Pricing and the Placebo Effect

This summer, Steve Silberman over at Wired wrote a great article called “Placebos Are Getting More Effective. Drugmakers Are Desperate to Know Why.” While the implications for pricing in the pharmaceutical industry are obvious, there are also important analogies to pricing activities in a much broader range of companies.

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.

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