Chris Bjorklund: You’re listening to the AllBusiness podcast. I’m Chris Bjorklund. If you’re getting this through iTunes, an RSS feed or an online streaming-media player, you can hear interviews with other experts at AllBusiness.com.

Chris Bjorklund: Is your pricing strategy more of a poker game than a science? And how do your customers determine whether your price is right and, more importantly, fair? Dr. Sarah Maxwell is the expert featured in today’s AllBusiness podcast. Dr. Maxwell is an associate professor at Fordham University, where she teaches marketing. She is also a co-founder of the Fordham Pricing Center and associate editor of the International Journal of Pricing. We are also joined by AllBusiness reporter Paul Kilduff. Sarah Maxwell, welcome to the AllBusiness podcast. Can you tell me why do you as well as others say that successful pricing is really more of an art than a science?

Sarah Maxwell: Well, it’s certainly--it’s becoming more of a science but it’ll always have to be an art. But we do have computer programs out there that if you--lots and lots of customers, like the airlines, they can come up with a pretty good idea of a price for you. But many businesses don’t have that luxury of having all that data available and in most cases even the best consultants can only give you a range of prices and you then have to figure out which of that, within that range, where you should price it. And even the big companies don’t get it right. I mean, for heaven’s sake, look at what the iPod did. It fell flat on its face. So it’s hard.

Bjorklund: So how do consumers determine what is a fair price for something, according to your research?

Maxwell: My research shows that they really take two steps. The first step is just whether the price is personally fair. Is it fair to them? And that means, is it cheap? And the way they figure it out, whether it’s cheap or not, is comparing it to what’s called a reference price. This is a price that they expect. And if a price is less than that, then they say fine, that’s a fair price. They buy it and they don’t think about it anymore. But if the price is not personally fair to them, then they consider the social fairness. And the social fairness gets into things like equity. Am I getting as much in return for what I’m spending? This doesn’t mean it has to be cheap. I mean, you look at Starbucks. The prices are by no means cheap but people feel as though they’re getting a decent return for it. So that’s considered fair. They also look at, “Am I paying as little as other people are paying? Does someone else get a better price than I do, because that’s not fair.” So these are social concerns in addition to the personal concerns.

Bjorklund: We decided to send out our AllBusiness reporter Paul Kilduff to ask some shoppers exactly what goes into their thought process when they look at prices and they make a purchase. Paul, did anything surprise you out there?

Paul Kilduff: Well, I think the denial aspect of people who are shopping caught me off guard, as a lot of people want to act like they don’t do a lot of shopping or they just dash in, pick something out, come out and they don’t want to really think about it too much.

Bjorklund: They don’t call that shopping?

Kilduff: Well, you know, they don’t. “Hey, I don’t shop. I don’t...this isn’t something that I do, you know, I don’t have time for shopping. I’m out running the world.” There was that aspect of things. Also, people, if they did any sort of research at all, it was on the internet and then they felt that was the end of it. So if they found a better price on the internet, then they felt they did their research. But I don’t think they really knew that much about how prices were set.

Bjorklund: Well so what’s, let’s give a listen to what some of them had to say.

Male: For large-ticket items, I usually go online and get an idea of different prices but they could all be high and I wouldn’t know.

Kilduff: How do you know that you’re getting a fair price for something?

Male: I don’t.

Kilduff: You have no idea.

Male: Well, I’d compare it, I guess, to what everybody else is paying, at different stores...

Kilduff: How much research are you going to do? Just depends on how much it costs?

Male: No, I let my wife do the research. She decides...

Kilduff: OK, your wife just says, “Go buy this at XYZ store.”

Male: Exactly. She makes all those decisions. I’m the courier.

Kilduff: That’s a good way to keep a marriage together. Is that what Dad does?

Kid: Uh-hmm.

Kilduff: How do you know you’re getting the fair price?

Male: Easy, we don’t do a lot of shopping.

Female: We do actually shop. You have to admit this, we do.

Male: Well, we do some shopping.

Kilduff: You do some shopping?

Male: Well, yeah, I’ve been in a shop before.

Kilduff: How do know you’re getting the fair price?

Male: I have no idea.

Female: The small stuff, we don’t care. The big stuff, we do and we research.

Kilduff: How much do you really know about how prices are set?

