It's time to know the truth about prices!

In modern business competition, price wars seem to have become a common weapon for companies to compete for market share. This article deeply explores the economic principles and consumer psychology behind prices, reveals the complexity and importance of pricing strategies, and through rich case analysis, tells us that price is not only a digital game, but also a battle of wits about value perception and market positioning.

1. Price Formation

My hometown is Shouguang, Shandong, which is known as the "Hometown of Vegetables in China". There are many secrets to why Shouguang vegetables are sold well all over the country. One of the most important is that the sales channels are very developed.

There is a main logistics park that undertakes relatively large supply and demand, with a daily trading volume of tens of thousands of tons; there are also more than 1,600 village-level markets that collect and sell vegetables from hundreds of farmers in each vegetable-growing village.

In fact, the vegetable and fruit wholesale markets are the ones that best reflect the operating principles of the price mechanism in the market economy.

Fresh products are non-standard products. Packaging, quality, and production area will all affect their prices. Supply and demand are also constantly changing. The price in the village market is basically the local price. Sometimes it is different in the morning and afternoon, and tomorrow's price may be different from today. It is impossible to set the price, and it can only be formed through market transactions and game-playing.

For example, vegetable vendors in a village market (also known as the local market) supply a certain type of vegetable to the owner of a vegetable wholesale market in Beijing. If the supply of this vegetable is small and the price is high in the Beijing vegetable market in recent days, they may arrange to raise the price and buy more, and if the supply is large, they may buy less or not buy it.

Vegetable vendors in local markets will also bargain based on local supply conditions and the situation of other buyers, and eventually reach a deal, or they may not ship to Beijing if the bid is too low and sell to wholesalers in other cities.

The farmers will also decide who to send their products to based on the quality of their products and the prices offered by several vegetable vendors in the area, and then bargain to reach a deal. Of course, the farmers have less room for bargaining.

My biggest feeling from my experience in the vegetable market is that prices are not given but are formed by transactions, which is also in line with the principles of economics.

But this is sometimes different from what we, as consumers, feel. We are used to going to supermarkets to select various products with marked prices. Even in places like vegetable markets and small commodity malls where we face sellers directly, the younger generation has gradually lost the strong bargaining ability of the older generation and basically buys at standard prices.

We are used to buying online. For example, when shopping for fresh produce online, it is sometimes difficult to know how much a certain product costs per kilogram. Some packaged fresh produce will just give you a number like 300g or 400g, and people generally don’t do the math and just buy it because they think it’s not expensive. Sometimes when faced with the question from my mother on the other end of the phone, “How much is a kilogram of your product?” I would be speechless.

For many businesses, there seems to be a lack of awareness of "transactions", and pricing is not based on the understanding and needs of consumers. There are two most mainstream product pricing methods. One is the cost-plus method, which is cost plus a certain percentage of profit.

This is the "self-talking" pricing method. You add cost and profit without considering the consumer's willingness to buy. There is no consumer in this pricing model. The problem is that consumers may not be willing to buy if you don't add profit.

What to do if you can't sell it? Add less profit, that is, lower the price.

The second way is the competition-oriented method, which is to anchor the pricing of industry leaders or competitors, and either copy them or consciously set them slightly higher or lower than those of competitors.

The flaw of this pricing method is that it hands over the pricing power to the competitor. Even in the same industry, each company has some differences in cost structure and demand pattern. Anchoring the competitor's pricing is equivalent to handing over the prospect of one's own profit growth to the competitor.

Because pricing determines how much profit a company can make, and profit is the lifeline of a company.

In addition, both cost-plus pricing and competition-oriented pricing that targets rivals are major factors leading to price wars.

"Price war" is a term we are all very familiar with in the past two years. Price wars in various industries such as clothing, beauty, daily necessities, catering, and automobiles have been extremely fierce.

However, the price war seems to have created a situation where "there are losers everywhere". For example, in the automobile industry, "nine out of ten car companies are losing money", and only BYD and Ideal are really making money in the electric vehicle industry.

The price of freshly ground coffee has been reduced from 9.9 yuan to 6.6 yuan.

