Author: Richard Harrington
Economists would have us believe that no price is too low. But as pricers, we know that this is not the case, as our price communicates a great deal to our customers about the value of our product or service. In this article, the author examines the importance of the price-quality effect in developing profitable pricing strategy. Author Richard Harrington is a Pricing Consultant at Holden Advisors, and can be reached at rharrington@holdenadvisors.com.
The Pricing Advisor, January 2018
As I went to pick up my morning coffee this week, I saw a sign that made me chuckle. In the window of a Dollar Store was an advertisement for steak – a full steak for only a dollar! Would you buy steak for a buck? Would you go for all-you-can-eat sushi for the low price of $10? Any takers? No one?
But why do we scoff? Economics would have us believe that no price is too low. As a steak lover, I should jump at the chance to have a favorite meal for so little money. So why did I pass up the opportunity? What is at play here is trust. It’s assumed in economics, but trust drives business relationships and you ignore it at your peril.
In this case, we are looking at the price-quality effect. Any time I purchase a steak, I am trusting that every part of the supply chain is honest and is delivering me a fresh cut of meat that won’t leave me in the bathroom at 2 am. Absent the ability to view each part of the supply chain, two pieces of information fall in to place to drive trust:
- Brand: If a company has built up a reputation so a bad experience can do them damage, they have skin in the game and customers feel they can be trusted.
- Price: A high price signals that the cost to bring to market is reasonable, putting customers at ease about the quality of the purchase and the risks they are undertaking when they consume.
In B2B markets, the price-quality effect is especially important for products in the introductory phase of the lifecycle. As new customers have no experience with the industry as a whole, they see the risk of purchase as high. If you price too low, they will be weary that you have priced in risks that they are not aware exist. In these circumstances, a low price can actually drive customers away from the market and a high price can soothe fears and encourage adoption.
In conclusion, beware dropping price and expecting a bump in volume, there are other factors at play that could come back and bite you!
