Thought Leaders
Pricing Mistakes and Their Antidotes

Despite the importance of pricing decisions, managers often do not set their prices correctly. Why? Wharton Associate Professor of Marketing Z. John Zhang, academic co-director of Wharton's Pricing Strategies: Measuring, Capturing, and Retaining Value, examined two of the most common pricing mistakes and potential antidotes.


Mistake #1: Exaggerating the Impact of Price Changes

Managers tend to engage in black-and-white thinking about pricing. "They think that if my price is too low, people will rush to buy from us, and we will never fulfill demand; if my price is a penny higher than competition, no one is going to show up to buy the product," Zhang said. "They look at demand in a lumpy way." This makes managers nervous and risk averse, so they don't change pricing or experiment with new pricing.

Antidote: Recognize That Price Is Multidimensional

One way to move beyond this black-and-white thinking is to look beyond the price as a single number. "Price is multidimensional," Zhang said. "When you have one number, it can only go one of two ways, up or down. But once you open up those other dimensions, you realize that you have lots of wiggle room and that if you charge a higher price, demand is not going to disappear."

The fact of the matter is that not all consumers fixate on list price when they make a purchase and the price charged to a consumer can be adjusted in many different ways. This means that firms have opportunities to fine-tune their price structure to make more profits. Even if two customers are charged the same price for a product or service, other dimensions can be adjusted that have an impact on the effective pricing. For example, Netflix charges a new user and a long-term, heavy customer the same price. But when a hot new movie becomes available, the company may send scarce copies to the new user first because the heavy user is probably not going to defect. In effect, the high-volume user pays a higher price, even though the bill at the end of the month may be the same.

In addition to service levels, other ways to adjust the effective price without tampering with list price include:

  • Renewal rates: Many magazines do this, offering an ever-higher percentage discount to subscribers while setting an even higher cover price.

  • Changing packaging: A slightly smaller package size effectively means paying more, even though the list price hasn't changed. Products can also be bundled or unbundled in different ways.

  • Discounting: In B2B markets, customers rarely pay list price because of discounts. Companies may also offer discounts for paying cash, for using company credit, or for customers transporting products themselves. These discounts mean that even if the list price is the same for every customer, what they pay will be quite different.

"There may be 10 different levers you can pull that will affect pricing," Zhang said. "The list price or invoice price is only one of those levers. Profits relate a lot more to other things than list price."

For instance, through transactional price analysis, which faculty explore in the Wharton program, managers can assess the best pricing strategies across different customers, different order sizes, and different promotions. "If you have that kind of information, you can always increase the percentage of sales at a higher price rather than just moving the list prices up and down," he said.

Mistake #2: Failure To Anticipate Competitors

A second common mistake is to ignore the potential moves of competitors. Pricing isn't done in a vacuum, and competitors can have a big impact on the outcome of pricing decisions. A company may think that if it lowers price by 10 percent, sales will increase by 5 percent, and profits rise by 20 percent. It is a pretty picture, but "if you lower price, competitors are not just going to stand there with their arms crossed on their chests," Zhang said.

Antidote: Anticipate and Dampen Reactions

How can managers address these competitive reactions? First of all, they can better anticipate how rivals might respond. "Like playing chess, you need to keep thinking a few moves ahead," Zhang said. During the Wharton program, participants explore game theory and other frameworks that help understand where competitive chain reactions might lead.

Managers also implement strategies that dampen competitive reactions, including:

  • Price guarantees: Price guarantees can make it harder for rivals to lower their own prices. If an electronics retailer guarantees to match any advertised price of competitors, when others lower their prices, it will just send customers to the retailer with the price-matching policy.

  • Disincentives for price comparison: Sometimes pricing plans are impossible to figure out, and this makes it harder to go head-to-head on pricing. Mobile phone plans, for example, are so complicated that even professionals can't figure out the best offer without knowing the user's specific calling pattern. This means that consumers cannot think too much about prices when they choose among different calling plans. This has caused competition to focus on other nonprice dimensions such as the quality of the network or flashy new phones. "Essentially, what happened is that if you can't figure out which plans are more economical for you, you can't be very price sensitive," Zhang said. "You are not making your buying decisions based on price, so this encourages nonprice competition."

    Is it an effective strategy to discourage consumer price comparison? While it may not work for every product, Zhang points out that cell phones have been a lot more profitable than landline service, where pricing is a bit more transparent.

  • Different pricing structures: A consultant might charge an hourly fee or a per-project fee or set up a retainer arrangement, whichever way that may best reflect the value of her service. Different pricing structures can make it hard to compare pricing side by side, dampening competitive reactions.

  • Advertising and branding: Advertising and branding can sometimes lead to less price sensitivity among customers. For example, Starbuck's strong branding means customers think nothing about laying out $4 for a cup of coffee. But overall, the impact of advertising on pricing appears to be mixed. In preliminary results of a current study with his colleagues, Zhang found that combative advertising leads to less price sensitivity in some categories but not in others. Sometimes ads in a given market lead to greater partisanship and other times to greater indifference. For example, in a political campaign, advertising may reinforce extremes in partisan preferences or result in noise that leads to many undecided voters.

"There has been this controversy for a long time. Some people say advertising does not do anything, while others say it works wonders. Both may be right. In some cases, it leads to more partisan customers, which would discourage price competition; and in other cases it leads to indifferent customers, which would intensify price competition."

The Right Tools

Above all, the right tools can help to more accurately set pricing. "Changing pricing really does have an immediate and sometimes even drastic impact. You need tools to know what you are doing," Zhang said. "Experience on a job often does not tell you a lot about pricing. If you have a good estimation of demand, knowledge of the price sensitivity of the market, and a good sense of customers, you can better understand the profit impact from changing price."

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