24 ounces of ketchup at $0.07/oz.

Turn that idea on its head.

32 ounces at $0.079/oz.  The price per unit goes up almost 13%.  Not bad for a commodity.

Note that the different sizes make it harder for buyers to know exactly how much more they are paying.  But hey, who doesn’t like upside down ketchup bottles.  You can probably even make the case that you end up wasting less ketchup.

If your maximum price is determined by the perceived differential value of your offering, how do you know what value customers perceive.  Many of them won’t tell you, especially if they think you’ll use that information to jack up the price.

Here’s an example of a product that for many buyers has a really high perceived value, with little demonstrable “objective” value compared to much cheaper alternatives.  Those who believe they “can hear the difference” may happily pay over $100 for a cable, while those who don’t can buy an equivalent option for less than $10.

How does Monster create the perception of value?  First, especially in the days before digital connections, there may have been some merit to their claims, especially if you had a lousy cable.  Second, the product looks better.  It’s bigger, badder, a monster, if you will.  It looks more heavy-duty than your typical cable.  Does it make a difference?  Not for most buyers, but it sure looks good.  Third, they position a premium offering that still looks cheap compared to the overall purchase.  Someone buying a new high def TV and a surround sound system may be dropping several thousand dollars.  At this point, the notion of spending an extra $100 to “make the most of your investment” seems to make sense.  Which leads to what be the most important point.  The sales rep at Best Buy urging you to make the most of your new purchase.  Best Buy might be making more profit on the cable than the TV.

Personally, I’m not a big fan, but you have to hand it to them for breaking free of commoditization.  If you’re a small business owner, how can you help customers perceive the value you deliver?

I’ll ask why they haven’t raised prices and there’s some hemming and hawing.  What it comes down to is that the owner doesn’t think he or she is worth it.  ”I know we’re the cheapest option for our customers, but isn’t $125 an hour a pretty good rate?”  Or, “I guess I just never saw myself as a guy making more than $100,000 per year.”  Or, “no one else in the industry is raising prices.”

Some of these folks run very successful businesses, but they are:

• Making (a lot) less money than they could
• Working (a lot) harder than they need to make the money they want
• Feeling controlled by their business instead of the other way around

When I ask about the value they deliver to their customers, they believe it’s there.  They believe it could be worth more.  But they are scared to ask for it, but asking for something means you might get rejected.  This is always the case, but you’d think that people who are brave enough to start a business would be brave enough to ask, right?  Well, we’re social creatures, and being rejected can be hard for anyone.  Some people know they need to raise prices, but don’t know how.  (We’ll deal with that in another post.)  Others really don’t want to go through the psychological trauma of asking for something.  Here’s the thing: the customers most likely to say “no” are the price-buyers– the ones you don’t like to deal with because you make little to no profit and they eat up all your time and energy.  In a free market, customers get to decide if they want to buy what you’re selling on your terms.  But you get to set those terms.  Customers don’t.  (Obviously, if your terms are out of whack with the market, you’re going to be in trouble.)

If the value is there, ask for the price to back it up.  Why wouldn’t you be “worth it”?  Professional athletes make millions of dollars playing games.  Are they “worth it”?  In some cosmic sense, probably not.  Remember when Kobe Bryant’s agent said “it seems silly to pay basketball players more than high school teachers, who are much more valuable to society, just because Kobe can put a little orange ball through a little orange hoop.  Kobe has resigned with the Lakers for $25,000 per year, which is really a lot, considering he’d happily play for free.”  I don’t remember that, either.

Back in the 60s, bands and promoters would split concert receipts 50/50.  Then Led Zeppelin showed up and sold out every venue they played.  Their manager said, if you want Zeppelin, it’s a 90/10 split.  And he got it, because the band delivered the value.

If you’ve currently got 20% margins, a 10% price increase will increase your profit by up to 50% (depending on your mix of fixed and variable costs).  But let’s say you don’t retain all your customers.  As you feared, many decide to go elsewhere. Fortunately, you lose the most price sensitive customers, the ones who don’t perceive much value in what you do.  You can have a conversation with them, to see why they don’t perceive the value, and perhaps change their mind.  But at the end of the day, you’re still making more money, and you’re not dealing with your worst customers.  You can concentrate on the ones who value what you do, the ones you like to help.  In addition to making more money, and spending less time and energy on work, you’re also creating more meaning.

