Pricing is a complex topic, and many organisations fall into common pitfalls when it comes to deciding on the right price for their products.
In this article, I’ll share five valuable pricing principles for you to put into action along with examples of the impact they can have. I’ll also give you two tactics when it comes to increasing your prices, that won’t leave your customers jumping ship.
My name's Phill Agnew and I'm going to talk about the psychology behind pricing. I'm going to walk you through five pricing principles and focus on two specific tactics that the majority of SaaS brands use, I'll explain the science behind those.
I am Director of Product Marketing at Brandwatch, the world's leading consumer intelligence platform, I've got lots of experience in building pricing strategies and applying them to a large SaaS business.
I also host Nudge the consumer psychology podcast where I interview behavior science experts, marketing pioneers, and try and understand the science behind marketing that works.
Specifically, in relation to this article, I've looked at the science behind pricing principles that really resonate with customers.
I'll be focusing on:
- Base pricing on customer value
- Why customers must see what they're paying for
- How pricing messaging shapes perceived value
- Anchoring pricing on your terms
- Reframing your product
- Hyperbolic discounting
- The decoy effect
Let’s start with an example
Before I start getting into the tactics, let's imagine you've started a company that sells a brand new type of soda.
This soda could be, for example, a fizzy fermented pineapple beverage sold in a can. You could use it as caffeine to perk you up in the morning, or maybe it's something that could go nicely with a cocktail, for example. That's not important.
The big question is, how much should you charge for this brand new product? You could obviously go cheap, undermining the likes of Coca-Cola and competing with supermarket own brands, for example.
Or you could go expensive competing with Red Bull and other organic brands, for example. It is a really difficult decision so you might be tempted to do something that the majority of marketers do - seems like a really sensible decision.
You might be tempted to ask your customers, how much would you pay? Or to go to the market and ask prospects how much would you pay? This obviously seems like a smart idea. These people buy cans of soda every single day, surely, they've got an idea of how much they should pay.
But in practice, this is a really bad idea, asking customers what something should cost and going with that price is destined to fail. To explain why let's look at a study conducted outside a library in San Francisco.
Now researchers following a really highly publicized oil spill were asking passers-by in San Francisco, how much would you be willing to give to help the wildlife? This question was not dissimilar to asking your customers how much would you be willing to pay for this product?
You're asking them to imagine the amount of money they'd give in a potential scenario. The problem is consumers are really bad at giving consistent answers.
When asked the question on average, consumers said that they'd give around $64 to help with the wildlife or to help with this oil spill problem. However, the problem is that this number, this amount they would be willing to give drastically changes based on how you frame the question.
When adding just one extra line to the question, for example, saying someone earlier offered $5 or someone earlier offered $400 you get drastically different predictions about how much somebody will give.
Adding that tiny anchor resulted in basically the offer being subtracted by $44, so people saying they're only willing to give $20 in the first scenario, or resulted in people willing to give $79 extra.
In other words, consumers can be heavily influenced when making spending decisions even by fairly nonintrusive anchors, like these. Consumers are really awful at predicting what they spend, and they can't foresee what they'll be influenced by when making a decision.
After all, $143 feels like a lot to donate but if your colleagues are giving $400 maybe it's not too bad.
Five pricing principles
Let's dive into five pricing principles that you can follow that are better than just simply asking your customers what they'll pay, and that are obviously better than going in blind and not having something to base your decision on.
I should add that these principles were inspired heavily by a conversation I had with pricing expert Lee Caldwell, on my podcast Nudge and anyone who wants to really delve into pricing should pick up a copy of his book called the Psychology Behind Pricing.
#1 Base pricing on customer value
Pricing principle number one is to base your price on customer value. Too many companies fall into the trap of simply taking their cost, adding a margin, and just going with that as the price.
Your customers shouldn't care about how much your product costs to produce. They should pay based on the value they gain. Take this example.
Example one: Coffee
These are two cups of coffee that really cost about the same to produce. They use similar beans. They're roasted in a similar way, they use the same milk.
Yet Costa coffee, a high street chain charges almost twice as much as Wild Bean a gas station coffee shop, Costa could have matched or even undercut Wild Bean by simply taking their costs and adding a smaller margin, but they'd be leaving money on the table.
The nicely designed cafe that they create, the smiling barista, the premium brand all add to the value that customers are happy to pay extra for. Similar studies in different scenarios have revealed this effect that customers pay for value, not for simply cost essentially.
Example two: Perfume
One study offered luxury perfumes at a London store, and consumers were asked to sample the perfume and rate their likelihood to purchase.
