If you’re interested in pricing and have done some research on the subject, you’ve probably come across the “you better err on the high side” advice.
Although in most situations I’d probably say overpricing may be better than underpricing, the reason why it’s true, has nothing to do with the widespread belief that it leads to a higher profit. That one is actually a misconception. Whenever you move away from your optimal price, regardless of the direction in which you err, you're worse of. Equally worse off.
When it comes to profit maximization, pricing too high and pricing too low are just as bad. You won’t get higher profits by erring on the high side.
Don’t believe me? Keep reading, and I’ll show you.
Imagine you have created your first online course, and in order to determine your optimal price, have surveyed your mailing list to understand how many of your subscribers would buy it depending on its price. Let’s assume you used proper methods and implemented them well, so your data is half decent.
Now in this table, we can see your expected monthly sales, depending on your course's price.
But let’s keep going with our analysis.
Let's then assume that whenever you sell a course, you have to pay a payment processing fee of 3% of your sales.
Additionally, you have to pay a monthly fee of $100 for the teaching platform.
As we subtract these costs to our expected sales at each price point, we get to our expected profit at each of the price points under analysis.
If you look at the numbers carefully, you see that the optimal price from a profit maximizing standpoint seems to be $125.
And furthermore, notice that you would get exactly the same profit if you charged $100 than if you charged $150. The same is true for $50 and $250. That means that pricing too high, and pricing too low, get you exactly the same less than perfect result. At least in terms of profit.
A note of caution here: this is a very simplified scenario.
For example, the additional work brought by the much higher number of students at lower prices isn’t being considered here; nor is the additional marketing effort associated with a higher price. In real life, that’s something you’d have to factor in together with your other costs when calculating your profit maximizing price.
But anyway, getting back to our example, the important thing to note is that regardless of whether you overprice or underprice, as you move away from the ideal price, your profit would be lower. In this example, your profit would actually be higher at $100 than at $200.
This leads us to conclude that the “you better err on the high side” that pricing experts keep talking about, isn’t about profit maximisation.
So… what is it about? Why say that it’s better to overprice?
Well… simply because in the vast majority of cases, it’s easier to correct a pricing mistake.
The big difference between making a mistake by pricing too high, and making a mistake by pricing too low, is how that mistake will later allow you to gradually improve your price, or if needed, clean up after your mess.
In the vast majority of cases, it’s easier to lower a price than to raise one. Although that’s not always true.
So, when is it safer to err on the high side?
When this leads to lower client dissatisfaction.
The thing is,
- Clients don’t always notice that a price has increased. Because the truth is… sometimes they don’t know how much it cost before. In fact, one thing that always surprised me when testing price recall, was how utterly unaware people often are of the prices they paid for something. In some cases, that they paid for on a regular basis.
- When they do notice it, customers don’t usually like price increases.
So, when are price increases dangerous? To start, when clients or potential ones notice them. But not all increases are equally noticeable.
Changes in prices of subscriptions (especially when frequently paid for), products that are purchased very frequently, and products that have a high impact on the customer’s budget (because of high price or purchase frequency), are easily spotted.
When people keep paying attention to a product’s price, they are likely to remember it. So when it changes, they notice.
If you have to price a product that people purchase repeatedly, and whose price customers are likely to remember, it really is better to err on the high side and lower.
Customers will be happy the next time they purchase it for less money. On the other hand, having to pay more for the same thing, won’t bring tears of joy to anyone.
But when is it safer to err on the low side?
Again, when correcting that price upwards leads to lower client dissatisfaction.
It may seem counterintuitive, but lowering prices can be problematic too.
- If you only buy a product once, and its price increases after you purchase, you won’t be annoyed by it, will you? you might even be happy that your product’s value increased, or that you made a good decision to buy when you did, right?
- On the other hand, if you purchased something that you thought would be an investment to later find out that you could buy it now for a much lower price, how happy would you be about that? Would you hurry to buy form this company when it launched another product?
Of course, people who haven’t bought yet may be annoyed by the increase. But again, they would have to notice it first. And it might even be a good incentive to get them to purchase before the price rises again.
So, when you are pricing something that your customers are likely to consider an investment, it’s less likely that you annoy them, lead to purchase delay, or even scare them off before they buy anything, if you raise your prices, than if you lower them.
In this case, it’s better to err on the lower side, because it’s easier to correct upwards.
Who wouldn’t be happy to see that the value of their investment increased?
So… can overpricing be better than underpricing? Profit-wise, no.
A bad price, is a bad price. You want to be close to the profit maximising one. When you move away from your optimal price, you miss out on profits. Regardless of the direction of your error.
From a price optimization point of view, yes. Overpricing can be better. So can underpricing.
It all comes down to your market and product.
This will determine how easy or difficult it will be to raise or lower your product’s price. In general, raising prices is tougher than lowering them, but that’s not always the case. So, do make sure you understand your specific situation before you chose the side on which you prefer to err.
Anyway, that's it for today! See you in the next post!