In a precedent article (Cost-based pricing dies hard! Why?), we introduced VALUE as the fundamental basis of pricing, while highlighting the difficulties of implementing value-based management and value-based pricing.
To get a complete overview of the pricing landscape, we need to go a step further in the 2000s, and consider two other dimensions: psychology and data.
The first one is based on the fact that we are far from being perfect homo economicus and challenges the assumption of human rationality as described in economic theory. Emotions and perceptions play an important role in our assessment of value and in the way we make decisions. Under the term “behavioral pricing” we find practices derived from Daniel Kahneman’s work on the psychology of judgment and decision-making.
Kahneman showed that our aversion to loss is stronger than the pleasure attached to gain. We avoid risk when it comes to earnings. Everyone knows that from popular wisdom: a bird in the hand is worth two in the bush. On the other hand, we are risk taking when it comes to avoid losses (serious gamblers know that very well).
The way of structuring and presenting offers often uses this asymmetry: guaranteed prices, discounts rather than surcharges for particular conditions, “threat” of a hypothetical price increase to trigger the purchase, supply of a free version or three-month trial offer, presentation of products in descending order of price rather than ascending, influencing price expectations (anchoring high prices early in the conversation), …
A study conducted in 26 countries in 2008 by Vocatus (research company in Germany) revealed that all purchase decisions could be divided into 5 different types of buyer’s profile, depending on the attitude and interest towards price and product:
- Indifferent buyer (shows low interest in price / product comparisons)
- Loyal customer (has strong confidence in the brand and the product or service)
- Bargain Hunter (for whom it is very important to make a good deal)
- The enthusiast (who loves the product or service and will accept the price)
- The suspicious (who is afraid of being cheated).
Whereas the asymmetry of loss and gain perception opens additional ways for influencing price acceptance and value assessment (other than the value derived from the product itself), the second one (buyer’s profiles) suggests a more challenging perspective. It implies that a company should understand the repartition of the buyer’s profiles towards its product category or even to its brand and then adapt its pricing strategy accordingly (buyer’s profile is product-dependent: one can be indifferent buyer for toothbrushes and enthusiast for mobile phones). For instance, a company would act differently for a price increase when 52% of its customers are indifferent buyers or when bargain hunters are the vast majority of them.
Behavioral pricing opens a very interesting field for B2B companies, for which human interactions are at the heart of prospecting, sales and negotiation cycles.
The pricing software landscape is relatively new (last 20 years) but is rapidly expanding. B2B companies, with varying levels of success, are gradually engaging in the implementation of pricing solutions.
The principle is to eliminate the well known “gut feel pricing” by leveraging large amounts of data and then increase transparency and adequacy of price setting across board. Various approaches exist, reflecting the diversity of our B2B world: price setting based on pricing rules, discounting management, price performance analysis, price optimization through mathematical algorithms and micro-segmentation, dynamic pricing or yield management, automation of configuring, pricing and quoting processes (CPQ), etc.
Although confronted to uncertainty in the choice of the relevant software and its underlying methodology, decision-makers become more and more open to the “pricing technology”. Software companies’ brochures mention science-based approaches and even AI (Artificial Intelligence), as well as significant profitability improvements.
The truth is that technology already is in many cases the driving force behind any ambitious pricing initiative.
The question now arises: what does this mean for value-based pricing?
Should we agree with those who claim that behavioral pricing goes far beyond value-based pricing and is now the new state-of the art standard? Is value-based pricing now obsolete and replaced by these two new approaches?
Let us start from the following hypothesis: your company exists and shows sustainable profitability, a good sign that you deliver some value to your customers. But you lack the discipline of consistently creating and delivering superior value to them. Value-based pricing is not in place. Governance, processes, practices and methods of value and price management are not formalized or to an early stage.
Question: can you expect a positive effect from a behavioral pricing initiative or from the implementation of a software package? Or should you invest first on fundamentals such as value management and value-based pricing?
A pure behavioral pricing approach can bring benefits (sometimes quickly) and improve the efficiency of marketing and sales functions. It provides multiple “tricks” to improve the value perception of your products or services. It also enables you to track and eliminate negative practices.
A pricing software package can also lead to rapid gains, notably through the “low hanging fruits” of non-legitimate price differentials (realignment of discounts, low-profit transactions, etc.). As we notice, those solutions leverage existing transactional data, which means their greatest impact is on existing business, with the assumptions that current prices somehow reflect customer value perceptions and price acceptance.
In both cases, value based pricing is not necessarily a prerequisite. It can therefore be said that pricing is not a staircase that one should climb up step by step with patience.
But this has limitations and risks:
One of the main issues of both behavioral pricing and technology is that it gives only few keys, if any, to pinpoint the value drivers of your customers or to embed management of value to customers in your processes across board. Pricing technology will be of little help for supporting your innovation process and for pricing innovative new products.
Similarly, the risks of failure of a pricing software package are significant in the absence of a strong value culture, as sales force may lack the ability to accept the guidelines “from technology” and use them in their discussions with customers, because the underlying principles of price variations are still the difference in value brought to the customer.
There is no magic wand that would exempt a B2B company from an in-depth work on value creation and customer segmentation in order to build robust pricing power with attractive value propositions.
Value based management and pricing, behavioral pricing, technology and, to some extent, cost based or competitive pricing are different and complementary strata of the same discipline. A pragmatic look at how companies operate shows that these components often coexist, and that there are some reasons for that.
Any pricing initiative should have its own recipe, adapted to the context and ambitions of the company: the combination of capabilities to build or strengthen on each of these strata. This requires expertise and experience.
Philippe Plunian, Partner at Powering
+ 33 6 80 89 68 42
Philippe Plunian specializes in the formulation and execution of customer-focused business strategies, sales & marketing transformation, sales efficiency and enhancement of pricing capabilities / execution
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