How much is something worth? Typically the first reply is what the market determines; this is the classical MBA version of how to establish pricing in a market. Everyone feels comfortable with this, because for humans it is damn hard for us to establish what is the value of something. Saying it is what the market determines is a neat, clinical and logical explanation for pricing.
But not as true as the pure economics suggest.
Perhaps another (and better) question is to ask is, ‘How do you influence the value of something to optimise profits?’
Setting a price in B2B can feel more difficult than B2C, because with consumers you have a few advantages. Firstly they are suckers for a range of tricks such as sales markers. For example by claiming a product is valued at $38 (RRP) and is on ‘sale’ for $29.99 stimulates an overwhelming buying behavior more than just advertising for $29.99 in the first place. Of tremendous value are the visual cues that can be engaged, with red type and everyone’s favourite word ‘SALE’ emblazoned on a sign or sticker, this adds to the power of sales markers.
You can’t really do this with a turnkey infrastructure project. Imagine on the front page of a tender document: ‘This month only, 10-lane freeway on sale. Was $1.2 billion, now a crazy $900 million!’ But the principle can hold true.
There is one common thread to pricing, irrespective of B2B or B2C, and that is the psychology behind pricing, and the use of pricing to make something more marketable. The professional decision-maker or consumer share the same human trait that makes it hard to establish value. We all need to be stimulated about value or told what the value of something is.
Tom Sawyer was a genius at value price setting when he had to paint a fence as punishment. Tom certainly hated the idea of painting, and knew that his mates would be hard to rope in. So Tom pretended to have an absolute hoot of a time painting the fence, and made it an exclusive ‘honor’. One by one the local kids gathered, and started to beg Tom for the chance to join in on the fun. Mark Twain teaches us the powerful lesson behind the marriage of economic science ‘supply and demand’ and the psychology of driving value.
If you think you are immune to such a scam, you’re not if you have used any of the web 2.0 models, such as Facebook, YouTube or Twitter. They have us painting their fences, while they collect the overwhelming benefits.
People do find it very difficult to establish a value on something, which is why a key part of price setting is known as anchoring – telling the other party what something is worth. From a psychological perspective the principle of ‘the more you ask, the more you get’ is used in many areas.
If you can establish a base price which is hidden and understood by you alone, and then increase the asking price, you have room to fall back, but also stand a greater chance of exceeding your hidden price, which should of course be set with a profit. That’s how Andy Warhol’s beach house was sold. The ‘true’ market value was $25 million, the listed price was $50 million. The eventual sale price was $27.5 million. If they had started at $25 million, it is doubtful they would have gained the extra $2.5 on top.
With an anchor of $50 million (a ridiculous asking price), the buyer had the 45% discount in mind, and didn’t even get to touch the ‘true’ market value to talk down the price, perhaps to $23 million (considering it was an odd house, and was on the market for seven years), instead paying a $2.5 million premium.
The point of this is not to say we should all artificially inflate our prices and act like hagglers in North African markets. But recognise the human trait of finding it hard to place a value, and therefore the power of anchoring can be used to set pricing as a marketing tool. It is not always supply and demand, nor markets which dictate pricing or value.
Ilan Ritov, an Israeli professor of education and psychology experimented with 148 management and engineering students, the B2B marketers and negotiators of the future. She created a bargaining simulation, with a buyer and seller locking horns to negotiate the optimal outcome for their own self interest. What she found was very interesting indeed.
People were randomly assigned the role of being either the seller or buyer of a fictional commodity. There were provided with specifications about delivery, discounts and price, with profit tables showing them how each of these factors affected their bottom line.
It is worth noting that there were no rules to this, but people still fell in line with traditional roles. Typically it were the sellers who made the first approach, with buyers happy to sit on their cash unless they were asked to be relieved of it.
Each party knew that the upper limit was $8000. And those who asked for $8000 gained a better final sale price then those who low-balled. But the real power belonged to those who initiated the contact, most likely the seller, and who set their price high.
In negotiations, the party who delivers the first price is at a clear advantage. When you name your number, that shifts the other side’s expectations of what will have to be paid, and what will be acceptable.
Business negotiators typically like to think that there is more clinical science behind what they do, the time they spend to work out what they want, and what the other party is prepared to pay. They live in a world where reserve prices are real and solid.
But other negotiators look at the psychology of anchoring. The mindset is that pricing is not evidence of what someone wants, it’s all about what someone ‘thinks’ he can get. Which is at the end of the day a guesstimate. The serious interest is in how you influence these guesses.
Donald Trump uses this psychology to great effect: “When I build something for somebody, I always add $50 or $60 million onto the price. My guys come in, they say it’s going to cost $75 million. I say it’s going to cost $125 million, and I build it for $100 million. Basically I did a lousy job. But they think I did a great job.”
Different industries have different pricing traditions. There are those who are price takers and price setters. No prizes for guessing who suffers from the least volatility. If you are more in the price taking market, then anchoring could prove difficult. That’s where bundling comes into play, where you create a package that is like love and marriage – you can’t have one without the other. In other words, the buyer cannot pick out different chunks therefore making it difficult, if not impossible, to compare.
The key to bundling is of course to make sure that the items you have are items that the market wants. No point throwing in steak knives if you’re selling to vegans! But bundling embraces more than product, it is about service, finance, payment terms or third-party offerings, where their capability becomes your capability.
Pricing is a very interesting marketing tool. It does not have to be sharp, in order to be effective.