In this article we’re looking at the gap between logic and reality, why conventional pricing reasoning can miss something important, walk through the main frameworks and what each of them means, then finally look at two examples of pricing at work.
There is a quote (among many) from Rory Sutherland, vice chairman of Ogilvy and genuine marketing genius, that stuck with me:
“The human mind does not run on logic any more than a horse runs on petrol”
The point Rory is making is that the logic we really use to make decisions is almost never the logic we think we use. I like to think I’m quite a rational person, then only last week I paid £8 for a coffee in an airport because the queue was shorter.
There are, of course, moments with rational and logical works and it’s a good starting point for businesses to set frameworks, certainly for B2B operations. Working out costs and understanding what the rest of the market is doing are the fundamentals. However, consumers’ minds are not running spreadsheets to work it all out.
Why customers don’t buy the way we think they do?
The central argument is that value is not an objective property sitting inside a product but more something that happens in the mind of the buyer, shaped by context, story, comparison and, more often than not, feeling. The price tag is a piece of information and buyers use it to answer questions they might not have consciously asked: is this trustworthy? Is this for someone like me? Will I feel good about this tomorrow?
In a commercial context this means that two identical products can command very different prices depending entirely on context – how they are presented, where they are sold and what surrounds them all make a difference:
Going back to Rory Sutherland, he uses the example of Stella Artois, which built an entire brand positioning around being reassuringly expensive. Rather than price parity or undercutting, they purposefully set a higher price. In doing so they created a perception of premium quality product to the buyer that no amount of messaging could have done as efficiently.
In another example, a candle that sells for a few £’s in a supermarket can be repackaged to command a far higher price in a boutique. Using the context of the retail environment and by adding tissue paper, a hand-written label and the story on the back of the box there is a shift in perception and with it, willingness to pay. Let’s remember, the wax and the wick are identical.
The commercial consideration is one of volume vs value, it’s always worth reflecting the size of the market, how much share you can achieve, how many of your ‘things’ you can produce or ship and what the long-term strategy is. For product makers, this is either exciting or uncomfortable depending on where you are right now!
The main pricing frameworks
For many businesses the pricing they adopt at the start, conscious or not, is what they stick with. The following are the main routes used by most to build up pricing structures:
Cost-plus pricing
Perhaps the most common and most straightforward starting point, calculate what the product costs you to make, add a margin percentage and arrive at a price. This method protects margin at a basic level and it is easy to explain to investors and stakeholders.
The risk with cost-plus is that it is entirely inward-facing and doesn’t consider what a customer is willing to pay. Two businesses might be making near-identical products with different cost structures so would land on very different prices, neither of which may reflect market reality.
Cost-plus is a good starting point to ensure you have a commercially viable product, where necessary you may need to adjust the margin percentage or the amount it costs to make.
Competitive pricing
It’s also important to look at what others are charging and consider where you position your product relative to them. You might choose to come in slightly under to win on price, match them to signal equivalence or go above to claim premium.
There are a number of risks when it comes to competitive pricing, for example, undercutting might lead to market devaluation, competitors may have incorrectly priced the market or you might have something far better and give away your advantage.
Competitive pricing is an essential consideration when coupled with a strong product strategy. If you know your product USPs, what the demand is and how customers perceive it, you can use competitive pricing in the right way.
Value-based pricing
This is probably the trickiest of the pricing strategies but one of the most worthwhile, by starting with the customer you can begin to understand what problem the product solves and how much that problem is worth to the person who has it.
Of course, we’re talking about logical and seemingly illogical choices here, this is where Rory Sutherland’s thinking becomes most useful.
Value-based pricing takes seriously the idea that perception, context and story are legitimate commercial inputs. It requires you to know your customer well, to understand what they were doing before they found you and what they would lose if they stopped using you. The effort that goes in is higher but the reward tends to offset it.
Using models such as Gabor-Grainger combined with contextual market research, it’s possible to build up a picture of consumer perception. Doing this can be costly in both time and money however, in our experience, it more than pays off.