However, halfway through the experiment, the researchers switched the labels on the test perfume, doubling the price from $40, which it was before to twice that - $80.
What was incredible is that after seeing the higher price, participants were more than twice as likely to rate the product highly. At the low price, only 33% of the users rated the product as being seven out of 10 in terms of smell or higher.
Whereas at $80, 78% of the potential consumers rated at seven out of 10 or above. The price anchored consumers and changed their perception of the underlying product.
Charging what the customer values rather than simply the cost plus your margin can increase sales and really double down on revenue. But it's not all just about charging more, charging on customer value can mean you can come up with some innovative methods of pricing your product.
- AWS, Amazon's platform charges not on a flat fee but instead is priced based on the amount of data you consume, very different from margin plus cost.
- MailChimp too doesn’t charge a flat fee but instead charges you based on the number of contacts you have in your system.
In other words, the price is based on what the user actually values, the data, and the contacts they consume and use. So if price is based on value, you can actually start to get more revenue, more margin, and get out of this loop of just pricing based on cost plus margin.
#2 Customers must see what they’re paying for
Principle number two is customers must see what they're paying for. All too many companies hide the value of what the customer will get instead hoping for simplicity, that it will be easy to understand.
But the science tells us that adding more descriptive elements to the items we're selling helps increase the intent to buy. I'll give an example to explain what I mean.
Example one: Menus
I spoke to Professor Sibyl Yang on my podcast, she was a professor at San Francisco University. She gave a great example of how adding tangible descriptive lines to menu dishes can increase the likelihood that customers will buy.
In her study, hungry restaurant customers were given one of two menus - one which simply had the name of the dish being sold, cod fillet for example, and the other which had more descriptive elements around the dish that was being sold, pan-fried cod on a bed of rocket with balsamic glaze or whatever it might be.
Perhaps unsurprisingly, the more descriptive version increases the money spent at the restaurant, increased the number of customers visiting, and even increased the actual enjoyment of the meal they then ate.
Yet, so many marketers fail to add descriptive elements to their products and services.
Example two: Tower of London
Take this site, it's selling tickets for the prestigious Tower of London. It's a World Heritage Site listed by UNESCO. It's hosted Royals, famous executions, and of course holds the British Crown Jewels rumored to be worth 22 million pounds.
There are so many great reasons to visit this place and yet the page that is selling the tickets struggles to get this across. There's a small section on the terms of the tickets, the price is at the bottom, and just those three bullet points explaining what you'll get entry to.
It hardly gets the imagination racing. B2B companies and B2C companies across the world fall into a really similar mistake. They showcase the product that they're selling but don't give enough tangible reasons to buy it.
They don't show a tangible value, whether that's the data you might get, the features you might consume, or whether you'll be purchasing a great day out if you're going to the Tower of London.
All of these things will help make your price look more appealing.
#3 Pricing messaging shapes perceived value
Let's move on to the third principle. The third principle is that the communication that accompanies the price we create will help shape the value that is perceived.
Example: Redbull vs. Coca-Cola
Take Redbull versus Coca-Cola. These are very similar drinks, each with huge marketing budgets behind them. They're both caffeinated beverages, and they're very seen as a bit of a treat to pick you up when you're feeling tired.
Yet Redbull charges three times more than Coca Cola despite their product being sold in a smaller can. You're spending three times more and getting less volume. Redbull isn’t able to do this because their product tastes much better or even because it costs more to produce, it largely costs around the same price.
Instead, they do this with the messaging that they've built around their price and their brand. Their unique marketing campaigns add value by stating that Red Bull gives you wings, essentially the classic Red Bull slogan.
The idea is to convince buyers that Red Bull makes you a better, stronger, smarter version of yourself. They've bought fast-paced football teams and Formula One winning race cars to further drill this home.
If you want to be fast, if you want to be exhilarated, then you drink a can of Red Bull and you'll pay them three times more for that as well because of all the value and the associations that they've built around it.
Now, it can be easy for many outside of the marketing industry to discredit this and say, "Yeah, you claim that advertising is allowing you to charge three times more, you claim that it's building all these associations. But that's not what really happens, after all, Red Bull can't really change our perception that much".
But studies suggest otherwise.
Example two: One night in Paris
In a famous study, 154 Parisien men were randomly given one of three drinks. They were given a vodka cocktail, a fruit juice cocktail, and a vodka Redbull.
Each of the men drank from one of these drinks and then went on a night out in the French capital. After an hour or so they were questioned again by the researchers.
