Careful Ascent

By Vikas Mittal

Many managers believe that the only way to get customers to pay more is to load their products and services with more and more features.

This is the classic value trap — provide more benefits to extract higher prices. Another approach — cost-plus pricing — relies on providing customers with justifications for price increases; justifications such as increased labor costs, inflation and higher raw-material costs.

Price increases, done incorrectly, often result in customer dissatisfaction and brand switching. It’s no wonder raising prices is a stressful, contentious and unpleasant process. When harried, some firms avoid raising prices by taking “self-harming” measures, such as reducing head count, lowering product quality and reducing services.

Such drastic actions may not always be necessary. Research on consumer reaction to pricing has identified several factors that can help firms to decrease customer price sensitivity. Reducing price sensitivity can enable firms to raise prices without negative side effects.

Four Levers for Raising Prices

1. Time your increases wisely.

Several studies have examined customer price sensitivity relative to economic cycles. The main result of a major study in the U.K. was that long-term price sensitivity of customers tends to decrease during economic expansions. Customers are more price-sensitive during economic contractions. These results have also been documented in a meta-analysis, where researchers summarized results of 81 different studies. While this may seem intuitive, firms often fail to take advantage of economic cycles to manage their pricing strategy. Firms may be more prone to give price cuts during recessionary periods to retain or gain customers, they should also recognize decreased long-term price sensitivity during expansion periods.

Especially in cyclical industries, such as oil and gas, firms should implement price increases during economic expansions. During these times, firms may want to tilt their focus toward managing customer value through non-price mechanisms. Lowering prices to retain or gain share may only train customers to become more price-sensitive. The costs and benefits of such a strategy should be carefully evaluated.

2. Focus on customer satisfaction.

In a classic study based on the American Customer Satisfaction Index (ASCI), the research team examined five years of data from several firms to determine the association between overall customer satisfaction and customers’ willingness to tolerate a price increase. Results showed that an increase in overall customer satisfaction decreased price sensitivity: “A 1% increase in customer satisfaction should be associated with a 0.60% decrease in price sensitivity.” Interestingly, the study also found an effect of competitiveness, as measured by industry concentration. It found highly satisfied customers of companies operating in highly competitive markets are less likely to tolerate a price increase. Identify customers who are highly satisfied, because they should be relatively more receptive to a price increase. If you decide to increase prices, do it in a way that analyzes and accounts for potential competitor responses. If you are in a market with many competitors, proceed with caution.

3. Build brand equity through advertising.

We all understand the difference between advertising and promotion. Advertising is communication designed to build unique, positive and strong associations with a brand in the minds of your customers. Promotions — discounts and giveaways — stimulate purchase behavior.

A long-term study of grocery store buyers showed that advertising helped build brand equity, customer loyalty and repeat brand purchases. In contrast, promotions prodded customers to become progressively more price-sensitive, harming long-term profitability. This is also consistent with another result: Price sensitivity for generic brands is typically higher than national brands, presumably because the latter have higher brand equity than the former.

Manage pricing strategy in conjunction with your advertising and promotion strategy. In many firms, especially B-to-B firms, pricing may be determined by the sales function while advertising is run by the communications group. Close cooperation between the two groups can be beneficial.

4. Tap into customers’ local identity.

A forthcoming paper in the Journal of Marketing showed that consumers with a stronger local identity are willing to pay more for products because of a sacrifice mindset. Once activated, a sacrifice mindset leads to lower price sensitivity, regardless of the origin of the products under consideration. As an example, management at a grocery store communicated with half its customers to activate their local identity. Then it raised prices for organic eggs, rice and milk. Results from this field experiment on actual purchase behavior showed that purchase quantities were less sensitive to price increases for the local identity group than for the global identity group.

Firms can use simple communication materials to prime a local identity among their customer base to decrease their price sensitivity. Global companies can execute these strategies without resorting to the costly approach of localizing production or positioning the company as having local roots.

Raising prices can be difficult. By linking price increases only to increased product performance, more features and higher value, firms may set themselves up for a vicious spiral of higher costs and higher prices. This can lead to feature fatigue, which can confuse and irritate customers. Raising costs can also erode long-term competitiveness.

Moreover, such an approach takes a very mechanistic and cognitive view of the customer. By expanding and linking their pricing tool kit to brand equity, customer satisfaction, customer identity and market factors, firms can view customers as complete human beings. These factors, when integrated into your pricing strategy, can build a longer-term approach to managing and mastering price increases.

Vikas Mittal is the J. Hugh Liedtke Professor of Management in Marketing at Jones Graduate School of Business at Rice University. 

This article first appeared American Marketing Association's Marketing News as Customer-Based Strategies For Raising Prices.