Pricing Professional Services: The Price – Quality Relationship

Why do nearly 30% of retail prices end with the numeral 5 (i.e. £4.95)? Why do over 60% of retail prices end with the numeral 9 (i.e. £4.99)? Why does Wal-Mart, a brand name synonymous with “real bargains” usually end its prices with the numeral 8? Even more curious, why is the third most common ending numeral (after 9 and 5); the number 0 (7.5% of prices)? The reason is psychological pricing.

Psychological pricing: Are consumers really fooled by odd-number pricing?

The theory is that consumers ignore the least significant digits rather than do the proper rounding. Even though the last two digits are seen and not totally ignored, they may subconsciously be partially ignored. It has also been suggested that odd-pricing is perceived by the consumer to be the vendor’s lowest possible price.

Walmart, being as clever as they are, opts to end its prices with an “8”, in order to appear just that bit less expensive than the competing odd-pricers.

High end, premium quality retailers (i.e. Nordstrom), on the other hand, tend to complete their prices with round figures (i.e. “$100.00”), suggesting a greater respect for their customers’ sophistication while sending a message that says “Hey, we know you know how to read a price, so we’re not going to try to bamboozle you into believing it’s less than it is.”

The take-away is: If you want to look like a real bargain, price oddly. If you want to appear as a premium offering, price in round numbers. In my view, few professional service offerings want to be associated with a “bargain”. One could say that there is something… unprofessional about it. It is, however, a viable option for those thriving in this space.

If you’ve read my other pricing posts you’ll already know that I have a bias towards premium pricing in professional services. Perhaps it’s my comfort zone, but I feel that certain fields would do well to avoid cutting costs to the extent that quality is diminished. And on a personal note, I’d rather work smarter than harder.

David Ogilvy, advertising’s “great man”, said it best when he wrote: “… there are now unmistakeable signs of a trend in favor of superior products at premium prices. The consumer is not a moron, she is your wife.”

The price-quality relationship: Is “expensive” a bad word?

I don’t think so. Like most things, it’s more complicated than that. In the absence of other cues (and that’s important), price is an important factor in the consumer’s perception of the product’s quality. The higher the price, the better the buyer believes the quality of the product to be. In one study (Myers and Reynolds, Consumer Behaviour and Marketing Management), 400 people were asked what terms they associated with the word “expensive”. Over two-thirds replied with terms relating to high quality, such as “best” and “superior”. This well-documented fact has been demonstrated repeatedly in marketing research.

However, as anyone who puts on their “consumer’s-hat” will attest, we find it nearly impossible to resist a real bargain. So, which option do you choose? Well, as discussed in a previous post on professional services pricing strategy, you have to choose one, or you’ll be fighting a war of two fronts. As we know, this is not a strategy with a high probability of success.

These charts and case study should help provide an example of how to use psychological pricing and what is known as the price-quality relationship.

The Price v Quality Matrix

This chart illustrates 9 market positioning strategies. As discussed, the “Average” position in grey, that many marketers decide to occupy, is literally neither here nor there. It is wishy washy, undefined, unappealing, and unimaginative. The yellow positions are viable entry points, but they are not places you’ll want to live for long. The red positions are deadly. And the green positions, are good strategic options, depending on your size and marketing strategy. You’ll find it useful to take a moment and imagine where your professional service business finds itself relative to your competitors.

We’ve been applying this approach with our clients for years. And, we used this approach nearly 10 years ago when we helped launch what can be arguably considered one of the most successful Clinics in a UK elective healthcare category. The following is a simplified illustration based on that example (some of the details have been changed but the logic remains the same):

Starting position: Average

The Clinic (“You” in the red circle) initially adopted the “Average” position. The competitors at the time were 2 large multiple players (in green) and 3 smaller independent players (in purple). In this scenario, the Clinic had to adopt a strategy that would put them in a light green position if they were to differentiate themselves from the rest:

So, which position would you choose? Obviously, the red and yellow positions are one that you’d choose to move away from, not towards. The “Ideal for Penetration” wasn’t really an option, because the Clinic, like most small businesses, didn’t have the competency or funding required to perform at high volume or “buy the business” with a penetration marketing strategy (read this post to learn more about penetration and creaming pricing strategies).

The “Real Bargain” position is an attractive one. It’s easier to sell in that space, but you’ve got to be work really hard and fast to recoup your start up investment. If you’re unwilling to cut corners on quality, you’ll find this to be a challenging and conflicting space in which to compete.

If we had chosen this position as an aim, this is what the market would have looked like nearly a decade later:

Positioning Option A: Real Bargain

Hindsight is always 20/20, but positioning in the “Real Bargain” space would have been a poor choice (besides, it went against the grain of this particular product’s life cycle – why sell a product in it’s introductory phase at a bargain price?)

Considering the players in the market and their likely strategies, we are really happy we didn’t choose this position. As it turned out, Competitor 4 raised its game on the quality dimension (occupying the corner we’d favour most in this position). Competitor 1 opted to offer the lowest price in the business which wouldn’t have helped our margins at all. Just to make things interesting, another well-funded and agressive competitor entered the fray, offering a cut-rate bait-and-switch approach that helped to significantly obscure both Competitor 4 and 1’s messaging.

Fighting for the scraps would have been difficult. And considering the owners’ unwillingness to cut corners; an impossibility to sustain. So we chose Option B: The Premium Offering.

Position Option B: Premium offering

This option, while somewhat risky, was considerably better suited to the Clinic’s disposition. But more importantly, there was more empty space there at the time. Granted, we didn’t know we’d have to deal with Competitor 6, but as I just mentioned, they opted for the illusion of “Real Bargain” positioning, so they didn’t really affect the Clinic we were working for.

As you can see, Competitor 5 raised it’s game in the time period (again, over nearly a decade), but because of its size and interest in gaining market share, remained limited in how much they could really charge (in spite of having options that are similarly priced to the Clinic in red). Interestingly, Competitors 2 and 3 either remained or gravitated to the average, which is, as I previously mentioned, a strategy that is really neither here nor there.

In the end, the best outcome of this strategy is the fact that the Clinic chose to charge a sufficiently high price enabling it to invest in innovation and quality improvement. It’s a win-win position. The customer gets the best quality they can afford and the Clinic gets to limit their volume (without adversely depressing sales or profit) thus maintaining their high quality positioning.

On the flip side, it’s really hard work. It comes from understanding and using value-based instead of cost-plus pricing. It comes from smartly increasing your prices over time while always upping the ante on value. And of course, it comes from delivering the goods.

Validating that you are “the best” isn’t easy, and it goes considerably further than simply rounding your prices off with a 0. But, if you’ve got the credentials, the courage to stick your neck out, and an unwavering commitment to excellence, the “Premium offering” positioning can be a healthy place to live. The only disadvantage, in my opinion, is that growth is slower than one might prefer.

The “Real Bargain” position can also pay handsomely. The successful competitor in this space must offer great value by keeping benefits well above price. The main disadvantage (in my humble opinion) is that you have to work so much faster to make it work that it invariably leads to a reduction in quality – which in medicine, isn’t always a palatable option.[/fusion_builder_column][/fusion_builder_row][/fusion_builder_container]