Price laddering and value stacks
Some businesses have a range of products, different options at different price levels. Having clear pricing structure alongside trade-up becomes essential, tangible benefits are the basics, intangible ‘feelings’ add perceived value and are what will add the cherry on the cake.
An entry-price product might be the hook that you use to bring someone in if your product is in a price sensitive market, however if you can price your premium product to be aspirational it’ll do disproportionate work in anchoring how the whole range is perceived.
The tiered approach works particularly well for product businesses with a larger range to manage, because it gives customers a natural navigation path and shifts the question from whether to buy to which one to buy. The psychology of that shift is significant, and we will look at it in detail below.
In practice: how Weber built a successful pricing ladder
Weber are a well-known barbecue manufacturer in a competitive and time-pressured seasonal market. As with many categories, it’s easy to view price as a blunt instrument correlated to the features and consumer selection based on whatever fits the budget. As with so many premium product makers, Weber understand that something more interesting goes on in consumer decision-making.
The Weber ladder runs from entry-level kettle grills at around £100 through to premium gas and pellet smokers well above £1,000. There is certainly a feature trade-up through the range that justifies the logical brain, however there is also another force at work…
For most people, the entry product is genuinely good and does not feel like a compromise designed to funnel you upward. However, the mid-tier and premium product offer more than control or versatility features. What they begin to introduce is ‘feeling’, a different relationship with cooking outdoors as an identity of someone who takes grilling seriously. Weber understood that for a meaningful slice of their customers the BBQ is a signal about how they spend their weekends, what kind of host they are and, therefore, what they value.
A good ladder also does something essential with perception across the whole range. The existence of a £1,500 ‘Summit’ product, named to match, makes the £400 ‘Spirit’ feel like a considered, sensible choice rather than a significant outlay for some customers. There are different theories that come into play when building a range, and what the sacrificial lamb should be, perhaps I’ll cover this in another issue…
For makers with any depth of product range, the question worth pondering is whether your range has any kind of intentional architecture or whether it has simply accumulated over time. A pricing ladder only works if the steps are clear and are both logical and ‘illogical’.
In practice: the cost of an underdeveloped price-range
A UK homeware manufacturer came to us with what looked, on the surface, like a sales problem. Their revenue had plateaued and so the MD wanted to explore where growth might be found.
When we sat down with the numbers, the sales picture was reasonable, they were taking a steady share of a market in overall volume growth. The problem lay with an aging product range that had built up over a number of years with zero pricing strategy.
Products at different price points were not clearly differentiated in terms of what the customer was getting for the step up, the range had grown organically rather than strategically leaving customers who might have traded up, with no clear reason to so. Virtually all the volume growth was going into lower-margin entry-level products.
We worked through two key areas with them: where value steps existed in the range and how to clearly communicate, and which products were earning their place versus which were just generating activity without generating profit.
The outcome over the following quarter: eight SKUs repriced with stronger value justification and a clearer narrative around the step-up and two bundles introduced at the top of the range that made the premium tier feel coherent for the first time. This enabled revenue to move into growth not seen for months.
What this means in practice
The practical takeaway is not to abandon your cost model or ignore the competition because both have a significance, however if they are the only inputs into your pricing, we would suggest there is likely to be headroom on the table…
A few questions worth sitting with:
- Does your pricing reflect what your product is worth to the customer, or just what it costs you to make?
- If you have a range, does it have a clear ladder with real reasons to climb, or has it just grown?
- Are your best-selling products also your best-margin products? If not, it is worth understanding why.
- What signals are your price sending about quality, trustworthiness and who this product is for?
The most valuable thing a price can do is communicate something. If yours is only covering costs and clearing the competition, it might be worth asking what else it could be doing.
Look at your products through a customer’s eyes and ask whether the step up from one to the next is obvious, compelling and worth the difference in price. If you have to think hard to explain it, assume your customer will not bother.
Need a helping hand?
If it all feels a bit much, we’re here to help. Since starting out we’ve come to realise that many businesses need help to build realistic plans and achieve growth.
As two ex-corporate professionals with the experience of building both local and global plans, often with limited resources, we have the knowledge to share.