At this time, all the men had drunk just this cocktail, they hadn't drunk any other drinks. They were asked how they're feeling, how many risks they were taking, if they were feeling free, if they were feeling drunk, intoxicated, and incredibly, all of the men reported feeling more intoxicated when drinking vodka Red Bull, they showed riskier behavior and were more confident with women when drinking the Red Bull infused drink.
What was interesting though, is that all three drinks contained the same amount of Red Bull. The shift in behavior was simply down to the value perception that came with the Red Bull brand and the messaging we associated with it.
Pricing messaging really does change the perceived value of the product. Messaging has powerful effects on us in all walks of life, not just drinking in Paris.
Example three: Golf
Another similar study gave golfers two sets of identical golf clubs. The only difference between the clubs was that one had the Nike logo on it, and the other had no brand on it. Otherwise, the weight, that type of metal, the quality of the grip, all of these things were identical.
However, every golfer when given these two different sets, when they were asked to go play with both different sets, found that they were much better when using the Nike branded set, they hit the fairway more, they avoided more bunkers, they putted the balls more than they would when using the Nike branded golf clubs.
The messaging we place around our price, the messaging we build around our brand, will change the perceived value. If you think that your price will just be viewed on just its price alone and just compared price by price to your nearest competitor, then you're wrong.
The brand you build, the messaging you create, will have an effect as well.
#4 Anchor prices on your terms
The fourth rule is around anchoring your price on your terms. Now anchors are incredibly powerful and you can use them to set your own terms and influence buyers.
The anchor is the idea that the initial piece of information that you offer to consumers will heavily anchor them based on what they see.
Example one: Mock courtroom
A great study that highlights this is research by Chapman and Bornstein. They revealed how anchoring on your terms can dramatically influence payouts in a mock courtroom.
The experiment in this scenario basically described a lawsuit to several different types of juries all made up of volunteers. Each different jury was given identical details about the scenario, the victim, the guilt of the defendant, but with one key difference.
In some of the cases, the prosecuting lawyer asked for a compensation award of $100. In other cases, they asked for an award of $20,000. In some cases they asked for $5 million, in some cases, they even asked for a billion dollars.
Now at a glance, this seems ridiculous, these anchors are extremely different. How can the exact same lawyer with the exact same case ask for a billion dollars in one scenario and $100 in another?
Surely the jury won't be affected by these extreme asks and will just simply give the amount that feels right. Of course, the opposite is true. In every scenario, the higher the request the lawyer asked for the higher the award.
Even when the amount requested was as ridiculous as 1 billion - when they requested 1 billion, the actual lawyer ended up receiving a much bigger payout than they would have done if they have requested 5 million, 20,000, or 100.
Anchoring your price on your terms will dramatically improve your prices. I'll cover this later in the article with the decoy effect.
#5 To change your price, reframe your product
This final principle is around pricing changes. Most of us when we think about increasing our price, simply add an extra 5% to the next bill for our customers and really hope our consumers don't notice.
Example one: Netflix
Netflix is a prime example of this, every few years they increase their price by around 15% hoping that customers don't catch on, hoping they don't switch to one of the many cheaper products.
But a large part they get away with this partly because there is so little competition out there, or at least there has been in the past, and partly because they also have such a differentiated product.
But as the number of competitors like Disney plus and others continue to increase, the number of customers that are willing to deal with price changes will shrink. The reason that customers often don't agree with price changes is that they don't have a clear understanding of what improvements or what is different about the product.
In fact, a 2019 study showed that the consumers that were being asked to basically increase their price on Netflix, were really sensitive to the price, they found that on average, if you increased the price of Netflix by $3, then 22% of standard tier users would downgrade to a less expensive plan and 16% would cancel their contract altogether.
For a company the size of Netflix losing 10% of its business, that results in $2 billion lost. But it doesn't have to be this way.
There are smarter ways to increase your prices without putting off your consumers.
Reframing your product
Ultimately raising prices is about reframing your product. Reframing in a way that gives a legitimate reason behind the price increase. I'll give an example of what you can do here.
One example is that if you're increasing the price of your software, you should chuck in extra features that suggest that you're getting access to a better product to justify the increase and saves you the pain of having to pay more without feeling you're getting any more value for money.
If you're selling physical goods another example is what Cadburys do. Instead of just increasing the price for their 150-gram bar of chocolate, they'll decrease the size of the chocolate bar from 150 grams to 120 grams whilst keeping the same price.
This reframes the product without necessarily getting the consumer to think about the price increase. This subtle reframing is a far more successful strategy than increasing price without reason.
