Pricing is sometimes seen as an analytical discipline, concerned with numbers and optimization. A place where squishy concepts like empathy and emotion have little place to play. Economics is sometimes known as the dismal science, and pricing is sometimes seen as a little subset of economics. It is not.
A compelling pricing strategy weaves in the emotions of the buyer and the seller. At Ibbaka we do this by using both economic and emotional value drivers in market segmentation and pricing design. Buyers have a strong emotional response to price and pricing fairness and will reject pricing (or pricing changes) perceived to be unfair.
I was reminded of this over the holidays while reading The Undoing Project by Michael Lewis. This book is a good complement to the Daniel Khaneman classic Thinking Fast and Slow. It tells the personal story of Nobel prize winners Amos Tversky and Daniel Khaneman and their intellectual love affair as they undid the assumptions of utility theory and replaced it with prospect theory. This work dates back to the early 70s and over the past few years it has been washing through the pricing community as behavioural pricing (see this blog post by Frank Kroeze from Simon Kucher as an example).
Behavioural pricing talks a lot about things like framing effects, risk aversion and isolation effects. Each of these play an important role in pricing (see below), but when you boil it down, prospect theory and behavioural pricing are about the emotional inputs into human decision making. When deciding if a price is fair, all of the aspects of prospect theory are in play.
Framing (reference point): Framing is one of the most important effects in pricing. In standard techniques like Economic Value Estimation (EVE) it shows up as the Next Best Competitive Alternative. On pricing pages it can be seen in how each tier shapes perception of the relative price and value of the ones to either side. To control the pricing conversation you need to control the framing.
Risk Aversion: Most people will pay more to avoid a loss than they will to win a gain. This is indicated by the shape of the above curve, where the value of gains flattens off quickly. For pricing this means that how value is communicated will have a gig effect on price acceptance. There is a risk discount built into B2B subscriptions. Finding ways to reduce that discount can lead to better pricing outcomes.
Isolation Effects: People are risk averse when it comes to gains (we prefer a sure thing) but will gamble to avoid a loss. Accepting a price is basically a gamble that you will get more value than you will pay in price. One can persuade people to take this gamble and pay a higher price by positioning the purchase as a way to avoid a loss. This is basically how insurance is priced. The same approach is being taken in forward pricing of professional services.
Prospect theory gives an economic grounding to emotional effects in B2B pricing. In the design world, empathy is widely seen as being central to design thinking. At some level, empathy is sensitivity to another person’s emotions. One will struggle to design a compelling solution (even a pricing solution) without empathy with the buyer. What does ‘empathy’ mean in the context of pricing? This question is worth deeper exploration, but it certainly includes the following:
Respecting the customer’s buying process
Communicating how and when value will be delivered (and reinforcing this communication across the customer journey)
Aligning value delivered to your customer (V2C) with how to claim back part of that value through price
Understanding how your solution will impact your customer’s financials
It takes a lot of work to really empathize with a corporate buying unit, and the whole process of buying, rolling out and adopting a commercial solution. Tools are needed to help us with this. Customer journey maps are a good way to organize the information that shapes the emotional response of buyers and users as they move through the buying process and adopt a new application. One should go beyond this of course, a good customer journey map follows the customer all the way to the end, when they leave your solution.
At Ibbaka we layer price and value onto the customer journey map. We want to capture the emotional and the economic aspects of value and how these evolve across the customer journey. This gives us insight into whether they buyer will experience the price as ‘fair’ and will help to make sure that Value to the Customer (V2C) is larger than the Customer Lifetime Value (LTV). These are two of the keys to sustainable pricing.