How do you know if pricing higher will lead to higher margins or volume losses? Many companies are left with simplistic models which markup products by a specific percentage above their costs. But is this optimal? Are there instances where price optimization and experimentation make sense?
Be Sure to Understand Price and Demand Elasticity – Look at surge pricing with Uber. If there is high demand, the price for a trip could double or triple. The justification for this is that there are two things happening. First, during a popular event or special evening (e.g. New Year’s eve) people are often willing to pay more to be sure they can get home. Secondly, the increase in fare encourages more potential drivers to work until supply meets demand. In general, this works reasonably well, but in certain instances, the public can become disenchanted. People generally understand paying slightly more on a snowy day in winter, but surge pricing can be met with a severe backlash if enabled during a natural disaster or crisis.
A better way to understand price elasticity and the willingness for customers to pay more for products is with measured experimentation. Optimus Price uses artificial intelligence to help you optimize your product pricing. Lowering prices in some instances to increase volume and raising prices when customers see more value.
Sunk Costs can be your friend – Many people are taught and remember the sunk cost fallacy. Prior investments should not affect future decisions. It’s common for someone to buy a ticket to a movie, only to find they hate the movie. Halfway through, rather than leave, they stay because they don’t want to waste the money they spent. But more importantly, sunk costs can make products substantially more valuable. Consider a broken rear tail-light on a car. If you already own the car, throwing the car away and buying a new car is significantly more costly than replacing the light, even if the cost of the light is sold at a higher margin above its costs. Part availability and convenience are often the more important factor.
Take a look and see for yourself!
This is the first of our 3-part series on cognitive bias and pricing 101. Make sure to come back in a few days for more!