How to Set Winning Prices

Last Updated May 6, 2010 9:04 AM EDT

Are you confident that your innovative pricing strategies capture value and customers for your company? If the answer is no, you're not alone, according to Smart Pricing, a book by Wharton professors Jagmohan Raju and Z. John Zhang. In fact, if you're like most managers charged with setting prices in an era marked by global competition, price transparency occasioned by the Internet, and increasingly value-conscious customers, it's more likely that you shun innovation in favor of mimicking the competition. During a recent conversation, professor Zhang said that's the wrong approach and offered some strategies on how to set prices more effectively.

Z. John Zhang BNET: Why do pricing decisions cause so much angst?

Zhang: They're difficult to make and have the potential to do a lot of harm -- or good. Also, they're very visible. No one in a corporate setting wants to make the type of decision that could result in public blame. So, it's easier to follow convention and justify it by saying that's what everyone else does.

BNET: What's the best way to overcome these hurdles and price more effectively?

Zhang: First, you have to know your customers, which includes understanding what they value about your product or service and paying close attention to their buying behavior -- knowing how they make buying decisions, what and where they buy, and how much or how frequently they make purchases. Next, you have to realize that, even for the same product or service, different customers are willing to pay different amounts. For that reason, it's rarely smart to set a single price. Finally, recognize that there are many creative ways to set prices regardless of how conventional the product is. For example, the publisher of our book could sell it outright to the reader at a fixed price, "rent" it to readers for a fee, or sell it by the chapter.

BNET: Can you offer a real-world example that illustrates these points?

Zhang: Sure. The band Radiohead provides a good one. On October 9, 2007, they began a 20-day experiment. Frustrated with traditional music distribution channels, the band decided to let fans pay whatever price they wanted -- including nothing -- to download its latest 10-song album, In Rainbows. When customers got to the online price box, they saw only a message that said, "It's up to you."

By the time the experiment ended, more than 1.8 million people had downloaded the album. Although 60 percent didn't pay, the rest did -- enough to make In Rainbows a success for the band. The average price paid, $2.26 per album, probably resulted in more cash for Radiohead than the band would have gotten through conventional album sales characterized by layers of middlemen. Plus, the band generated valuable buzz with this strategy.

BNET: What does this tell us about Radiohead's fans?

Zhang: To a large degree, they're fair-minded and devoted. It wouldn't be a great idea for Big Oil or Big Pharma to try a similar experiment, which is why it's so crucial to know your customers.