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Pricing: how to keep customers content

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On the MIT Sloan Management Review website, Rebecca W. Hamilton, Joydeep Srivastava and Ajay Thomas Abraham discuss pricing strategy, and the dilemma of whether to "nickel-and-dime" customers by charging separately for things like shipping, installation and warranties, or to bundle everything into one price.

The authors emphasise that one approach does not fit all, and which you should take depends on a variety of factors, such as:

• whether customers comparison shop;
• whether customers are more sensitive to the prices of some components of the overall service than to others;
• whether the price of one component is small or large relative to the others;
• whether the company controls the costs and quality of a particular component;
• which components are most central to what the customer wants.

In the article, Hamilton, Srivastava and Abraham summarise the respective advantages of partitioning prices and combining prices, and the strategy of benefits-based price partitioning.

PARTITIONING PRICE

Partitioned pricing is where the total price of a product or service is divided into two or more mandatory components, as might be the case with telephone services, etc. Although the customer has to pay for all the components, each has a listed price.

The authors explain why providers might use a partitioned pricing strategy rather than quoting their prices using a single combined price:

"Consumers tend to focus on the base price they are quoted rather than the ancillary fees that boost the total price. And the research suggests that consumers mentally process the base price more thoroughly than they process other components, such as taxes and fees.

"Thus, when consumers try to recall the total price after seeing a partitioned price, they tend to recall the base price accurately but forget about the other components, thereby remembering a lower total price."

Also, pricing components separately might position products more favourably against the competition, and helps the seller avoid blame for high prices where taxes and fees are added.

COMBINING PRICE

However, Hamilton, Srivastava and Abraham warn that researchers have noted "shipping-charge scepticism" among consumers. For some, offers that include shipping in the total price are more attractive than those partitioning the price. Combining prices can avoid highlighting components that consumers would rather not think about, or a warranty that might raise questions over reliability.

Also, combining prices up front can avoid surprising consumers later on with fees, which runs the risk of upsetting them and ruining goodwill.

BENEFITS-BASED PRICE PARTITIONING

The authors insist the approach of benefits-based price partitioning – pricing components based on customers’ sensitivity to the price of each component – can be "a win for both managers and customers".

They explain: "Benefits-based price partitioning suggests that profit margins should be higher for components for which customers are less price sensitive and lower for components for which customers are more price sensitive."

They add: "By holding the total price constant, research shows that customers will be more likely to buy when components they don't like are de-emphasised (either by decreasing their profit margin or by combining them into a total price) and components they do like are highlighted (either by increasing their profit margin or by partitioning them from other components)."

Hamilton, Srivastava and Abraham say it's difficult to argue against this strategy because it improves outcomes for both the seller, by increasing customer purchase intentions, and the customer, via greater customer satisfaction and perceived value, while keeping the total price constant.

DECISION FRAMEWORK

The authors also provide guidelines for deciding which will be the more effective pricing strategy for a particular case. This involves asking several key questions, as follows.

1) Is the consumer already committed to making a purchase from you?

If yes, price partitioning will have less influence on their decisions. If no, partitioning could create lower price perceptions than combining prices, making comparisons with competitors more favourable.

2) Where consumers engage in comparison shopping, do competitors partition prices?

If the industry norm is to combine prices, partitioning may be perceived poorly by customers, even if the partitioned prices appear more attractive compared to competitors’ prices.

3) Is the price of the component small relative to the price of other components?

Research shows that eBay bidders do not bid significantly less when the shipping charges for an item are high than when they are low, suggesting that they are not fully accounting for added costs. But if the price of the partitioned component is large relative to the price of the other components, partitioning becomes less effective.

4) Do consumers react negatively to the component?

If consumers perceive the component negatively, as can be the case with installation and warranty, consumer reactions are likely to be more favourable when this component is combined with other components rather than partitioned.

5) Does your company control the costs, quality and delivery of the component?

If not, it may be more effective to partition the component so that the costs can be attributed to a third-party provider.

6) Does the component satisfy a goal for consumers?

The authors point out that consumers are more sensitive to the prices of components that are not consistent with their goals than to the prices of components that are.

They explain: "If the component is aligned with a specific goal of the customers being served, such as being compensated for a used car being traded in, partitioning the component will make the overall price more attractive. If the component does not satisfy a goal for consumers, keep things simple by combining prices across components."

Source
When Should You Nickel-and-Dime Your Customers?
Rebecca W. Hamilton, Joydeep Srivastava and Ajay Thomas Abraham
MIT Sloan Management Review

 

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