Now Netflix might be much more successful at doing price increases in the future if they reframe the package they're offering. Perhaps allowing users to opt-out of price increases, but meaning if they did, they would miss out on the latest TV shows, on the latest movies that could encourage far more consumers to stay on board with Netflix and can encourage that 16% that are likely to churn to stay on board.
It could mean Netflix doesn’t lose $2 billion every year when they increase their prices.
Many of us go into pricing blind without any idea of what works, without an idea of what to try. What's worse is that most of us will only look at pricing once, we'll set a price at the launch or after the go to market and then leave it and hope it works out in the future.
Example: Flight fares
A great example I'd like to give is to imagine if an airline did this. Imagine if the price for a United Airline ticket between London and New York was set in 2018 and kept the same for two years - if they didn't alter it at all for two years. That would be crazy.
Obviously, airlines alter that price and test their price based on consumer insight and demand. So why don't we do the same in the SaaS industry, in the B2B industry, and in product marketing?
A better approach is to apply some rigor to your pricing, apply these five principles, and you'll increase the amount of value you can get out of your pricing strategy.
But point five and point four they're especially difficult and often the responsibility of those two principles is left on the shoulders of product marketers.
So how can you do stuff like increasing your price, especially if you're a SaaS product marketer? How can you increase your price without putting off customers and getting customers to churn?
Well, I'll cover two specific tactics that can help you in the second part of this article.
Two tactics to increase price
The first tactic I want to focus on which will help you increase your price without losing customers is something called hyperbolic discounting.
#1 Hyperbolic discounting
It's a fancy word for something we all know. It's the feeling that when you have a mountain of work piling up, and you know you need to get it done within the next couple of days but you just can't find the motivation to do it.
You put it off and instead watch Netflix and convince yourself that tomorrow you'll get all that work done. In that scenario, you have fallen victim to something called hyperbolic discounting.
Hyperbolic discounting is a cognitive bias where people choose smaller immediate rewards, so watching Netflix and feeling a bit of satisfaction, rather than larger rewards in the future, essentially getting all that work done and feeling real relief.
The problem: immediate gratification
Now, initial studies into this effect showed that subjects when offered $15 immediately, $30 in three months, or $60 after a year, always take basically the wrong amount. In the right scenario, if we were all smart, rational consumers, we would all take the $60 - that's worth the most it's the best package we could get.
But most of us pick the $15 immediately, the salience of gaining something quickly and immediately beats having to wait.
Interestingly, when consumers asked the same question with the same intervals, but a year in the future, so what do you want in one year? What do you want in one year and three months? What do you want in two years? We choose the largest $60 dollar reward.
This reveals that we just clearly are impatient, we prefer immediate rewards in the short term, we just want it now. We prefer those immediate short term rewards, but we're also more patient in the long term as well.
For individuals, this creates a lot of problems I won't get into today, things like not saving for retirement but one of the ways that you can get around this and one of the ways you can convince your prospects that doing something may be difficult in the short term is worthwhile is by breaking down big goals into smaller manageable chunks.
The solution: chunk it
The problem with things like saving for retirement is that saving is a huge challenge, the amount an American needs to save is about $1.7 million for their retirement.
Obviously saving that much takes a lot of money and almost a lifetime to achieve. With huge goals like that, it's much better to break it down into smaller tasks with a reward coming after each chunk.
That way, the reward is no longer a far off possibility, but something that is more immediate and guaranteed. This works not just for people trying to save for retirement, but for big brands and product marketers who are trying to justify their high prices.
Let's pretend you're selling a high-value Mercedes Benz, you could show the full cost for $40,000 today, or you could show the cost broken down perhaps by using a bit of this hyperbolic discounting insight.
You could say it's broken down to $32 per week, or $4.75 a day over the course of two years, but which would look most attractive to the user?
One study actually analyzed this to reveal conclusively which was seen as the most attractive price, the researchers presented one of three numbers at random to over 500 participants and the results revealed the shorter the timeframe, the smaller the cost, the more appealing the deal.
In fact, when the prices were shown as daily figures, they were five times more likely to be rated as a great deal than when they were shown annually.
For SaaS marketers, for product marketers, this is a really interesting insight. We're quite good at doing this, we often break our pricing down per month, or maybe even per week, maybe there is an opportunity to break it down even further and really benefit from hyperbolic discounting.
Where possible in the future, we should purse the extra bill, the cost of payment off into the future, we shouldn't encourage consumers to spend 40 grand now instead, we should get them to make small commitments like $4 a day.