The vast majority of companies involved in the price war suffered a devastating blow to their profits, with revenues generally increasing but profits not increasing, or even no revenue increasing at all.

However, some brands that do not compete on price but have unique value have achieved good growth.

For example, Nintendo's Switch has sold 140 million units worldwide in the seven years since its launch. Hardware sales have driven software sales, with cumulative sales of game software exceeding 1.1 billion copies. Nintendo's profits from the Switch's continued life cycle exceed its profits from the previous 35 years combined.

Brands that provide unique emotional value, such as Disney, Pop Mart, and Lego, have also seen quite good growth;

There is also Haidilao, whose prices are not cheap either. Its performance has rebounded significantly in the past two years, with a net profit of nearly 4.5 billion in 2023, and both revenue and net profit have set historical performance records;

People who have carefully compared prices will also find that the things in Sam's Club are not cheap, but last year Sam's 48 stores in China had cumulative sales of 80 billion.

Therefore, a low price does not necessarily mean a good product, and a high price does not necessarily mean that the product cannot be sold.

Pricing is definitely not just a number that is added to a product after it is produced, nor is it used to engage in price wars. Pricing is a strategy that represents the product positioning, value and insight into consumer needs.

I have always been curious about the formation of prices in business. Regarding prices, three points can be summarized:

For consumers, price is a perception, a reflection of value in their hearts. Cheapness is not the basis of consumer decision-making. They pay for perceived value.

For enterprises, price is a series of strategies related to maximizing the company's profits, not a number that is thought up at random.

Companies should attach great importance to price strategy, which is also what Chinese companies lack. At least, price strategy should be placed on the same level of importance as products and sales. The essence of price strategy is to find consumers' value perception, do a good job of product positioning, and provide differentiated value and pricing. Only then will consumers remain loyal and companies can maximize long-term profits.

Let me explain in detail below.

2. Price is a perception

For consumers, price is a perception.

For example, more than ten years ago, small commodity cities were booming everywhere. Some vendors in the small commodity cities would mark up their products very high, and buyers would often bargain fiercely, and if they didn’t get the price down by half, they would suffer a loss.

The vendors occasionally perform a "double act". When a customer asks for the price, the vendor A at the front of the stage will pretend not to know, and turn around to ask the vendor B who is pretending to search for goods among the goods. The vendor B will say a price so that the customer can hear it clearly, such as 188. The vendor A seems to have heard it wrong and turns around to tell the customer that it is 88. The customer seems to think that he has got a great bargain, and may even give up bargaining, and just buy it and leave.

When asked by friends and relatives where he bought the clothes he was wearing and how much they cost, the customer, who thinks he has obtained this product at a very rare price under very rare circumstances, will always smile proudly.

Merchants use fraud to set an "anchor" to make customers feel that they have gotten a great bargain, gained a great sense of satisfaction, and felt that they got great value for money.

As for how much the item actually costs, it is no longer important. This is the "anchoring effect" of price.

Even if no such trick exists, we are still “anchored” unconsciously.

For example, when a mobile phone or a car is launched, there are usually basic version, standard version and flagship version, and the prices increase successively, but most people buy the standard version.

But if the Ultimate Edition is removed, not so many people will buy the Standard Edition, and some will end up buying the Basic Edition. Why?

With three prices, the standard version becomes the "middle price". When customers know very little about the product's objective quality and price, they hope to make the best choice based on limited information.

For most people, the middle one is a rational choice. Compared with the cheaper ones, it has better quality, but compared with the more expensive ones, you won’t waste extra money.

If you go to a store to buy suits, handbags and other products, and you are hesitant when you ask about the price of a product you like, the salesperson will often pull you to see some more expensive products, under the pretext of "giving you a comprehensive understanding of our products." After seeing them, you will think that the one you just saw is not expensive, and your decision-making time may be greatly shortened. This is also called being "anchored."

Classical economics assumes that both buyers and sellers are rational people, sellers pursue profit maximization, while buyers pursue value maximization, and both parties have comprehensive and equal information. But in practice, this ideal state is difficult to achieve.

