Does the price of something equal its true value? While speaking with a friend in the Swiss luxury watch business the other day I learned that the cost of building one of their brand models was $6,000. However, then I learned that the watch would be sold for $45,000. This got me thinking about the true value of goods in comparison to their price on the market.
There are many theories about pricing. In the area of marketing, pricing is one of the most important elements of the marketing mix, as it is the only part of the mix which generates a turnover for the company. However, no matter how much you theorize about pricing, it always comes down to the consumer’s personal perception of value. What is the product worth to the consumer? How much would he or she be willing to pay? The interesting part of this assessment, taking place in our minds, is that we can be deceived to come to certain conclusions about what something is worth. The luxury watch is a perfect example. If the company lowered the price of their luxury watches too low, the consumer perception would change. The watch would no longer be perceived as luxury. They would probably sell fewer units at $100 than they would at $45,000. This aura of extreme luxury is supported with the proper promotion, distribution and packaging.
If you think that this human psychology trait has somehow changed because of the so-called new economy you would be mistaken. A perfect example of this comes from the music industry. There was a time when consumers expected to pay $15 or $20 for an album or CD. There was a perception of value. The new distribution platform that we know as the Internet suddenly changed all that. The advent of file sharing provided millions of consumers to exchange and download music for next to nothing. What happened was the perception of the value of music suddenly changed. “I just don’t agree with perpetuating the perception that music has no value and should be free,” said, Taylor Swift. Well, I hate to say it Taylor but that is the direction that we have gone. I am not convinced that the consumer currently has a concrete perception of the value of a digital musical file.
While working with a service based startup I was in charge of pricing a service that had no precedent. There was nothing really to base the assessment of the value on. I could use every pricing theory in the world yet most of it was based on assumptions. I knew what the cost structure was, so I could set a floor price multiplied by the minimum number of service contracts we expected to sell in order to cover those costs. There was one major problem. We had no revenues. We had no customers at that point. I had no idea if our price would meet the perception of value determined by the market.
During the same time, we started to see the proliferation of the Freemium model. Something we also considered as a company. Companies all around us were giving everything away for free. The theory was, if you could entice the consumer to use your product or service they may see how valuable it really is. Then you could start charging. The problem would remain though. What price is the right price? Many of these companies went under because they lost most of their users once they began charging for the products. In spite of what many say, free or really cheap does not necessarily translate into more customers. The price of a product or service has a perceived value by the market. The challenge is to find that price that represents the value perceived by the market.
The best way to determine price is to test the market, as the market ultimately decides and sets an equilibrium. Use focus groups or the like to help determine what the perception of value is. This is a widespread problem among many startups. They don’t test the market for their products or services, so they take a stab in the dark by picking a random price point or just giving it away, hoping to charge for upgrades later. This is a dangerous practice because once the market is influenced into picking up a bargain at lower and lower prices, those price points will then become the perceived value of the product in the market and that is very difficult to reverse.