Adam Smith’s flash of genius was his recognition that the prices that emerged from voluntary transactions between buyers and sellers–for short, in a free market–could coordinate the activity of millions of people, each seeking his own interest, in such a way as to make everyone better off.
– Milton Friedman and Rose Friedman in Free to Choose
Is Kid Rock the Most Humane Rockstar Ever?
Ever attended a rock concert? If you have, or have always wanted to attend one, you will certainly know that attending a rock concert is not cheap. If you plan to attend a rock concert of your favorite rock star, and if he or she happens to be famous, the cost of tickets could go northwards of $1000 – equal to the cost of the latest high-end smartphone. And it may not always be worth it.
Well, the story was not so different 10 years ago either. Mick Jagger, the lead singer of the Rolling Stones and probably one of the most famous rock stars ever even went to the extent of telling his fans through Chicago Tribune that ‘If you really can’t afford a ticket, it’s sad. I feel bad about that.’ This was after his fans were quite upset of the band’s decision to price the tickets to their summer tour at a staggering $650.[i]
But there are always exceptions. In this small set of people, we also have Kid Rock. For a moment, let us forget the controversies that surround him. In 2013, for his nationwide tour, the prices for most of the tickets were set at $20, a staggeringly low price point compared to the fortune that his fellow rock stars were charging. He even decided to reduce the price of mementos that were available for purchase from his tour. Not only was this well received and most of his shows were sell-outs, but he also apparently made more money than on his usual tours. In fact, Live Nation described the tour as an unbelievable money maker and bolstered Kid Rock’s image as a musician who is fair about pricing. Who doesn’t love low prices, more profit, and a stronger brand?[ii]
Why did the concert succeed? Obviously, the price was ‘right’. The price was not just low, but it was also right. And because the price was right, customers responded in the right way. Price was, is, and will probably be the most important criterion that drives a purchase decision
Is Price Really That Important?
Go to any travel website and try booking a ticket. I am sure you will be lured by extraordinarily low prices that you get hooked on. But that is where the good news stops. Apparently, there are a lot of perks that these airlines sell including seat selection, extra luggage, hot meals, and the privilege of boarding onto and deboarding from the flight early. You end up paying nearly 100% of the ticket price if you add up all these privileges. But it turns out that very few travelers are buying into any of these perks and benefits.
This is also the reason which has led to the growth of brands such as Oppo, Vivo, and OnePlus which were able to undercut the then established brands such as Samsung and LG and attracted customers by offering great or good products at superb price points.
Even Walmart learnt this the hard way. Around the second half of 2010s, Walmart ran a multi-year experiment in which they wanted to understand the correlation between price and sales. Commonly known as the ‘Price Experiment,’ this clearly established the fact that people still buy more when prices go down.[iii]
But why is price so important and why will remain it as one of the biggest criteria going forward? I believe it is because of the four reasons that I call as BEEP.
- It directly affects the individual’s or Buyer’s budget and finances.
- It can create a ripple effect on the way Economy functions.
- It sets the foundation for Ethical pricing.
- It can create the right Perception for the product.
The BEEP or Why Price Is One of The Most Important Factors?
Understanding buyers’ and users’ needs and wants
Comic taken from the comicskingdom.com
The funny thing about most resources is that most resources are limited, and it is quite tough to get hold of them easily. Money is one such resource. It is in limited supply, and for most people, it is extremely limited in supply.
Because money is a limited resource, everyone will consider price as a very important factor before any purchase. The pricier the item, the more important it becomes for the purchase. For example, the price may not be a deciding factor between a 50c and a 60c toffee but will certainly be a strong difference between a $45,000 car and a $50,000 car.
In its fundamental form, the price of a product or service reflects the cost that a buyer has to pay to acquire the product or service. And for every purchase, the buyer knowingly or unknowingly sets a higher and lower price – a ceiling and a floor – that will act as guiding bars for the purchase decision. And these price ceilings and floors change based on multiple aspects of the purchase – when, where, why, how, and for whom.
For example, as per a study published in Journal of Consumer Research, people are willing to spend more money on gifts for others than they would for themselves. In the study, participants were given a budget of $20 to purchase either a gift for someone else or an item for themselves. The researchers found that participants spent more money on the gift than on the item for themselves, suggesting that people may be more generous when buying for others.[iv] Or in other words, we tend to buy pricier items when we buy for others, because we tend to give a different importance to price when we buy for others.
The importance of price is directly proportional to the relative cost of a product or service vis-à-vis the overall financial capability of the individual. For example, if a person earns around USD1,000,000 a year, an iPhone may seem relatively cheap compared to what a USD400 phone may seem for an individual earning USD20,000 a year.
