Dr Jeff Cornwall

My column in this week’s Tennessean looks at pricing strategies for start-ups.

Pricing is one way a business communicates about its products and services to its customers.  The power of pricing to shape what customers think about the quality and value of a product is often underestimated by new businesses.

Science Daily reported on a new study about placebos that demonstrates the psychological power of pricing.  In the study, researchers administered a light electric shock and asked the participants in the study to rate the pain of the shock.  Then all of the subjects were given a placebo (a sugar pill) that they were told was a new pain-killer.  Half of the subjects were told that the cost of the new pain mediation would be $2.50 per dose, while the other half were told that it would cost $0.10 per dose.  “In the full-price group, 85 percent of subjects experienced a reduction in pain after taking the placebo. In the low-price group, 61 percent said the pain was less.”

Why the significant difference in the power of the placebo with the higher price? People often use pricing as a means to judge quality of a product or service. 

There is a great example that comes from the story of a psychiatrist who tried to use pricing to phase out his practice.  He was getting ready to move toward retirement.  So he decided to double his rate for any new clients, assuming that nobody would pay that much for his services.  But, the opposite occurred. Referrals and new patients came in at the highest rate he had ever experienced in his long career in practice.  So he raised his rates again hoping this would do the trick and keep away any more new patients.  However, you guessed it — referrals increased even more.

When a business enters the market with prices well below the rest of the competitive landscape, which is common with many new entrepreneurs, they make a statement to potential customers.  Setting a below market price creates a phenomenon that I call “apologizing to the market.”

It is as if the entrepreneur is saying: “We are not as good as the rest, but hope our low price gets you to buy our product anyway.”

Entrepreneurs need to set a price that puts their product squarely where they want to be in the minds of their potential customers.  “We are as good as the rest.”  Or, “We are better than the rest.”  There is always a risk that you can over price your product and price yourself out of the market.  But, the most common pricing error we see in new businesses is to under price.

Often a new businesses needs to initially offer lower prices to attract customers.  It is best to do this through a temporary discount — through a grand opening sale or coupons.  Make it clear that the discount is to introduce the product so they give you a try. 

When it is hard to objectively evaluate the quality of a product or service, consumers look to other ways to judge quality.  And pricing can be one of the most powerful tools to communicate quality.