September 30, 2013
High reference prices are a tactic we all know well as consumers. MSRP for cars, the “original price” at Kohl’s, the first price you’re offered when buying a souvenir at a touristy market.
Why is this tactic so common? Well, in short, it works. As JC Penney found out the hard way, scrapping high reference prices can make buyers feel like they’re getting less of a good deal. Even in B2B, procurement managers often focus more on the discount than the absolute price.
So, how can you make reference prices a competitive advantage?
First, find a new reference. I recently saw the above sign at a second-hand clothing store in San Francisco.
My reaction: Ten bucks for a whole pound of clothes? Clothes usually cost more than food, but lots of foods cost over $10/lb. What a deal!
I’m not into vintage clothes myself, but the store was packed so I decided to see how good a deal it really was. Turns out, a T-shirt weighs almost half a pound; a pair of jeans nearly triple that. I don’t think “Used T-shirts, $5” or “Old jeans, $15” would have had the same draw, do you?
Likewise, you can flip to an outcome-based pricing approach, as my former colleague Colin Carroll outlined in detail in a PPS journal article. A famous example is Rolls Royce, a jet engine manufacturer who introduced “Power by the Hour,” a program that enabled a whole new set of reference prices by charging customers for outputs (hours of flight propulsion) rather than inputs (engine, service parts, mechanic labor, etc).
Lastly, there’s a type of reference price you can use with your own sales people – called “target price.” Your sales people know you don’t expect them to sell everything at list price. But, what price do you expect? You can communicate this with a target price, or a price that a sales person should be able to close a deal at. A scientifically-optimized target price, specific to the sales situation and the relevant segment of your business, can be a powerful lever in driving sales to achieve better prices in negotiations.
In fact, one customer of ours rolled out optimized target prices to several divisions, except one (for various reasons, that division wasn’t ready). Target prices drove a 6% increase in average selling prices across the divisions that implemented it, while the one that didn’t – despite being in a similar business – actually saw selling prices decline.
Now, about that pound of T-shirt…can I get that to go?