How do TRUSTED Companies Price their Products and Services?
Updated: Jun 26, 2022
If your product costs you $100 to make, how much should you sell it for? This is one of the most fundamental questions in entrepreneurship and marketing classes. The answer is not $200, $1,000, or even “more than $100.” The answer is, “as much as your customers are willing to pay.”
But two more components dictate not only whether your customers will buy your product but also whether they will trust your company and become loyal to your brand.
Four Components, Explained
Cost (C) is how much it costs your company to make the product (or service) once. It is measured in currency (let’s just say Dollars), and it will include all expenses, fixed and variable.
Price (P) is how much you will be charging for it. It is not the pre-discount price, price before add-ons, but rather the price that the customer will actually be paying. If you price a car at $10,000, but the customer has to pay $12,500 with the accessories, registration, tax, and other fees, then the price is really $12,500. If you price a product at $1,000 but discount it by 20%, then your price is really $800.
Perceived Value (PV) is the value the customer believes they are getting from your product when they make the purchase decision. Money is just pieces of fancy paper, but there are other things it can buy. At the moment of the purchase, the customer balances the value they believe they are getting from your product with the value of the other things they can buy for the same amount. Therefore, even the perceived value can be measured in Dollars. The perceived value is heavily subject to marketing and sales techniques, such as scarcity, special discounts, limited-time specials, and other behavioral economics factors. The perceived value is what
Real Value (RV) is the value the customers realize your product delivers long after the purchase, when the marketing and sales techniques have long been gone, and the product delivers value. It is the real value “when the rubber meets the road,” and the product is put to real use. You may learn that it doesn’t do what it was supposed to or how it was supposed to do it. You may find that to make it do what you were led to believe it can do, you must purchase some accessories. But you may also find that it has more value than you initially thought it did when you purchased it, albeit the latter is rare.
Like Trust, Value is Relative
Value is perceived differently by different people, just like trust. People value different things. When buying a car, a top 1% earner who is an empty nester may value performance and brand recognition more than gas mileage and reliability. In contrast, someone who uses the car for pizza delivery would value gas mileage and reliability much more than brand and performance. At the same time, someone who takes their family on road trips would value comfort and safety more than the other two. Both the perceived and real values are relative and considered differently by different customers. Therefore, the following relationship should be considered in the context of the intended customer for the specific product (and price point). The value may include other considerations beyond the product, such as the social values of the company, its labor practices, environmental sustainability efforts, etc.
What the Best Companies Do
The most successful and trusted companies maintain the following relationships between the four components: their Real Value is greater than the Perceived Value, which is greater than the Price, which is greater than the Cost. Mathematically speaking:
Replacing the order of any two components would make the company less successful and/or less trusted and should be considered bad business. The distance between every two components would affect how good the business (and company) is. Let’s look at every pair now.
Price vs. Cost
The price is what the customers are eventually willing to pay. It has nothing to do with how much it costs you to make the product. The more customers are willing to pay above your cost of making the product, the more profitable and financially viable your business is. Some businesses have a profit margin of more than 90% because of such high demand for their products. Other companies have profit margins in the single digits (the personal computer market was notorious that way). If customers are willing to pay less than what your product costs you to make, you will be losing money with every sale. Either fix your cost structure (improve manufacturing efficiencies, remove unnecessary features, etc.), or you will be out of business because this relationship between price and cost is not sustainable. You may be targeting the wrong customer, who sees less value in your product (and since their perceived and real value must be above the price you are charging, forcing the price below your cost). If this is the case, retarget your product at customers who see the most value in it. That is why a company would be the most successful when its products and services are aimed at the market segment that sees the most value in them.
Perceived Value vs. Price
If your customers believe that your products bring them value more than the other things they can buy for the same amount of money you are asking for, they will be more likely to buy. The bigger this difference is, the more they will be willing to buy and consider your product a great deal. But this relationship is relevant only during the moment in which the customer is making the purchase decisions. It could be heavily influenced (and unfortunately, it often is) by marketing and sales techniques designed to cause the customer to perceive a higher value than the product really has at that moment. Reality will sink in later and be discussed in the next part. The bigger the difference between the perceived value and the price (with the perceived value being higher than the price), the more likely customers are to buy. Customers will not buy your product if the perceived value is lower than the price you are asking for. It’s that simple.
Real Value vs. Perceived Value
After the purchase is complete, “rubber meets the road,” and the product is put to its real, day-to-day work. All the excitement around the purchase and the impact of the marketing and sales techniques (that might have made false promises) have evaporated. Does the product do what you expected it to do when you bought it? Does it perform as good? Is it worth what you thought it did when you bought it?
This is where trust comes in. If the value you get from the product exceeds the value you thought it had when you purchased it (the perceived value), you would trust the company. They didn’t lie to you, and the product delivered what you thought it would (or even more). You will now believe what this company tells you much more than other companies who sold you products that didn’t live up to their expectations.
But, if the marketing and sales techniques (not to mention flat-out fraud) inflated the perceived value beyond the real value you realized from the product, you will lose trust in them. You will realize that they oversold and misled you into believing that the product has more value than it really did. You will not feel you need to be loyal to them.
One of the worst things companies can do at this point is to indicate that this difference between the real and perceived values is actually “clearly described” in the small print. They made the print small because what’s in there will not be considered when customers determine the perceived value, and the customer will remember that the company hid behind the small print.
Remember one more thing: that bad is much stronger than good. We are significantly (some would say 3 times, as the Critical Positivity Ratio would suggest) more likely to post a negative review if we had a bad experience than to post a positive review if we had a positive experience.
Customers are much more likely to distrust a company (and not be loyal to it) when the real value they get from the products, after the dust of the marketing and sales efforts settled, is lower than the value they were led to believe the product had when they purchased it.
But what if the real value is lower than the “inflated” perceived value during the purchase but still higher than the asking price? The customer will likely consider the product a good purchase (real value greater than price) but still distrust the company for inflating the value.
Dr. Yoram Solomon is a trust expert, author of The Book of Trust, host of The Trust Show podcast, a two-time TEDx speaker, and facilitator of the Trust Habits workshop that helps building trust in organizations.