Naturally, most small business owners are not basketball or rock n’ roll prodigies.  You have to deliver the value.  If the value isn’t there, go back and fix that.  But if it is, you should get paid for it.  Don’t be scared of making money.

If you’re better, be better, NOT cheaper.

If you believe your offering is worth more than the competition, but you don’t know how to ask for it, if you’re somehow embarrassed about the price, here’s an exercise you can do as a buyer:  Go test drive your favorite car– preferably something expensive and Italian, but as long as it’s (really) expensive, it doesn’t matter.  This sounds like fun, so far, right?  Then tell the sales man that you love the car but you just can’t see paying $X, since it pretty much does what the Kia across the street does for $20K.  Ask if they’ll match the Kia price.  If you don’t want to drive any cars, pick a different category.

The point is that no one is going to sell you a brand new Ferrari for $20K.  They might laugh, but they will be able to tell you why the Ferrari is different from the Kia, and why, if the Ferrari is really right for you, it’s a good deal.  And way, if it’s not right for you, you should just head on down to the Kia dealer.

If you can’t do this from the seller’s side when someone challenges you on price when you offer more value, you are destroying your business.  Don’t fret, lots of businesses do this and recover.  So have your story ready.  Bonus points for having a lower-priced, lower-value offer ready for price sensitive customers.  (They key is to make sure you have a good fence between the different levels of value and different price points.)

The article discusses how big pharma saw controlling the central nervous system as a path to a whole new class of profitable drugs. What they found was that the mind had a huge impact over the body, but not necessarily because of the active ingredients in drugs. Patients who thought they were taking drugs often showed improvement even without taking actual drugs (placebo). This has been documented for some time. More interestingly, patients who received placebos from doctors who actively engaged with them and suggested the patient would get better had better results than patients whose doctors were strictly clinical and aloof. (They did as well as patients on the leading drugs– not that I want to veer into a discussion of health care reform.)

Placebo effects (or “responses”, as some experts prefer to call them) can also work the other way. Patients told of a drug’s potential negative side effects are more likely to report those side effects.

In short, our minds form expectations that end up shaping how we interact with the world and become self-fulfilling, or at least self-reinforcing prophecies.

So when you focus your conversations with customers on price, cost, discounts and other aspects of the pricing calculation, pricing takes the fore and you find out that customers “only care about price.” If you express your relationship with the customer in terms of the customer’s benefits, what other similar customers have achieved, and other aspects on the value side of the ledger, you generally find lower price sensitivity.

Don Hammalian, Senior Vice President at Alexander Proudfoot, a business process improvement consulting firm with a large sales process practice notes:

Salespeople tend to credit their competition with strengths and abilities that go far beyond reality, especially around competitive pricing. I’ve been with client salespeople who, on their way to close a sale, succeeded in convincing themselves in the car that they had to reduce pricing, even though the customer had not made it an issue. In some cases, they cut prices by 10-15% based on their own self induced fears. Rather than selling the value proposition, service and dependability of their organizations they focused on assumptive prices they could not match and missed their positions of strength. In nearly all cases, these concessions are made without a complete understanding of the impact on margin and market positioning. This is a formula for failure … they failed.

Selling on value is covered in Sales 101 and Pricing 101. The particulars of any given sales situation make it much more complex to implement, of course. Some organizations and individuals will try it, and most will see some kind of success. But it’s often anecdotal (despite the views of professor Jenny McCarthy, this does not make it valid). A couple of setbacks, and companies stop trying.

The goal is not remove price sensitivity, or win every deal at full price. This would be absurd. The idea is that overall, you can create a small but meaningful shift in pricing results, simply by positioning price appropriately. And if your margins are 10%, a 1% improvement just added 10% to your bottom line.

How can you use this effect to your advantage with your customers and sales team?

Part of it is a mindset shift.

We saw one company whose new executive team knew that it had to increase margins. They explicitly focused on value and improving price yield rather than just whether the deal is signed. They moved price exception approval from an administrative function to an executive function. They used our software to get details of open opportunities and how they compared to similar opportunities with the same customer or related customers. They even rejected a few deals that might previously have been considered acceptable. Within a month, the sales team had adjusted to the new regime and stopped asking for massive discounts. Sales and close rates did not change.