For example, in life, whether you drink coffee that costs more than 30 yuan, or 9.9 yuan or 6.6 yuan, quite a lot of people don’t know whether they are drinking single-origin beans or blended beans, washed or sun-dried, let alone the details of which estate it comes from and its approximate value.

There are also various beverages and yogurts that claim to have “zero sugar”. Do they really contain no sugar or do they contain erythritol or xylitol?

It takes time and effort to truly understand a product, and people’s ability to obtain and process information is limited. The goal of ordinary consumers is not to maximize their own interests and utility, but to comfort themselves with a "satisfactory" result.

In addition to the "anchoring effect", there is also the "Veblen effect", which is that for certain high-end products and luxury goods with a halo, the more expensive they are, the higher their sales volume, thus bringing higher profits to the company.

For example, LV raised its prices again a few days ago. In the past three years, when everyone was busy with price wars, LV has raised its prices ten times in total, and Hermes, Chanel and others have also increased their prices.

These luxury goods have the "Veblen effect", and the rich regard them as products that demonstrate their status and preserve the value of their assets.

Luxury brands have also achieved “class segmentation” through rounds of price increases, screening out the customer base that “focuses on participation” and making those who can afford to buy feel that they are getting more “value for money”.

After all, according to data from 2022, about 2% of the world's top consumers contributed about 40% of luxury goods sales.

The picture shows the top ten global luxury goods companies in fiscal year 2022 (million US dollars)

(Source: Deloitte Consulting "2023 Global Luxury Power", Eastmoney Securities Research Institute)

But luxury brands cannot simply raise prices. As I said before, behind the price is a comprehensive consideration of products, marketing, and perception of consumer demand.

Second-tier luxury brands like Burberry and YSL have not gained additional sales from the 2% group even with price increases, but have alienated people outside the 2% who contributed to their sales. So these brands have recently started to cut prices again.

High-end luxury car brands such as BMW, Mercedes-Benz and Audi have also joined the price war in the past two years. As a result, not only has the overall profit been extremely limited, but they have also lost the high-end brand image accumulated over a hundred years. As the gains do not outweigh the losses, they have no choice but to withdraw from the price war.

Even if they don't buy luxury goods or high-end products, many people still adhere to the simple principle of "you get what you pay for" and buy something in the middle or upper price range that they can afford. This is different from the mentality of buying something at a low price.

In addition, in life, various sales strategies and pricing of merchants attempt to influence consumers' perception of product value, such as hunger marketing and combination pricing of various packages. Many prices even end with "9", such as 9.9 yuan, giving people a feeling of discount.

All of these are actually intended to make consumers feel that they are getting good value for money, that the money they spend is worth the money they buy, and that they are not being cheated.

Therefore, consumers’ most fundamental purchasing motivation actually comes from the value they perceive, rather than the price itself.

3. Prerequisites for Pricing

Since consumers view prices in this way, for companies, pricing is about understanding consumers’ perceived value and positioning their products well.

But before making pricing, companies need to first correct their understanding of profits, because pricing is directly related to how much profit the company makes. If profits are not taken seriously, then there is no point in talking about pricing.

Many companies suffer from "profit inability" and "profit shame".

The ultimate example of "profit incompetence" is the so-called "entrepreneurship trilogy" that was popular in the past few years: start-up, scale-up, and cash out. This trilogy has nothing to do with profit.

After completing this journey, people like Jia Yueting of LeTV and Dai Wei of ofo went to the United States to start new businesses. The former founded FF and the latter opened a coffee shop.

The large-scale expansion of the Internet in the past few years has resulted in excessive focus on market share and sales volume, sacrificing profits. Many businesses have not yet generated profits. For example, among Alibaba’s many businesses, the only ones that contribute to profits are domestic e-commerce, cloud business, and Cainiao, while the others are basically in the red.

"Profit shame" means that merchants exaggerate the fact that they do not make any profit and say that they are selling at a loss.

At the Xiaomi SU7 launch conference, Lei Jun admitted that Xiaomi SU7 was "losing money" when it was sold: "Xiaomi SU7 is losing money when it is sold for 215,900 yuan, and it is also losing money when it is sold for 245,900 yuan."

