Pricing and its Effect on Customer Adoption

I was at PC Forum in Scottsdale last March listening to a panel on the importance of customer ratings. Open Ratings, an MIT incubator company, reported that people will pay more for products where there is trust.

However, there is often a tendency to lower the price of a product so that more people can afford it and will, therefore, buy it. Henry Ford epitomized this pricing practice, making automobiles so affordable that they became pervasive. But even before he cut prices, he established trust. High-tech companies are especially reliant upon low pricing as a strategy, at least initially in the product life cycle. PC companies provide a classic case patterned after the Henry Ford model: reduce price to increase sales to more people. Laptops, palmtops, scanners, printers, biometrics, speech recognition, software, etc., all have engaged in the low price strategy.

Customers want products they can rely on; therefore, the purchase decision is based on a prerequisite level of confidence. A product with a high-ticket price encourages confidence and, therefore, trust. Pricing provides tangible proof that the product can be relied on. Because it is tangible, many vendors rely on price as the primary element in their pricing decision.

Many factors, both tangible and intangible, go into creating demand and fostering use (see Figure 1).

Tangible factors: Intangible factors:
  • Price
  • Product
  • Rating
  • Service
  • Supply
  • Benefits
  • Brand
  • Convenience
  • Credibility
  • Investment to Select
  • Investment to Use
  • Perceptions
  • Result
  • Trust
  • Value

Figure 1: Factors that Influence Demand

Tangible means that a metric can be assigned to it. Intangible means that it is abstract, a metric can't be assigned or the interpretation of it could be easily disputed. Customer purchase is based on a combination of the two. The more complex the product, the more these factors enter into the decision.

Low-Complexity Product

Many consumer packaged goods (CPG) companies are very sophisticated in their pricing models and evaluate price elasticity, i.e., how incremental differences in price affect the purchase of their product. Often several factors enter into the equation. For example, in vacation destinations such as Hawaii and Florida, sun products are priced more expensively. Price can also be equated to convenience so that if you are in a resort, chances are you will be paying more for your suntan lotion. The result is that sunscreen is more expensive at a Hawaiian resort ­ because it is more valuable there.

Incidentals and sundries cost more at hotels because of the service and convenience. While in a hotel you are a captive audience, and it is usually not convenient to get these items somewhere else. The hospitality industry (hotels/airlines) knows at what times rooms or flights are more valuable, and they charge accordingly. The hospitality industry is very sophisticated at revenue management and seeks to fill every room or seat at the highest possible price.

High-Complexity Product

These hospitality and CPG companies provide commodity products with little, if any, differentiation. Companies that serve this market are keenly aware of the factors that affect people's purchases. Technology, on the other hand, is more complex. In addition to the product itself, there are add-on products as well as supporting products and services that make pricing more difficult.

The high-tech industry has very sophisticated models for pricing which take into account many factors. The problem lies in thinking that lowering price will reduce the importance of these other factors.

A low price can contribute positively to people's ability to afford the product or service. But it can also contribute negatively to their perceptions. Randy Johnston, executive vice president with K2 Enterprises, recently reported that Platinum offered an accounting package for $2,000 and it wasn't selling. After increasing the price to $10,000, Johnston said, "It sold like hot cakes." The lower price led people to believe that the product was not capable enough to meet their needs.

This is an excellent example of how customers can question the viability of a product when it carries a low price tag. Price, in this case, affected the level of trust. The hike in price improved the perception of product reliability and substantially raised its perceived value.

The Role of the Customer Buying Model

It is crucial to consider all of the factors ­ tangible and intangible ­ that go into the purchase decision. Taking this wide range of factors into account can make a significant difference in increasing adoption. Pricing based on intangible factors takes into account the product's application to the users' businesses, their motivation, as well as what customization and training are needed to fit the users' requirements.

Next month's column will address value chain management.

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