Pragmatic Pricing

Do you give a discount to customers who buy higher volumes?  Most companies do.  Why?

Stop reading for a just a moment and think.  Why do you do it?  Why do other companies offer volume discounts?

One answer to this question is because it costs us less.  We only had to process one order.  Our sales expenses were lower per part.  Our marketing expenses per part are lower.  It simply costs us less per unit when one customer buys more than one part.  Why shouldn’t we pass that savings on to our customer.   This answer is common, it’s logical, and it’s wrong.

At least it’s wrong from the perspective of optimal pricing.  Why should we charge less simply because it costs us less?  This sounds  a lot like cost based pricing.  Optimal pricing is about capturing our customers’ willingness to pay for a product.  The answer should be based on how customers perceive our value, not based on our costs.

There are 3 good reasons for giving a volume based discount, all of them based on VALUE.

1.  Customers who buy higher volumes typically spend more money.  The more someone spends on something the more effort they are willing to put in to get a great price.  Customers who put in more effort to find or negotiate a lower price by definition are more price sensitive.  If giving them a lower price keeps them from looking to our competitors for a lower price, then we win.

2.  For whatever reason, our competitors may charge less for higher volumes.  Our customers are now comparing the price of 100 of our products vs. 100 of our competitors, so our volume prices must be comparable (value adjusted of course) to the volume prices of our competitors.  If our competitors use volume based pricing, we probably have to do the same just to remain competitive.  Remember our customers measure value by comparing our products and price to our competitor’s products and price.

3.  For many products, especially consumer goods, the second unit is less valuable to our customer than the first.  Imagine that you want to buy a CD so you go into a record store and shop around.  You find one you really want and are ready to check out when you see a sign, “Buy one get the second one for half price”.  You weren’t going to buy a second CD, at least not at full price, but now you might shop around and find a second one so you can take advantage of the discount.  This is an example of how your willingness to pay for the second CD was less than for the first CD.  Volume discounts can allow you to capture incremental sales without having to discount the first sale.

These are three very good reasons to offer volume discounts.  In your business, what volume discounts are you offering?  Why?

Action:  Think about your volume discounts.  Are you offering them for one of the three reasons above?  If not, you may want to rethink them.

Can you think of any other good reasons to give volume discounts?

In the Harry Potter books, every new student at Hogwarts dons “The Sorting Hat”.  This hat reads the essence of the student and then declares in which house that student best fits. 

Pricing Utopia would include a Value Sorting Hat.

Imagine a customer walks into your store and is interested in buying one of your products.  You ask the customer to put on the Value Sorting Hat and the hat tells you exactly how much this customer values your product, exactly how much this customer is willing to pay.  You can then decide whether or not to sell it at that price.  (Of course in our utopia you can charge different customers different prices without ill effects.)

The Value Sorting Hat takes into account the amount of inherent value your customer will receive.  Will your product solve a major problem?  Will it bring them happiness?

It considers the other options your customer has for that money.  Which competitors, if any, are they considering?  How do they value your product compared to your competitors?  What do they know about your competitors features and prices?

The Hat processes your customer’s level of uncertainty.  How low of a price do we need to make them act now?

This is utopia.  No demand curves.  No conjoint analysis.  No statistics.  We can maximize profit and make every customer happy.

Why should you care about this pricing utopia?  Because you want to be moving closer and closer to this vision in real life.  Our customers, our competitors, and even simple economic issues keep us from reaching this pricing utopia, but by occasionally looking toward utopia we can see the direction we should be moving.

For example, customers do not tell us how much they value our product over our competitors.  But do we ever ask them?  You interact with customers every day.  In normal conversations you can learn a lot about how your customers think.  Have those conversations.  You may not have a Value Sorting Hat to know about each individual customer, but by having conversations with individual customers you will develop a picture of your customers as a group.  You will learn new ways to segment them for products and for prices.

Move toward pricing utopia.  Become your own Value Sorting Hat.

Action:  Talk to your customers.  Ask them about their decision processes.  Don’t interrogate them, rather have conversations and ask curiously, because you really want to know.