This may be Xiaomi Auto's attempt to quickly capture the market, establish brand awareness in the automotive market, and subsequently make profits through cars with higher profit margins, matching a complete set of product pricing strategies.

However, the "loss-making" Xiaomi cars have made scalpers a fortune. Some people have made a net profit of tens of thousands of yuan by reselling a single SU7 car, which means that part of the profits created by the product has flowed to the scalpers, and many buyers are unable to buy it through regular channels.

Many companies have good products, but they also claim in marketing that "you lose money on every product sold", making customers feel that they are making a profit when they buy, and that the price they pay is far less than the value they get. This has a promotional style of "Jiangnan Leather Factory has gone bankrupt... and is now selling at a low price."

Brands would rather use gimmicks like "selling at a loss" to influence customers' value perception than use better products and services to influence customers' value perception and make normal profits at the same time.

If manufacturers have no profit margins, where will innovation come from? This is not a virtuous cycle for manufacturers and the supply chain.

Apple, Intel, Nvidia, Microsoft, Huawei, etc., after earning high profits, invest huge amounts of money in research and development, lead and control global industry standards, gain higher pricing power and control over the industrial chain, and then give back to research and development.

If you don’t offer a normal price, you will easily fall into the trap of low prices. However, from the perspective of the entire business development, it is even more difficult to become a low-price brand than a medium- and high-price brand. The low-price strategy is generally “one general’s success is the result of the sacrifice of thousands of people”.

Because most markets can only accommodate one or two "low-price-high-volume" companies at most, while most markets can accommodate multiple companies with high-end pricing and provide sustainable growth space.

For example, "hidden champion" enterprises, that is, "specialized, refined, special and innovative", are in an absolute leading position in a certain segment. They may be "small and beautiful" small and medium-sized enterprises, but have high profit margins. Low-priced products are difficult to achieve high profit margins, and they must continue to expand to achieve high sales. They are prone to collapse because of being too big and comprehensive.

This also explains why there are basically no winners in price wars. Once a company cuts its prices, almost all its competitors will follow suit. If everyone cuts their prices, if you are not strong enough, your potential sales share will be immediately eroded. Without high profit margins, sales will also be eroded, and it is only a matter of time before you are destroyed.

So some people say with a little exaggeration:

"In war, the atomic bomb and the price have the same limitation: both can be used only once."

4. How to set the price?

It can be said that a company’s pricing strategy is no less important than its product strategy and sales strategy. Price determination should be synchronized with the new product development process. The analysis and research of customer value and pricing should begin during the product development phase, rather than just before the product is launched.

So how can we price better?

This is not an easy question to answer. Price setting requires a thorough understanding of two aspects: one is how customers perceive the value of the product, and the other is the profit level that needs to be maintained or improved based on this perceived value.

Understanding customer value perception is a comprehensive skill. Corporate strategic decision makers need to consider their company's goals, the consumption habits of customer groups, their general willingness to pay, and the behavior of competitors. Only by weighing different goals can difficult decisions be made.

This will lead to a series of follow-up questions, not just limited to price and sales: What factors drive customers to make purchasing decisions? Is price the only factor that drives sales? Are there other better ways to increase sales? Can customers perceive the difference between us and our competitors? How can we expand our competitive advantage? ...

In short, to achieve an effect, there must be differentiation in pricing. Differentiated pricing first requires differentiated products and services.

For example, the reason why Apple and Huawei's high-end mobile phones have better sales and higher profit margins is the differentiation brought about by years of continuous investment in scientific research, brand, design, etc.; Nintendo's Switch pioneered the integration of portability and home consoles, realizing the ability to play games anytime, anywhere, and its software can also continue to innovate, such as "The Legend of Zelda: Breath of the Wild" and "Mario Odyssey"; when Haidilao was first established, its service was called "You can't learn Haidilao."

Differentiated innovation of products and services is very essential, and can be said to be at the level of "Tao". If a company and its decision makers do not understand the market and consumers at the level of "Tao", it will be difficult to create a great brand and product.

