How Product Managers Price Products For Irrational Customers

Product Managers Need To Understand How Our Customers Make Their Buying Decisions
Product Managers Need To Understand How Our Customers Make Their Buying Decisions

Who has to deal with irrational customers – isn’t “irrational” just another word for “crazy”? If you’ve ever had to set a price for your product, then you know what I’m talking about. No matter what price you pick (or how you pick it) people are always going to be telling you that it’s the wrong price. Is everyone crazy?

When we bump into problems like this that don’t seem to have any answer, it’s always a good idea to go talk to an expert. In this case, the expert is Dr. Dan Ariely who is an expert in behavioral economics and who works at Duke University’s Fuqua School of Business. Oh, and by the way, he wrote the book on what goes on in our heads when we go to make buying decisions: Predictably Irrational: The Hidden Forces That Shape Our Decisions.

All of us with a technical bent will not be pleased to hear what Ariely has to say. His main point is that when we go to price our products, we need to take into account that our customers will be using their irrational human behavior when they are deciding to buy us or not. Dang -  I hope that he’s got some suggestions for us…

Ariely’s first tip is for those product managers who are dealing with a revolutionary new product – one that really does not have a direct competitor. Just what do you price something like this at? His suggestion? Price it so that your customer can compare it with something that they are already familiar with. Why do this?

It turns out that we human being find that making decisions is quite tough to do. So when we encounter a new type of product, we struggle to place a value on it because we see it as existing by itself – in isolation. More often than not, what we end up doing is relying on old, past decisions (including comparisons to other products).

A great example of this is the TIVO DVR product. Just how do you go about pricing something like that when it first came out? The value is time saved, but what customer is going to sit down and calculate how much their time is worth and then figure out how much time they might save if they bought a TIVO?

We all rely on our past impressions in order to infer value on new things. This means that product mangers who want to understand how our potential customers make decisions about our products will need to take the actual decision process into account. Which is why relativity is so important…

Ariely also thinks that we need to know that the relativity of prices is a critical part of the customer’s decision process. If you were the TIVO product manger and you told your customers to compare the product to a VCR, then your customers are going to be unwilling to pay $500 for your products. However, if you told them to compare it to a computer, then they’ll be more than willing to spend $500 to buy it. Or you can do what Apple did…

Ariely’s final point is that the price that you use to define the value of your product will stick in your customer’s mind for a very, very long time. The most recent case study for how this works is Apple’s iPhone.

When first introduced, the iPhone was priced at $600. Almost immediately they slashed the price to $400, apologized to initial purchasers and gave them price difference refunds if they asked for them. Silly mistake on Apple’s part or clever pricing?

It may have been clever pricing: now a $400 iPhone seemed like a great deal when compared to the initial $600 price. When the price dropped to $200 it now looks like a fantastic deal because we all still remember the initial $600 price.

Do you take into consideration how your customer make their buying decision when you are setting prices for your products? Do you provide your customers with a product to compare your products price to? Do you start out pricing your product high so that customers will feel as though they are getting a great deal later on when you start to discount? Leave me a comment and let me know what you are thinking.