Pricing

Leveraging the Law of Relativity With Your Pricing

Written by James Garvin for Gaebler Ventures

Pricing is a difficult decision for many new businesses. Often pricing is done by copying the same format as other competitors in the same industry thus offering little differentiation between firms. Knowing how to use the law of relativity and how it drives purchasing decisions can help you and your firm use pricing strategy to successfully differentiate yourself from the competition and acquire new customers.

In his book, Predictably Irrational, Dan Ariely describes a young Howard Schultz and his drive to create a new experience for coffee drinkers.

At the time, most consumers were accustomed to buying their coffee for $1 at their local Dunkin Donuts or bakery or simply brewing their cup of joe at home. Why in the world, would someone now pay $2 or more for a cup of coffee? The key to success for Starbucks as described by Dan Ariely, was to change the consumer experience so much that they wouldn't even compare the coffee at Starbucks with the coffee at Dunkin Donuts. Starbucks made it so that it was very clear that it was not the same cup of coffee.

The law of relativity states generally that decisions are based on the perception of value of something similar, especially when it comes to valuing a good or service. It is very difficult to assign an absolute value or price to a product or service with out some sort of relative product to compare it to. Relativity is used in every single purchasing decision we make. Think of the home you bought or rented.

Odds are you looked at more than one home before settling on your place of residence and compared the value of your current home with other comparable homes. The "other homes" were the relative source that helped you base your decision on living where you are today.

It is very difficult for any new businesses to garner its own unique identity that separates it enough from the current competition, however this is often the key driver for success. For Starbucks, every little change they made in their operations such as calling their cup sizes tall, grande, and venti rather than small, medium, and large helped to separate Starbucks and the Starbucks experience from other coffee chains.

Cumulatively, these changes allowed Starbucks to successfully create its own identity that prevented its customers from comparing Starbucks to Dunkin Donuts. In other words, Starbucks and its customer experience were so different from Dunkin Donuts that consumers did not think about the price of coffee at Dunkin Donuts when they went into Starbucks to buy coffee. They changed the game of relativity in the coffee market.

Consumers always purposefully or accidently compare a product offering and its price with the next best offering. This is why when firms get into a pricing war, consumers only look at price to compare the products. The value of any differentiation has been depleted and as such consumers win as they are provided with the lowest possible price. Whether you are a consultant bidding on request for proposals for a client project, a consumer goods company, or a B2B firm, understand how the law of relativity impacts your customers buying decisions.

Evaluate how you can use this understanding to change game and avoid having your customers evaluate your product or service merely on price with other products. Do what Starbucks did for coffee to differentiate your offering and you will succeed in being able to charge higher prices then your nearest competitors.

James Garvin began his education studying biotechnology. In recent years he has turned his interest in technology to helping two internet startup companies. The first business was an online personal financial network and the second was an e-marketing platform created to help entrepreneurs demo their web sites. Currently a student at University of California Davis, James is spending his summer incubating two new online businesses and writing about his entrepreneur experiences.

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