This effect is also why companies spend a lot of money on the customer experience outside the core “product.” Fancy restaurants have fancy decor and nice plates, setting your expectations for the food (and the bill). A Lexus showroom is very different from a used car lot. An Apple retail store looks different from Fry’s. Businesses communicate expectations about price and value, deliberately or not. Better to be deliberate, and aligned with your value proposition.

So if you feel you have a premium offering, act like it. This will help set customers’ expectations for price. If you want to communicate that you’re a low-price offering, don’t try to be as fancy as the more expensive competitor. Just don’t fall into the trap of saying you’re the premium offering and acting like you’re the discounter– you’ll incur the expenses of developing the premium product, but fail to achieve premium margins.

Meanwhile, as some of you may have heard, Apple launched a new iPhone, along with the AppStore, which allows iPhone owners to install applications, much like you can buy music through iTunes. Prices for most apps range from free to $9.99 (see this post from Pinch Media with price distribution).

Bringing these two storylines together, someone wrote an iPhone application called I Am Rich, which simply displayed a ruby-like gem. The software cost $999.99, the highest price point that Apple currently permits in the AppStore. According the author, the I Am Rich application “always reminds you (and others when you show it to them) that you were rich enough to afford this.” Nothing like a little humor.

It turns out that Apple does not find this amusing, and removed the application from the AppStore. ZD Net writer Jason O’Grady thinks the cause may be angry customers who did not really mean to buy the application.

Tricking someone into buying something they did not mean to purchase is not good, on a number of levels. (Reminds me of the Dilbert cartoon where the team discusses charging a million dollars with a $999,999 rebate. “We only need one person to forget to send in their rebate form.”) At the same time, conspicuous consumption is a pretty big driver of the economy. Anyone know how many people actually bought “I Am Rich”?

Edit: Apparently, 8 people bought it. That means about $5,600 for the developer, after Apple takes a 30% take. My guess is that’s a lot more money than most of the $1.99 apps have made.

Oracle raises list prices by 15% or more
Oracle is making waves with double-digit price increases (see “Oracle increases prices 15 to 20 percent: The joys of pricing power” on CNet), but what does this really mean? Are they really getting customers to pay 15-20% more? Probably not.

Oracle is unusual in the software industry in that they publish a global list price. Most enterprise software companies (Mimiran included) vary pricing by region and don’t publish prices to avoid focusing on price early in the sales cycle. Oracle’s prices and earnings are dollar-denominated, meaning that overseas software sales have been getting cheaper for customers in Europe and Asia, while Oracle’s local expenses have gone up in dollar terms. In other words, a nominal price increase was necessary just to reverse the price decrease brought on the falling dollar.

Second, enterprise software deals rarely close at list price. The price increases provide more room for negotiation. One of the most important aspects of list price changes in B2B environments is how much of the price change flows through to the actual price the customer pays.

Third, the move serves as a nice signal to SAP and other vendors to stop driving prices into the ground.

The software industry is consolidating, especially around Oracle, which has been gobbling up competitors, but they won’t get a real 20% price increase. However, if they end up netting 1 or 2%, that’s still a few hundred million dollars in incremental profit.

Apple’s “Cheaper” iPhone 3G
Apple made a big splash by announcing that their new iPhone would not only support faster 3G internet access and GPS, but would also sell for the magic price point of $199. This represents a $200 price drop, along with more functionality. Isn’t the rapid march of technology amazing? Not so fast. At the same time Steve Jobs announced that he was making the iPhone more affordable, AT&T upped the price of data plans for the iPhone by $10/month. To get the discounting price, customers must commit for 2 years. So you might save $200 up front, but you spend an additional $240 over the next 2 years, and an additional incremental $10/month after that. Basically, Apple and AT&T are financing your iPhone purchase for you with a very high interest payment plan. The beauty of it is that the lower upfront cost only happens once, while the ongoing revenue stream stays as long they can keep the customer. And while everyone who does the math knows that this is actually a price increase, what sticks in consumers’ minds is “wow, an iPhone for $199.”

On the backend, AT&T’s payments to Apple make it a strong pricing move for Apple, as well, and analysts seem bullish on the revenue potential.

Airline Surcharges
And now let’s get to everyone’s favorite pricing punching bag– the airlines. American, United, and other carriers have introduced fees on checked luggage to go along with fees for fuel prices, talking to a person, using curb-side checkin, and buying inedible snacks on planes. Delta also announced fuel surcharges on redeeming frequent flier miles. Naturally, travelers are unhappy. Checking a bag on some carriers will now cost you an extra $15, while the second bag will cost $25. And it’s an extra $50 if you actually want to pick it up at your destination. (Just kidding about that last part.)

