampered the company’s trip through the media meat grinder. Instead of being duped the “Villains of the financial services”, hurting their brand and causing much agony to their customers, just think about how the right pricing strategy could have turned the day of the price increase into just another day of business.
When it comes to pricing strategies, an ounce of prevention is often worth more than a pound of cure.
Let me know how you've made price increases in the comments
Thanks for reading!
- Sally Khallash
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