Female: I used to be a dress buyer. Most of our dresses were 36 percent higher than what we paid wholesale.

Kilduff: How much do you think the average consumer knows about how prices are set?

Male: I think that people like to spend money. I went to a store with my brother where he was buying T-shirts for $100 each and I thought, how crazy is that? But he bought seven of them and then they were all too small and he had to return them. I hope they have a good warranty.

Kilduff: How do you know that you’re paying a fair price for something?

Male: I don’t. I always suspect that I’ve overpaid.

Kilduff: How much do you know about how prices are set by a retailer?

Male: I just assume they move it to whatever they can get away with.

Bjorklund: Sarah, do any of those comments surprise you?

Maxwell: I think one thing that should be pointed out is that almost all the people interviewed were men and men have a very different attitude toward shopping than women do. Men like to be cavalier about it. They like to show that they go in and spend money and shopping is not really--that’s a woman’s job. So I think that that needs to be pointed out. The fact that they don’t know confirms a lot of research. They’ve done research on prices in grocery stores, 50 percent of the people don’t have the vaguest idea what the price is. The second they’ve taken something off the shelf, they don’t know what the price is. So this is not surprising.

Bjorklund: Speaking of women, have you found that most businesses really underestimate kind of the emotional aspects of pricing and if they do ignore that or underestimate it, does it lead to problems?

Maxwell: I was going to say that they don’t just underestimate it, they ignore it totally. They think that prices are very rational and that people are very rational when they come to looking at prices. But that’s not the way things happen. I mean, people are emotional about looking at a price and it’s good or it’s bad. And this is very important because the research shows we can’t even make a decision without emotions. They’ve done studies of people who in their brain, something is touched so that they can’t get up their emotions and they can’t come to a decision. This stuff is very sad. It is the emotions that are just a yes or a no.

Bjorklund: Sarah, if a company doesn’t look at the emotional aspects of pricing, can this really backfire on them?

Maxwell: It backfires because they think people are much more rational than they are because businesses themselves are rational. Businesses think that people are very price sensitive. They think they are far more price sensitive than they actually are. And the reason is that a tiny, a cent difference means a huge amount to a business but it really doesn’t mean so much to the consumer so they overestimate the rational aspect.

Bjorklund: So Sarah, what are some of the most common methods for setting prices? There must be something that’s in all the textbooks if you’re really looking at this from an academic point of view.

Maxwell: What the textbooks say are the three C’s of pricing, which are competition, cost and consumer. I think there’s another C, which is just custom. But I’ll go over each of those. Competition pricing is obvious. It’s when you meet or beat the competitor, when you guarantee the lowest price. This is a very good thing to do because people like it.

Bjorklund: I mean, this is the American way.

Maxwell: It’s the American way. We like competition. This is the way things should be. So that’s fine. Cost-based pricing is the traditional kind of pricing. It’s, I think of the woman who spoke about marking up the dresses, what, 36 percent? This is the way things are done and if you’re in a grocery store, for heaven’s sake, and you have thousands of choices then that’s the only way you can do it. So...

Bjorklund: Is that why those T-shirts were $100 that Paul was talking, you know, he heard about it on the street?

Maxwell: I don’t know if they just marked that up a certain percentage or they decided that they were dealing with buyers who really liked spending $100, which was exactly what that customer did.

Bjorklund: Any comment there Paul?

Kilduff: Well I think that the guy, the brother who summed it up and you just did as well, that people want to spend a certain amount of money on an item and it doesn’t really matter to them whether it’s worth that or not. I know my wife is a little bit like that. The first thing she will ask me, if she sees me wearing a new shirt, even if she, you know, likes it or doesn’t like it, is well, “What did you paid for that?” So that’s the beginning of how she’s going to form a judgment about it. You know, and I think everybody does that to a certain extent. But I don’t, you know, $100 for a T-shirt, that seems a little extreme but for some people, maybe it isn’t.

Bjorklund: So go ahead, Sarah.

Maxwell: Well I would step in to say I think there is a symbolic quality to prices that people assume that the price means how much the thing is really worth. So a $100 shirt must be a very good shirt. And this is something that I think you can underestimate it, because it certainly happens. OK to get back to the other kinds of pricing, customer-based pricing is what the airlines are doing. This is where you go out and you charge as much as the customer will pay for something. The economists really like this kind of pricing because, of course, you get the most out of every single customer that you possibly can.

