MSU Extension Product Center

Michigan State University Extension recognizes that pricing a product is not easy. To set the right price, a business must intimately know their product, their customer and their competitors. There are no silver bullets in gaining this understanding. There are, however, tools that quicken this learning process. In the sixth edition of their book “The Strategy and Tactics of Pricing,” Thomas T. Nagel and Georg Muller detail several universal ways that customers consider prices. The effects they describe can help businesses navigate the challenging landscape of pricing.

Competitive reference price effect

No product is completely unique. Customers look to satisfy a need within a category of options. Each category comes with a “competitive reference price,” effectively a price that customers deem standard for a category. A fair price for any specific product is determined in relation to this standard, which is often the most highly visible brand in a category. Go to the area of the grocery store where your product is sold and reference dominant brands to get an idea of what the competitive reference price may be.

Businesses need to know the competitive reference price for their category in order to set their optimal price. Businesses also have an opportunity to frame their product within the most lucrative category. Nagel and Muller, for example, note in their book that a laundry detergent was able to maintain a high price premium in the face of stiff competition. They did so, in part, by framing their detergent not as an alternative to conventional detergents, but as an alternative to dry cleaning.

Switching cost effect

Buyers are more sensitive to price when it’s easy to switch brands. Choosing a new brand of salsa does not require learning new skills, changing family recipes or purchasing specialized kitchen equipment. Choosing a new cell phone provider, however, comes with more switching costs. The user needs to research different providers, learn a new interface system and may find that their app purchases will not transfer.

Customers will more easily bare price increases when switching brands is more difficult. This depends a lot on the industry. It is possible, though, for any business to increase switching costs. Loyalty programs increase a customer’s incentive to stay with a business. Personal relationships with customers matter a lot, too.

According to an article by Amelia Lucas appearing in CNBC, Panera Bread, for example, is aiming to increase loyalty through more personal experiences and a loyalty program that increases convenience.  

Shared-cost effect

The percentage of a price that a customer must pay influences their sensitivity to price. Airline tickets are a good example. Leisure travelers, Nagel and Muller note, can be price sensitive. This group may be more reticent to pay for direct flights or early boarding. Business travelers are much less price sensitive because their employers are paying the price.

The applicability of this effect varies based on industry. However, all businesses can design a shared cost into their offerings. A good example is the Double Up Food Bucks program, which matches Supplemental Nutrition Assistance Program (SNAP) recipients’ spending on milk, fruit and veggies. SNAP recipients are likely to buy more in these categories when they pay only half the cost.

End-benefit effect

How significant is the benefit a customer receives from a product? The higher the end-benefit, the higher the price the customer is willing to pay. Nagel and Muller identify an example of industrial glue used in Boeing planes. This glue is held to high quality standards. It also costs significantly more than other products because it is a part of a very high-value product.

Different end-benefits can rationalize different prices. Let’s take, for example, catering. The end-benefit from catering a wedding is much larger than the end-benefit a customer receives from a catered office event. Where a business identifies high end-benefits among customers, there’s an opportunity to differentiate product offerings to increase profit margins.

Read part two of this article to learn about the fairness effect, difficult-comparison effect, price-quality effect and the expenditure effect.   

MSU Product Center

Pricing is a crucial function for food businesses. Consider working with the MSU Product Center to examine costs, pricing structure and value communication for your food product. The MSU Product Center is an organization that brings together on-campus expertise in the sectors of food, agriculture, and natural resources to help entrepreneurs define and launch innovative products. Field-based innovation counselors advise entrepreneurs on business planning, regulatory requirements, and product development needs. To access business development assistance, select the request counseling tab on the MSU Product Center website or call 517-432-8750.