Several other factors also play an important part in increasing the relative importance of price. It may be the buyer’s upbringing (some people really cannot understand the need to buy an iPhone for such an exorbitant price) or the current economic conditions (the price of onions in times of scarcity). It can also be the importance or the lack of it a product may have in the life of the buyer. For example, a shoe may be just another shoe for most individuals, but it may be a very important buy for a jogger, or a runner.
Different individuals will give different levels of importance to price, and it is virtually impossible for organizations to understand the exact nature of importance. But organizations will be better off if they try to understand this subtle difference – either quantitively (as far as possible) or qualitatively and try to build the pricing of their products around this difference in importance.
Economy is reliant on pricing
Cartoon from The Hindustan Times
The people of Manila love spring rolls, and for these spring rolls to taste good, they need large quantities of onions. But the people of Manila now must adjust to a less tasty variety of their favorite spring rolls as the prices of onion across the world have shot up. More than 7,500 km away in Mexico, people are dumping onions and tomatoes and using artichokes to cook tagine, a traditional Moroccan slow-cooked dish. Increasing onion prices have resulted in several countries including Morocco and Turkey to temporarily halt the export of onions. Philippines has called for an investigation to identify the possible role of cartels for this price rise.[v]
The price of onions is not a small matter. It can bring down governments. In India, the 1980 elections were fought based on onion prices. Rising onion prices were the reason for the fall of the ruling coalition government as the opposition stormed back to power.[vi]
Apparently, it was the price of bread that led to the French revolution in the 18th century. Even the latest Arab Spring revolution spread quickly because an increase in the prices of several staple food items such as wheat and oil, which was already high, pushed people over the edge.
Prices are important because it drives the economy of a nation or even a region forward. For example, the fall in prices of oil can affect the economies of most of the OPEC nations. A small increase or decrease of certain products can create ripple effects that can damage the entire economy of the nation. In fact, the changes in prices of certain products can lead to a drastic change in the supply and demand of these products. Or vice versa. And it can create a lot of unwanted side effects such as current account deficits, high inflation, decreased customer spending, increased wage levels, increased interest rates etc.
That is why governments and people worry about pricing and prioritize it. And that is the reason why governments really want to have a say in the way organizations price their products, but do not want to be seen as restrictive. Organizations will have to respect this need yet find methods to make sure they stay well ahead of what the economy and its customers want with respect to pricing.
Ethical pricing is the need of the hour
Cartoon taken from Tulsaworld
A few years ago, Novartis was faced with a dilemma. They found out that a drug that they sell for a group of very rare diseases could potentially be used for a much more common ailment. But there was just one catch – the selling price of the drug was $16,000 for each dose. Because it was being used for a rare disease, the government was OK with this high price. But if the drug were to be used for a common ailment, Novartis would have to cut its price. And by doing that, it would have to forego the revenue that it would have earned from the rare disease. And if it did not reduce the price, it would be blamed for profiteering.[vii] Should Novartis look to maximize its profits, or should it look at being ethical and reduce its prices?
Luckily for Novartis it did not have to answer that question as FDA did not approve the use of the $16,000 for the common ailment as some scientists downplayed the idea. But the price of a product or a price gains prominence because people equate price with ethics and justice.
Questions are always asked on Uber’s surge pricing. Uber was castigated for its surge pricing policy during the Australian hostage crisis or during the recent hurricanes in the US. But it is also important to realize that the prices that were being shown by Uber were a result of matching the demand with the supply.
Ethical pricing is confused a lot with fair pricing, and wrongly so. Ethical pricing is about doing the right thing, and fair pricing is about following the unseen pricing guiding bars that I spoke of earlier. There are chances that organizations may veer away from what customers consider as a fair price, but it can still be ethical. No one blames Armani of being exorbitantly costly, and being unethical, because its products are meant to be costly. But if an organization indulges in price gouging, hidden fees, or predatory pricing, we have a case of flouting the rules of ethical pricing.
In fact, when I recently booked flight tickets for my family and I, what started out as an attractive price of USD500 became USD800 by the time I had finished booking considering all the fees, surcharges, and convenience fees. Mind you, this was after a discount of around USD100. Another example of unethical pricing is the case of Martin Shkreli, CEO of Turing Pharmaceuticals, who raised the price of a life-saving drug used to treat HIV from $13.50 to $750 per pill overnight. This sparked outrage and led to calls for greater regulation of the pharmaceutical industry.[viii]
What a customer perceives as ethical, and fair may not be ethical and fair to another customer. While ethical pricing is a factor that is a consideration for many customers, it is also a factor that plays in the mind of organizations. While they do not want to miss out on getting the extra dollar by underpricing, they also would not want to alienate customers by over-pricing.[ix]
Research has shown that people are OK with products being priced a bit above what they truly are worth in times of extra demand, but beyond this invisible point, prices gain further importance and will become a point of decision.
