Setting a price on your product or service can be one of the most difficult decisions a marketing manager can make. Different people value your product differently. Most of the time, it is impossible to get accurate information regarding the percentage of your target market that are willing to pay a certain price for it.
However, even with perfect information, the pricing question can be very vexing. Say you know full well that 30% of the population is willing to pay a substantially higher price for your product. Setting the value at this higher price means that you lose out on the remaining 70% of your market who are not willing to pay that price. Setting a lower price means that you have wasted the spending power of that 30% who will now pay a lower price than what they were willing to pay.
What we need is a way to charge a higher price for those who are willing to pay more, and a lesser price for those who are willing to pay less. Simply ask each customer how much the product is worth to them, and charge them on that basis!
However, your customers might throw a fit if they realize that they are being charged simply because they are willing to pay more. No one likes to feel that they are paying more than another person who is getting the same service. In addition, customers will have a strong incentive to lie. Just because I’m willing to pay a high amount for a service doesn’t mean that I wouldn’t like to pay less for it.
The way to achieve this differential pricing is to identify customers who are willing to pay less for your product based on their behavior and charge less when you observe that behavior being followed.
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One example is computer gadgetry. When a new computer gadget comes out, those who will only pay a lower price for it (the cheapskates) will not buy it immediately. When it comes to computer gadgets, cheapskates always feel that the prices will come down several months later. Therefore the best strategy for a company that is bringing out a new computer gadget is to charge high prices when the product comes out and deliberately lower those prices for the cheapskates later on.
Those who pay a high price for the gadgets will get bragging rights and the knowledge that they are the first adopters of the technology.
In most cases however, it is very difficult to identify the cheapskates. Fear not. Certain strategies exist that make the cheapskates identify themselves. This is called self selection. Using certain strategies, your firm can cause the cheapskates to unknowingly reveal their true colors. You can then charge them accordingly.
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The strategy cannot be as simple as, “Whoever says that they are too poor to afford this product will get a 15% discount.” If it’s that easy, then everyone will follow it to get the discount. The idea is to make the cheapskates work for their discount. Those who are willing to pay a high price for the service are usually price insensitive and will not bother to go through the extra effort to get a lower price.
For example, several restaurants charge lower prices in the afternoon. Most people enjoy going to a restaurant in the night when they can party with their friends as part of a later plan to enjoy the rest of the evening. However, by offering lower prices at a time of the day when it’s slightly inconvenient, you invite the cheapskates to get your meals at a lower price. There’s no danger of your richest clients coming at this time simply to save a few bucks. For them, it’s simply not worth it. But you manage to get others who would not normally have come to your restaurant.
By making the cheapskates reveal themselves, you cause them to self select and are free to charge them lower prices. The self selection is always implicit instead of explicit. It’s never mentioned that lower prices are being charged for the sake of cheapskates. Pretty sneaky, huh?