The lower your prices, the happier your customers will be… right? (Not really!)

One personal story

I found myself in charge of pricing software services for Europe at DEC. Customers had fewer problems with the more recent versions of our software, and we wanted them to update. First, we implemented a policy saying that once the software was two versions old, we would not support it anymore. That seemed to have no effect. Then the business leader, Denis de Pentheney O’Kelly, decided to add financial motivation. If customers were on obsolete versions of software, they needed to buy ‘Mature Version Support’ at a price premium of 50% over the standard support offer. In addition, Mature Version Support had a level of service described as ‘best effort’, with no guarantee of actually fixing anything. We sent this message to all potentially affected customers. Surprise! They were just delighted, and 100% took up this new offer, which they considered to be a premium service. Why does this make sense?

Expectations and perceptions improve as price increases

Dan Ariely and colleagues Baba Shiv, Rebecca Waver and Ziv Carmon ran a striking (and painful) experiment at the MIT Media Lab facility. 100 Bostonians went through the experience. While waiting, they were asked to read a brochure about a new painkiller, Veladone-Rx. The brochure said that in clinical trials “92 percent of patients reported significant pain relief within 10 minutes.” The brochure also said the price was $2.50 per pill. The subjects (victims, in my opinion), were then told that the experiment was about perceptions of pain. They were connected to wires and subjected to a sequence of electric shocks, ranging from mild to very painful indeed. After the painful part, the subjects were given water and a capsule of Veladone-Rx.

Fifteen minutes later, Waver asked them to return for a second series of identical shocks. Almost all reported significantly less pain in the second round. It must have been the Veladone-Rx! Surprising, since it was just a capsule of vitamin C. In the following phase of the experiment, only one thing was changed: the brochure now said that the price of Veladone-Rx was just 10 cents per pill. Now only half of the subjects reported pain reduction.

In addition to the obvious conclusion that pricing has a surprising placebo effect, my conclusion is that behavioral economists are sadists.

Lest you think this is not relevant

My colleagues in HP’s outsourcing business were very concerned. The CEO of a major multinational bank had recently testified to a US Congressional Committee. Included in his testimony were the words, “I knew nothing about any of my employees helping US citizens to avoid taxation.” The bank wanted to be certain that this was true and wanted to implement what is known as eDiscovery software, and compliant archiving software to prove it. Ten companies were bidding. The bank’s procurement people had told the account team that we were among the three most expensive, and had no chance.

The account manager came to me, pleading for a price reduction, having tried other methods. All our business with the bank was at risk, according to him. I asked him to imagine the following discussion between the CIO and CEO. “Hey Fred, remember that software we need to buy to ensure you don’t wind up in prison? You will be happy to know I chose the lowest-price vendor.” I asked the salesman how likely that conversation was to happen. He understood, and a few days later we were told who was on the short list of three finalists. Guess what? The three most expensive solutions were the only ones left.


(As is often the case, this blog post is a mildly-edited version of a chapter in one of our books. In this case the book is Customer Experience Strategy – Design and Implementation. All of our books are available in Kindle and print versions from Amazon.)