Pricing Strategy Is My Business

The Pricing Newsletter

May 2020

Hello Pricers,

Welcome to the month of May! Some of you may be surprised to learn that the expression mayday has nothing to do with the month of May.

The term mayday comes from the French phrase m'aider (literally help me).

If you're confused by your pricing, feel free to use the phrase mayday to signal your need for help. In fact, you can even use it when filling out my contact form to arrange for a private consult.

Pricing Question from a Reader

Everyone is telling me that Covid-19 is killing the economy. Should I lower my prices to compensate?

Introduction

There are few questions that an economist will answer with a simple yes or no. Amazingly, this is one of them. My answer is as follows:

No!

Do not change your pricing just because there's a terrible virus out there. You may, however, want to reduce your pricing if that virus happens to be causing shifts in your particular market that a price cut would prove beneficial.

Let's take a look at a model that you can use to analyze your situation.

Modeling customer behavior

As I described in The Software Pricing Handbook, one of the most powerful means of classifying customers is by estimating their willingness and ability to pay for your offerings.

Using this framework, customers can be slotted into one of the four quadrants below.

  Low willingness to pay High willingness to pay
Low ability to pay    
High ability to pay    

Your pricing tactics will depend upon the quadrants in which your customers are placed.

High willingness to pay, high ability to pay

If you're lucky, the majority of your customers will fit neatly into this quadrant. There is little reason to reduce your prices for these buyers. If they're willing and able to pay your prices, why would you go out of your way to charge them less? Any reduction in your price will result in lower margins for you, and unnecessary negotiations and explanations for both you and your customers. In other words, if it ain't broke, don't fix it!

Some vendors might even raise prices for customers in this quadrant. I'd suggest extreme caution before considering any price hikes in the current environment. Not only do you risk damage to your goodwill, but many attorneys general are eager to punish any behavior bearing the slightest hint of price gouging.

Some clever marketers may be able to protect themselves from prosecution through the use of pricing trickery, such as the forced bundling of desirable products with leftover productlines, but I wouldn't necessarily recommend taking such risks.

Low willingness to pay, low ability to pay

Customers in this quadrant represent the opposite end of the spectrum. These buyers are the least desirable and are often not worth pursuing in the first place.

If your firm finds itself with limited inventory, or a negatively impacted means of production, it may make sense to reject orders from these buyers entirely.

That said, if you absolutely need to attract these buyers, and they appear to be hesitant to make a purchase, you may want to reduce your prices for them.

Low willingness to pay, high ability to pay

Customers in this quadrant represent lost opportunity. Simply dropping your price to meet their willingness to pay will effectively convert them into clones of the absolute worst type of customer (low willingness and low ability to pay).

Keen observers will note that these buyers are already halfway to being excellent customers. They already have the funds, now all they require is the desire.

Rather than dropping your prices for shoppers in this quadrant, you would be better off to use your sales skills to try to increase their willingness to pay. Those whose behavior remains unchanged may be worth dropping entirely, depending upon your business strategy.

High willingness to pay, low ability to pay

This quadrant is the most interesting, but it also requires the most nuanced response.

Many vendors will take one look at these customers and drop their prices. After all, one cannot squeeze blood from a stone.

What these vendors forget, however, is that when potential customers really want to buy a product that they cannot afford, they will usually agree to trade-offs. As a vendor, you owe it to yourself to ask what these potential buyers can offer in exchange for a price reduction.

Here are a handful of trade-offs that might prove desirable:

  • Relaxation of requirements - Customers who can't afford your usual price may be willing to accept inferior substitutes (either in terms of quality, quantity, or timeliness). A butcher might select different cuts of meat. A printer may switch to a lighter paper stock. A consultant may make himself available less often. The key point is that by offering items that aren't quite as good, vendors can reduce costs without anchoring their traditional offerings at a low price point. Once these customers have more to spend, they can still switch back to the higher-priced offerings. And who knows? Maybe the inferior goods will produce higher margins, either on an individual or aggregate basis.
  • A share in third-party profits - Middlemen who act as distributors for goods might be willing to sell items on consignment or, at the very least, share the margins, when goods are sold to a third party. Even when their margins are slim, they may be able to provide insight into their customers' identities and buying habits that can open up the potential for direct sales on a limited basis.
  • Security - Customers without cash flow now might be willing to agree to long-term purchasing contracts. Skilled negotiators might even be able to include escalating prices so that, over the course of the contract, total profits for the vendor actually increase.
  • Goods and services - Money isn't the only means of value exchange. Many buyers have the potential to provide noteworthy value in other forms - especially when their offerings require the investment of significant fixed costs or low opportunity costs. A tailor, aided by his expertise, could create a suit without significant opportunity costs because much of the value that goes into it is his expertise and knowledge. An accountant might be able to provide advice about how to lower one's tax burden without any out-of-pocket costs. The owner of a billboard might be able to provide highly visible signage to a vendor looking to build its brand.

There's even one option that vendors can use to increase their profits while at the same time removing its' buyers costs.

As described in the barriers to purchase section of the DUMB model, there are many costs, financial and otherwise, that buyers must accept in order to make a purchase. In many cases, these costs do not provide financial benefit to the vendor in question. As a result, vendors who can find the means to reduce these costs stand to reduce the total purchase costs of their goods without harming their bottom lines. For this reason, many vendors would do well to examine opportunities to streamline processes such as onboarding, transportation, installation, training, and disposal.

Conclusion

Many business pundits and self-proclaimed pricing experts are telling vendors that they don't have a choice. They must reduce their prices if they want to survive. Don't fall for such nonsense.

Yes, some businesses would be well-served to reduce their prices for some customers. That said, dropping prices for all customers without performing even the most basic of analyses is a recipe for disaster that could cripple the viability of countless businesses and throw our economy into a tailspin.

Questions come from readers like you. If you'd like your questions answered, send them my way.

Pricing in the News

From the Blog Archives

Notable Pricing Quote

"That which costs little is less valued." -- Miguel de Cervantes

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