Bjorklund: It’s efficient.

Maxwell: It’s efficient. Yes, exactly. And the final kind is custom and, as I say, people ignore this because it’s so obvious that people don’t even think about it. Nine-10ths of a cent added onto gasoline prices, I mean, this is bizarre. How did this ever happen?

Bjorklund: Yeah, why isn’t it rounded?

Maxwell: I don’t know where it started. And there are other things, like you don’t charge for elevators...

Bjorklund: That’s right.

Maxwell: You do charge for shipping and handling. It used to be that food was provided free on airlines. These are just customs.

Kilduff: What is handling anyway? I mean, you understand shipping but the handling, what are they doing?

Maxwell: That’s putting it in the box, there’s a lot of work involved in that.

Kilduff: I guess so. It costs a lot.

Maxwell: It does cost a lot.

Bjorklund: So custom is, as you said, rarely thought about by people setting prices?

Maxwell: No, they don’t think about it because it’s so obvious. I mean, it’s the way you do it. So it’s just hidden away there.

Bjorklund: So which method is the most fair to consumers?

Maxwell: Anything that is customary is fair. I mean, if this is the way it has been done for ever and ever and people expect it, then they consider it fair. So if you follow the customary price systems, that’s certainly considered fair. The problem is when you change. If you change it to the benefit the customer, that’s considered fair. If you remember when AOL changed from--they had a per-usage fee and then they changed to a flat fee?

Bjorklund: That’s right.

Maxwell: That’s considered just fine. I mean, that benefits me.

Bjorklund: And when they became free, that was yet even better.

Maxwell: Oh that’s even better. Conversely I was dealing with a museum recently and they’ve decided to change from free parking to charging for parking. Yes, this is considered very unfair so...

Kilduff: Do you--I’m just jumping in for a second--do you think that consumers, when they find out that something is free, I mean, I always kind of get this impression that, “Oh, this is free but they’re just going to charge me, it’s a hidden cost that I’m paying in some other item that I’m buying or some other part of the service.” So if something is free but I’m actually paying for it.

Maxwell: I think they certainly think that. But particularly with the internet, people are beginning to assume that they can get a lot of things for free. This is not good. I think Napster did us all a huge disfavor because it’s very bad to get this idea in people’s heads. But I think that some free things like free shipping and handling, I accept that as being free and that’s certainly a good thing. And certainly as you were saying, competition is considered a good thing. It’s certainly an American ideal and it is considered fair. Where do you get into some problems with cost-based pricing and customer-based pricing? Cost-based pricing has traditionally been considered fair because it was based on external things that you had no control over and so it wasn’t your fault. It was understandable. But it seems--I’ve done some research and this seems to be changing. That customers are now saying, “What’s wrong with you? You can’t control your suppliers? Why don’t you go to China and find someone cheaper to supply you? I’m not going to pay for the fact that you aren’t managing your costs.” This is a big change I think.

Kilduff: What is that, like the Wal-Mart syndrome or something? Is that--everybody knows that.

Maxwell: Yes, I think so and I think all through the ’90s there was so much cost cutting that people started getting just used to the fact that you can control your cost. This is not something that is beyond your control. So basing your price on your cost is not necessarily a fair thing to do. Customer-based cost of pricing is even more tricky because it’s hard to find a segmented market. You should certainly segment your market and be charging different prices to different groups based on how much they value your service. This is a good thing to do but customers can think you’re taking advantage of them. Like the airlines charging businesspeople extra because they buy their tickets late. Businesspeople think this is taking advantage of them so this can be a difficulty. Also, what’s included in the cost can be a problem. Included in these costs are the wages for the CEO and you get some CEOs earn over $140,000 a day...

Bjorklund: And that’s a sore point.

Maxwell: That’s a sore point. Why should I be paying for that?

Kilduff: And they can’t even hit a fastball, I mean that’s just--I don’t know what is up.

Maxwell: That I think is a real problem, to say nothing of what percentage you’re adding on. You look at some of the--like the gasoline companies, the amount of profits they are making? Who’s to say that’s fair? This can be a real problem.

Bjorklund: You’re listening to an AllBusiness podcast with Dr. Sarah Maxwell, author of The Price is Wrong, and AllBusiness reporter Paul Kilduff. Sarah, can you tell me if different rules apply to pricing products rather than services? I don’t know about you but it seems like kind of a tricky area and a slippery slope for the consumer of services.