There are also some "techniques" that can make pricing differentiated, such as creating consumption scenarios and making good use of different channels.

If you ask how much a can of Coca-Cola costs, it may be difficult to answer because the price is different in different consumption scenarios and channels, and the difference may even be huge.

For example, the price at a big restaurant is definitely higher than at a supermarket or convenience store, but many people still buy it. This is because customers have natural differences in their willingness to pay in different scenarios;

If placed in the mini bar of a luxury hotel room, Coke may sell for the highest price. This is because the differences in customer groups corresponding to different sales channels lead to differences in willingness to pay.

In addition, it is also related to the degree of competition in different channels. For example, when selling on high-speed railways, the lack of effective competition and substitutes will also affect consumers' willingness to pay.

The purpose of saying this is to illustrate that different consumption scenarios and channels will lead to different willingness to pay.

Therefore, many brands are also creating some consumption scenarios, such as "If you are afraid of getting a sore throat, drink Wanglaoji", putting people in the scenario of looking for a drink after getting a sore throat. Its positioning becomes "a drink that can prevent getting a sore throat". If there is no such scenario, then it can only be a herbal tea, and can only compete in the very small herbal tea category.

There are also "Cass one hour after meal" and "RIO tipsy moment", which correspond to a scenario and potentially affect consumers' willingness to pay and purchasing decisions.

At present, different channels also correspond to different customer groups. For example, Taobao is the shelf e-commerce with the most complete product categories. Brands have pricing power here. If new products are launched, it is a more suitable channel; Pinduoduo is more suitable for low-price inventory clearance of fast-moving consumer goods, consumables, etc.; JD.com has channel advantages in the 3C and home appliance industries with higher average order values.

However, it is important to note that product differentiation needs to be done in different channels. Channels with low-paying willingness customers should sell basic and affordable products, retaining the most basic product functions; channels with high-paying willingness customers should sell the latest and flagship models. If the same product can be bought at a lower price in other channels, I'm afraid no one will spend an extra dollar.

In addition, there are some other pricing strategies, such as thinking from the perspective of customer needs. Customers needing a certain product may not mean that they must buy it to be satisfied. They value the product's ability to help them solve problems. If your product has such characteristics, you can transform selling products into selling services.

Aircraft engines from General Electric and Rolls-Royce were previously sold, but in fact, the competition in the sale of aircraft engines was fierce and the profits were not high. The high-profit margin came from engine maintenance, but the threshold for engine maintenance was relatively low, so the profits were taken away by other competitors.

So General Electric and Rolls-Royce changed their business model from selling engines to leasing thrust, charging airlines based on the time the engines were in operation while also providing other services such as maintenance, which instantly expanded the profit sources for both companies.

There is also combination pricing, which is to sell several products in a package. Typical examples are McDonald's classic meal (hamburger + French fries + soft drink) and Microsoft's Office software suite.

However, the principle of "buying the box and returning the pearl" tells us that some customers just don't like packaging and only want the box to put the item in, but not the item inside the box.

IKEA has seen through this demand. Many of its products can be sold separately. Even the Samra storage box for storing sundries has been separated into three parts: the box, the lid, and the locking clip that fixes the lid. Customers can buy them separately or as a set. Some people may only need a box at first, but later they need the lid and the locking clip when they move, and they can buy them for a little more money.

There is also a membership pricing method, the most typical of which are Costco and Sam's Club. Costco's Venus membership fee is 299 yuan per year, and the opening special membership fee is 199 yuan per year. According to Costco's financial report, more than 70% of its profits come from membership fees, while the profits from selling goods are not high. In other words, Costco mainly makes money from membership fees, and its high-cost-performance, low-profit products are mainly used to attract people to become members.

There are many other pricing methods, so I won’t go into detail here. In short, companies that successfully implement pricing strategies either have disruptive products and services or have insight into consumers’ potential consumption habits.

This is all based on a profound and universal perception of the market and consumers, and is from a value perspective rather than simply a price perspective.

As price wars rage on until there are no winners left, more companies may realize that the main battlefield of competition is gradually shifting from price to value, and that their own pricing strategies deserve attention.