This article originally appeared on HBR.org.
Price wars have broken out in consumer industries around the world. Retailers such as ALDI and Walmart have used price to position themselves against traditional competitors in their markets, pinching margins all around. Financial asset managers have been out-price-cutting one another in exchange-traded funds in a bid to gain market share. Major U.S. telecommunications carriers now compete fiercely on price as they try to win new customers. And airlines are gearing up for a price war on trans-Atlantic routes as some low-cost carriers plan service between the U.S. and Europe.
These companies are reducing prices because they believe that will boost their perceived value to consumers. As pressure intensifies to reduce prices, either by cutting the list price or offering a discount, managers may act hastily, without the same rigor they apply to investments elsewhere, such as capital deployment or product enhancements.
But when managers reduce prices, a fundamental question sometimes goes unasked: Will customers notice and respond as expected? All too often they don’t. That’s because how customers perceive the price is as important as the price itself. Even if customers fail to notice specific price moves in isolation, companies should make sure customers have a good sense of how the firm’s prices compare to those of competitors. And most companies—luxury purveyors aside—want to be perceived by consumers as having lower prices, relative to competitors, than they in fact do. A store with the same prices as a competitor’s would like to be seen as having lower prices; and a retailer with average prices that are 10% higher than a key competitor’s would love to be perceived as being only 5% higher.
There are clear winners and losers in the battle to manage price perceptions in order to get this so-called “pricing credit” from consumers. Bain & Company and ROI Consultancy Services (formerly PollBuzzer) recently surveyed almost 2,200 consumers in Atlanta and Washington, DC, about the prices at eight retail chains carrying groceries. We found that retailers can get either more or less credit for their pricing than actual shelf prices would suggest.
For example, one retailer’s reputation as an upscale discounter, built through its store and product design, has given consumers the perception that it charges a price premium, when in fact its prices run slightly lower than the average in the two cities. Its pricing strategy does not mesh with its overall proposition to customers, with the result that the retailer does not get the pricing credit it deserves. One option for the retailer would be to raise its prices slightly, since customers have already baked the (incorrectly) perceived premium into their shopping decisions.
The intense competition on pricing that pervades many industries makes consumer perception more important than ever. Aggregator and comparison websites have brought greater price visibility and ease of product comparison to banking, insurance, hotels and other consumer markets. It’s also easier for consumers to split their spending among different providers, depending on which firms offer the best perceived price-value equation. Bain’s grocery survey shows that half of consumers’ monthly spending goes to stores that are not the consumer’s primary store.
Managing price perception, not just pricing structure and actual price points, thus has become a critical capability for firms in consumer markets.
How can companies get more credit from consumers for their pricing, so they can build traffic and earn loyalty?
Companies can choose among tactics in four categories: offering lower prices, shouting out those prices, giving great deals, and tailoring the experience. Examples of tactics within these categories include price-point policies (such as ending a price with the digit 9), in-store or website signage, coupons, and a good/better/best assortment mix. The right combination of tactics, of course, depends on a company’s sector, strategy, and proposition to customers.
A traditional grocer that caters mainly to higher-income customers, for instance, needs to have a broad assortment and high perceived quality. It would focus on very targeted moves to align price perception with its high-end value proposition, including strategic promotions and signage, rather than on tactics that would significantly change the proposition, such as price matching or coupons.
A discount grocer, by contrast, typically uses private-label goods to influence price perceptions. Since its customers are less sensitive to product quality and breadth, the discounter can offer a narrower assortment, which allows it to present a lower-price and lower-end image in stores.
To determine which of these tactics to deploy, a company should first gain a deeper understanding of its current price position relative to consumers’ perceptions. Checking its prices against competitors’ prices on comparable items will reveal actual price gaps. Then, determining consumers’ perceptions will show whether and how they see those price gaps. The key survey techniques involve asking consumers to select a couple of competing providers with whom they shop, and gauging how they view each provider’s pricing on the relevant products. By aggregating hundreds or thousands of responses, a distinct pattern of price perception for each company will emerge.
The next task is to identify the factors that have the strongest influence on perception. These can be gleaned through in-store visits and surveys asking consumers about the provider’s signage, coupons, and so on. Again, aggregating responses allows managers to see how consumers perceive the company’s performance in each tactic relative to competitors. If consumers perceive a chain’s prices as lower than they really are, the analysis can home in on the tactics that most effectively drive that perception.
Data on the factors influencing perception is the foundation of a plan to build an effective price image, a plan that will likely include a mix of direct price changes and indirect tactics like rewards programs.
The experience of a European discount apparel retailer illustrates the power of a disciplined price-perception program. Facing stiff competition from other fashion discounters, the retailer fought back by slashing prices across the board, but customers largely didn’t perceive the price change, and the retailer didn’t achieve the anticipated boost in sales volume. It decided to step back and take a more nuanced approach. In a process similar to the survey approach described earlier, the retailer analyzed its prices relative to competitors and customer perceptions and discovered that consumers incorrectly perceived that the company had higher prices than its key competitor. One reason was that the retailer offered a broader range of prices than its competitors, which confused people. Also, the company discovered that customers were more price sensitive about certain product categories, like children’s T-shirts.
The retailer defined new “roles” for product categories, based on customers’ perceptions of products, and priced according to these roles; for example, some products were assigned the role of driving foot traffic to stores, while other products played the role of enhancing margins. The retailer refined communications about pricing to make them consistent with the price perceptions it sought, and it reduced the number of price points. As a result, the company achieved its desired “price image” as a value retailer, developed a more strategic approach to pricing, and increased revenues by roughly 1%.
As this retailer discovered, there is a lot more to pricing power than just adjusting prices. Directing investments to lower prices may not supercharge sales. Worse, it might backfire if consumers’ perceptions don’t give the company sufficient credit for its price position. More indirect tactics, such as adjusting signage and using private labels, on the other hand, may have an outsized impact on pricing perception—a proven route to profitable revenue growth.
Sandeep Heda is a partner with Bain & Company’s Customer Strategy & Marketing and Retail practices, and is based in Atlanta. Stephen Mewborn is a partner with Bain & Company’s Customer Strategy & Marketing and Retail practices. He leads Bain’s global pricing work and is based in Chicago. Stephen Caine is a partner with Bain & Company’s Customer Strategy & Marketing and Retail practices, and is based in Chicago.