Governments and organizations can do a lot to maintain the ethics of pricing. As a start, governments can set a price cap like many governments have set for ride-sharing services in their countries. Organizations can also do their bit by planning to counter potential demand upswings and also communicate the increase in prices, if any, in a clear and transparent way.
In fact, organizations will have to accept that it may not always be possible to stay within the realms of fair prices, but it is always possible to stay in the realm of ethics.
Perception plays an important role in driving the importance of price
And the choice depends on your perception
Have you ever observed how high-end retailers always have spacious retail outlets whereas the retailers who are known for offering the best prices have their items stacked dime-a-dozen with hardly any space to walk around? This difference is clear when you visit a Walmart and a Marks and Spencer hypermarket. The target market is different, and the perceptions that both these brands want to project are different.
Walk into a Starbucks and you will be surprised by the fact that decaffeinated coffee costs more than or as much as regular coffee. Even if the decaffeinated coffee does not actually have coffee powder in it. Why? Because of perception.
Do you know why organizations launch an insanely priced product along with a moderately priced lower version of the same product? It is because of an effect called the decoy effect which states that the presence of a third option will motivate the customer to buy the lower end version.
In an ideal world, low prices are equated with inferior or average quality, and high prices are equated with scarcity and/or higher quality, and the way prices are perceived create the differences in the relative importance of prices.
For example, buying a candle from Walmart may not elicit many thoughts from the customer and the customer may not be bothered about the price of the product, but buying a hand-crafted scented candle made by disabled artisans from a high-end retail store may create a thought or two in the mind of the customer before the actual purchase is made. It is not just because of the price of the product, but also because of the nature of the product – a common product made through uncommon means, and also because of the way the profits from the purchase may be utilized – the chances of a customer making this purchase may be higher if the customer perceives that a part of this money will reach the artisan, than if it is not made evident.
Another example shows how framing the price itself can change the relative importance of price. As New York Times found out, asking consumers to choose between a basic New York Times subscription, “$9.99/month New York Times web and app,” and an upgraded version, “$16.99/month New York Times web, app, print, podcast, and crossword,” 23% of consumers chose the upgraded option. However, when the price for the upgraded version was framed as “plus $7.00/month,” twice as many consumers (47%) chose the upgraded option. Furthermore, they rated the premium subscription as less expensive when they viewed it from the differential pricing viewpoint.[x]
How customers perceive the price of a product is as important as the price of the product and will be a key driver of the relative importance of a product. Let me give you another example by highlighting a trick played by some of the best salespeople. If a salesperson feels that his or her customer is focused on the price of a product, they may show a higher priced product to reduce the bias and in turn reduce the importance of price to overcome the resistance and make the customer buy the product.
Organizations over the years have understood the impact of perception on pricing. They understand the concept of perceived value and are attuned to effects such as anchoring effect, decoy effect, or framing effect. And as customers, it is important that each of us understand the importance of perception in deciding the importance of price in a purchase.
So, How Important Is Price?
In a recent survey done by PwC, a staggering 96% of surveyed customers intended to adopt cost-saving behaviors over the next six months.[xi] So, if I extrapolate it would be very safe to say that a lot of people, and in fact most of the global population rely on price as the most important criteria for their purchases.
The as-a-subscription model was able to reduce the reliance on price as a major criterion to a certain extent, but the recent economic downturn and the increase in awareness of the total cost of ownership is again putting the focus back on price. In fact, Basecamp, known for its project management software, went public in its admission that most SaaS services are priced exorbitantly when they decided to put an end to their usage of cloud computing.[xii]
Price has the power to not only define the success of a product, but also decide the future of an organization and the fate of a government and the economy of a country.
While it is always tempting to slash prices and take the price out of the equation, I suggest that organizations take a long-term view of prices and understand the importance of prices vis-à-vis the product and service they offer. As Apple found out when they cut the prices of their iPhones 68 days after launch, not every price reduction may be taken in the right spirit by the customers. And as Netflix found out in 2011 when they increased their prices which led to customer erosion and plummeting stock prices, not every price increase may also be taken in the right spirit by the customers. Because price is still the most important factor for most customers, and I do not foresee a change in the near future.