Now that's one way you can reframe your products to push for a higher price. It works because you have to remove that immediate pain of payment. But it's not the only way you can reframe your price.
#2 The decoy effect
I'll finish by highlighting one of the tactics that a lot of SaaS marketers use, but not one that the majority of us particularly understand. It's the decoy effect.
Example one: Popcorn
To explain the decoy effect, I'll give a bit of a story about myself and I'm weirdly habitual when I go and watch movies at the cinema. Every time I go and watch a movie, I buy a ridiculously large amount of popcorn.
After the movie, I always regret how much I've eaten, I'm usually full after a couple of handfuls, but I always plow through to the bottom and I always eat this popcorn.
Nevertheless, next time I go, I'll also buy it again. I keep getting into a habitual loop and I feel awful every time, but I can't get out of it. Now when looking at the price of popcorn, I start to realize why I keep falling into this trap.
This is the actual price of popcorn at my local cinema in London, it's a lot of money I know. There's something really interesting about these prices, right? The extra-large is obviously too much, £7, that will be about $10 in America, that's almost the price of the actual cinema ticket.
I'd never spend that much but the next option down which is just 50 pence more than the smallest option, the large option at £4 looks like a much better deal. You get so much more, you get a large for just 50 pence more than the small option.
With this pricing, I can't help but pick this middle option, it looks like such a good deal. The reason it looks like such a good deal is due to something called the decoy effect. I'll come back to this example at the end.
Example two: The Economist
But let me explain the decoy effect by bringing in the famous study which was cited by Dan Ariely in his book, Predictably Irrational. So Dan, being a professor at Princeton University, spotted the decoy effect, not in the cinema, but while flicking through The Economist.
He found that The Economist had these three pricing options that they were publishing, they had that online only subscription at the top, which was $59, the print-only subscription $125, and then the print and web subscription for also $125. That's quite weird, right?
With this third option, you get both the print and online versions, but it's the same price as the print option by itself. The Economists were doing that same pricing and Dan thought this is a really strange phenomenon. Also, why would anyone buy the print only option? After all, it's the same price as the print and web option.
Basically, Dan predicted that The Economist was using this strange pricing strategy to create a decoy and encourage more consumers to spend $125, rather than the $59 for the online-only subscription.
To test this hypothesis, he tested it out on his students, he showed one set of his students the actual pricing with the decoy included, and the other set of students an edited version with the decoy - the print only option - removed.
He wanted to see if removing the decoy price changed what people thought about the product and change what people wanted to buy. Turns out removing that decoy had a huge effect.
When students were shown the decoy effect option, which was the one that The Economist had on their site, they would, on average pick the most expensive print and web subscription, it looks like such a good deal, because it was the same price as the print subscription and yet it had the web subscription included as well.
Yet, when Dan showed his students the edited version, without the print subscription included, suddenly students were far more likely to pick the online subscription only, the majority of students only spent $59.
That's really interesting. Just the way that The Economist has priced their products, the way they frame their pricing, the way they built their options, dramatically changes what consumers want.
That's one of the main takeaways I want to give from this article is that your consumers won't view your pricing independently without any biases, they will view it with biases attached.
They will buy a higher price if they're decoyed by a different option or solution. They won't if you don't include the same thing. It's really important, maybe not to just apply all of these principles, but definitely to understand them.
I'll finish by going back to that popcorn example again, this is the example I actually have at my cinema and I spent £4, and it's because I'm really decoyed by that large price. It's way too expensive. It shouldn't cost £7, it should probably cost something more reasonable.
Yet that high price anchors me and encourages me to spend more than I should. Yet if the prices were weighted evenly, so this is my new example below where they're weighted properly, where extra-large costs £7, large costs £5, medium costs £3, the majority of people I'm sure, me included, would buy the cheapest option because it feels like the right price.
It's really important to understand these sort of effects, it's really important to understand things like the decoy effect and hyperbolic discounting because it explains why consumers make the decisions they do when purchasing your product.
I've done a big dive into five main pricing principles. I've covered additional tactics like hyperbolic discounting and the decoy effect. But I must be honest, I've really only scratched the surface.
There's so much more behind pricing psychology and for that, I really would recommend picking up two books:
- The Psychology of Price by Lee Caldwell, and
- Priceless by William Poundstone.
Two brilliant products, two brilliant books on pricing, so do pick those up if you are in charge of pricing.
Psst. Wanna learn more about pricing and get product marketing certified? Check out Product Marketing Core, study full-time or part-time, and get your hands on a coveted certification.