When Customers Help Set Prices

To many managers, the idea of involving customers in pricing decisions seems counterproductive. But it may be time to reexamine that assumption.

For most companies, pricing has long been a sensitive, private affair. Management has a fundamental obligation to recoup costs and earn an adequate return. But it’s worth asking: Is your pricing model one of your core competencies? And does it provide you with a competitive advantage? If your answer to these questions is “no,” then it may be time to rethink the way you look at pricing. This article is directed at managers who seek to profit from differentiation. If you sense that your company is leaving good money on the table and struggling to convert product differentiation into revenue and profits, then you should consider enlisting the help of unlikely partners: your customers. To be sure, the thought of working with customers on a critical business activity such as pricing can be unnerving for managers. However, in the same spirit that companies today are recruiting customers to improve product design and marketing communications, managers need to recognize that it’s those who purchase a company’s products or services who ultimately determine what they are worth. While customers need not have sole discretion over these activities, they can certainly provide important input. It’s critical to recognize that outsourcing pricing to customers isn’t an all-or-nothing proposition: Managers can select pricing models ranging from complete oversight to complete delegation. The trick is to choose an approach that is suited to the characteristics of the market you’re in and that limits the costs, real and potential, that may arise. In this article, we integrate classic views on pricing with the latest research and practice to develop a simple framework to help managers decide how much pricing control they should retain and how much they should relinquish to customers. (See “About the Research.”) To be clear, we do not recommend that companies go out and fire their pricing teams and invite customers to pay whatever they wish. However, we do recommend that companies take a fresh look at their approach to pricing — a part of the business that may be ripe for revamping.

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References

1. To be fair, the literature already contains several classifications of pricing models. Probably the most popular are those that describe different levels or types of price discrimination — for instance, the distinction between first-, second- and third-degree discrimination. However, in our mind these alternatives tend to have a strong academic slant and consequently are less useful from a practical standpoint. For an excellent early example that has inspired much research, including our own, see M. Harris and A. Raviv, “A Theory of Monopoly Pricing Schemes with Demand Uncertainty,” American Economic Review 71, no. 3 (June 1981): 347-365.

2. For a thoughtful discussion on the economic inefficiency of single fixed prices, see L. Phlips, “The Economics of Price Discrimination” (Cambridge, United Kingdom: Cambridge University Press, 1983).

3. For more about these examples, see J. Valentino-Devries, J. Singer-Vine and A. Soltani, “Websites Vary Prices, Deals Based on Users’ Information,” Wall Street Journal, Dec. 24, 2012; and D. Mattioli, “On Orbitz, Mac Users Steered to Pricier Hotels,” Wall Street Journal, Aug. 23, 2012.

4. A. McAfee and E. Brynjolfsson, “Big Data: The Management Revolution,” Harvard Business Review 90, no. 10 (October 2012): 60-68.

5. For more information, see C. Hays, “Variable-Price Coke Machine Being Tested,” New York Times, Oct. 28, 1999; and D. Leonhardt, “Why Variable Pricing Fails at the Vending Machine,” New York Times, June 27, 2005.

6. For more information, see J. Moreton, “Which Mobile Network Is Most Likely to Give You a Better Deal?,” November 15, 2013, http://blogs.which.co.uk; and J. Moreton, “Save £100s by Haggling for Your TV, Broadband and Phone Bill,” July 17, 2013, http://blogs.which.co.uk.

7. For a thoughtful introduction to pay-as-you-wish pricing, see J.-Y. Kim, M. Natter and M. Spann, “Pay What You Want: A New Participative Pricing Mechanism,” Journal of Marketing 73, no. 1 (January 2009): 44-58.

8. In the banking sector, GoBank lets its customers pay whatever they think is fair (between $0 and $9) for monthly membership. In legal services, both Summit Law Group, in Seattle, and Valorem Law Group, in Chicago and San Jose, California, feature “value adjustment lines” on their bills, allowing clients to make any type of adjustment on previously agreed-upon fees.

9. J. Walker, “Interview: Humble Bundle on Humble Bundles,” Aug. 23, 2013, http://rockpapershotgun.com.

10. For details, see “Case Study: Food Retail — Carrefour,” www.pricer.com/en.

11. For more on the relationship between pricing and customer engagement, see M. Bertini and L. Wathieu, “How to Stop Customers from Fixating on Price,” Harvard Business Review 88, no. 5 (May 2010): 84-91; and M. Bertini and J.T. Gourville, “Pricing to Create Shared Value,” Harvard Business Review 90, no. 6 (June 2012): 96-104.

12. See “Community Pricing — You Set the Price!,” www.logos.com/communitypricing/about.

13. This argument is developed in Y. Chen, O. Koenigsberg and Z.J. Zhang, “Pay As You Wish Pricing,” working paper, London Business School, London, United Kingdom, 2014.

14. A recent study by PricewaterhouseCoopers shows that 84% of companies engage outside help of some kind with pricing only “occasionally” or less. See D. Lancefield, “The Power of Pricing: How to Make an Impact on the Bottom Line,” November 2013, http://www.pwc.co.uk.

i. The term “nudging” was made popular by R.H. Thaler and C.R. Sunstein,“Nudge: Improving Decisions About Health, Wealth and Happiness” (New Haven, Connecticut: Yale University Press, 2008).

ii. The notion of social norms and social preferences has many ramifications. For an excellent article that focuses on identity and self-image concerns, see A. Gneezy, U. Gneezy, G. Riener and L.D. Nelson, “Pay-What-You-Want, Identity and Self-Signaling in Markets,” Proceedings of the National Academy of Sciences 109, no. 19 (May 8, 2012): 7236-7240.

iii. For more on the Disney experiment, see A. Gneezy, U. Gneezy, L.D. Nelson and A. Brown, “Shared Social Responsibility: A Field Experiment in Pay-What-You-Want Pricing and Charitable Giving,” Science 329, no. 5989 (July 16, 2010): 325-327.

iv. For pay-as-you-wish pricing in the context of repeated interactions between sellers and buyers, see G. Reiner and C. Traxler, “Norms, Moods, and Free Lunch: Longitudinal Evidence on Payments from a Pay-What-You-Want Restaurant,” Journal of Socio-Economics 41, no. 4 (August 2012): 476-483.