While this is irritating for fliers (I’ve heard some say “why are you nickel and diming me?”) the alternative would be to raise prices across the board. Airlines are hemorrhaging money (what else is new?) because of higher fuel prices and the slowing economy. They need to do something, and price increases are an inevitable part of the mix. Flying is going to be more expensive for a while, until jet makers can create much more efficient planes. The next generation will help, but not enough to offset the rise in fuel prices.

Of course, airlines are good at slapping on surcharges. They are not good providing a good customer experience. They haven’t done anything to address the ridiculous “security” procedures. (I’ll save the story of how I accidentally took a swiss army knife in a carry on bag that was hand searched by TSI for another time.) They have taken pillows off planes and charged for “snacks”. Why not work with the government to reduce the unnecessary elements of the security burden? Why not team up with airport restaurants, or even bring in Starbucks or someone similar to allow customers to order onboard food when they checkin? The system might take some work to implement, but it would allow the airlines to bill customers immediately instead of worrying about making change on the plane, allow customers to get some halfway decent food (depends on the airport), and the revenue sharing would probably bring in more incremental profit than the current program. The partners would drop food off before the flight, the airline could keep the hot food hot and the cold food cold and deliver it after take off. The passengers waiting inline for 15 minutes at Starbucks would save 15 minutes. Food revenue per customer would probably go way up, even if the airlines turned the bulk of the revenue over to the partner.

Other luxury goods typically make a pretense that they offer some kind of functionality to justify their price. Ferraris are fast. Fine, rare wines are supposed to taste good– even if you’re not really supposed to drink them. Fancy jewelry is supposed to look nice. Even luxury watches, which are no more accurate than $10 digital watches, have complex mechanisms to tell you the phase of the moon or some other piece of not really useful information. But a watch that doesn’t even pretend to tell you the time?!?

As a pricing person, this is brilliant. This is about the story that you tell when someone asks you about your $300,000 watch. I imagine it goes something like this:

Nice watch. How do you read it?

See here? This means it’s day. If it was over here, it would be night.

Oh, I see.

Yes, it’s extremely useful when I’m in the media room of my yacht and I just really want to know whether it’s day or night, and my VCR is still flashing 12:00, so I just look at my watch.

Why don’t you just ask your butler?

Usually I do, but sometimes I’ve just sent him to get a bottle of that Chateau Lafite that you’re really not supposed to drink, but I’ve never understood senseless luxury, you know?

That’s great. Chronographic technology has come so far since man looked at the sky. I can never keep up with the time zone changes when I’m in my yacht. I should get one of those.

Sorry, they’re all sold out.

So can anyone come up with a luxury item to top this?

As we pointed out in the recent post “In Luxury Goods, Pricing Is Part of the Value“, high prices for certain goods create a perception of high value in some markets. Brownwyn Fryer over at the Harvard Business Review Editors’ Blog takes a much more practical, hands-on view of the experiment we discussed that doesn’t involve MRI machines, but does require purchasing one bottle of expensive wine. (See “Are Your Prices High Enough?“) Bronwyn herself left a comment on one of the other comments referencing a recent New York Times article called The Double Lives of High-Priced Call Girls.

And when it comes to price, Ms. Xi’an shared a secret. When someone pays her $1,250 an hour, he gets exactly what he would for $200, her rate when she started out. The difference is psychological, she explained: “The more somebody pays for you, the more they’ll respect you.”

“Tell a guy you’re $100 and they’ll treat you one way — tell them you’re $1,500 and they’ll treat you better,” Ms. Xi’an said in a telephone interview from her home on Long Island. “I’ve heard a lot of girls saying, ‘Is this girl getting $5,500 an hour because she’s more beautiful? Is she doing something I don’t?’ The answer is no. But that girl is able to look a guy in the eye and say, ‘This is what I’m worth, and this is what you have to pay if you want me.’ And you have to be able to do that, and believe it.”

This can be true for a lot of purchases. People who buy expensive, top-of-the-line offerings, whether they are stereo systems, software applications, wines, or other indulgences think more highly of their purchases and invest more heavily in them that those who purchase cheaper offerings.