Maxwell: Well, I think pricing services is very difficult because you don’t have cost to base your price on. But if you do have cost, you can sort of fight this external thing that’s forcing you to make the price. But if you’re with a service, it’s just the person or list of chore service, you have like restaurants who also have food and they can just mark up the food like three times to get their price. But if it’s a pure service like a consulting service, you’re just paying for that person and this is a much more difficult task. What I would certainly suggest people do is you have to establish your reference price. If you remember this price that people use to determine whether a price is fair to them, you have to get an idea in their head that this is what my hourly rate is. This is my normal rate and then maybe you discount it for them. But you want to make certain that they get that reference stuck in their heads. And how do you do this? Well, you talk to people. You ask people. You ask your peers. What do they charge? If you ask your customers if they’ve talked to other people, what their prices were, you get some idea of people in your kind of work what they’re charging. And then you base your price on that, depending on whether you think you’re better than the usual or whether you think you’re just beginning. Whatever, but it’s difficult.

Kilduff: There’s a radio commercial for a plumbing service now that I’ve been hearing where they tout the fact that they just charge a flat rate. Is that a better deal for you when you’re hiring, say, a plumber, do you think?

Maxwell: This whole thing about a flat rate or an hourly rate, it’s very interesting. It can work either way. I talked to a lawyer who said, he was a trial lawyer, and he said that he always gave his customers a choice between having a flat rate or having an hourly rate. And he told them that the hourly rate generally worked out to be cheaper because things got settled out of court and he said 100 percent of his customers chose the flat rate because, even though it was more expensive, they knew how much they were going to be charged. And this gets back to expectations...

Kilduff: So it’s the certainty of knowing I’m going to pay X amount, that’s it.

Maxwell: Right, even if that X is higher than you might have paid if you paid the hourly.

Bjorklund: Sarah, in your book you talked about knowing, if you own a business, you should know what are your objectives before you set a price. Do you find that a lot of companies haven’t figured that out first? That they don’t sit and think about it that way? And why is that important?

Maxwell: It’s important because you’re going to have different charges. I mean, most companies they just start out thinking about profit, that this is everything that they want to do but there are many other concerns that maybe one who established a reputation--so you’re going to charge a low price in order to get some real plum jobs. Maybe you want to enter a new market, maybe you want to establish a new product. Maybe you have to get some cash. I mean, all of these are going to change how you’re going to price your product or your services.

Bjorklund: If you owned a small business or you were advising a small business owner who wants to have a reputation for promoting fair prices, what are some of the things that you would tell that business owner or tell yourself if you were mapping this out for someone and they got a fresh start and they’re creating this fair-price image?

Maxwell: I would say, first, they’d have to read the entire book, The Price is Wrong, but I’ll say three things that I think are most important. The research shows that having a price that’s stable is what is considered most fair, particularly in business to business. If you can swallow some of the increases and not pass them on but somehow maintain the same price over time, this is considered more fair than any other kind of pricing. Another big concern is that your price is beyond biased and this means that they can’t be biased against the customer. And how you present the price is very important. I think Coke’s vending machines, I don’t know if you remember, they came out with a vending machine and it was said that it was going to lower, it was going to increases prices in the summer because it was hotter and more people wanted Coke. Now, if they had said that they had a machine that would lower the prices in the winter, people would have thought that was fair. But increasing prices in the summer was biased against the consumer and so they don’t like it and that’s unfair. And finally, I’d say it’s important if you can, to give your customer a voice in their price. That this is part of the American ideal that we have freedom of choice. You don’t want to give too many choices. I think if you look at the mobile phone people, there’s so many choices you can’t figure out what on earth I want to do. But you need to give them several choices so they don’t feel as though they’re stuck. I think this is one of the reasons that eBay has become so popular is because the customer has total control, has total voice in what kind of price they’re going to pay. I think that’s most important.

Bjorklund: So those three things again are keeping the prices stable...

Maxwell: Keep it stable, keep them unbiased and give the customer a voice.

Bjorklund: Well, thanks so much for talking to us to us today, Sarah Maxwell. I enjoyed it and many thanks to our AllBusiness reporter, Paul Kilduff.

Kilduff: You’re welcome.

Maxwell: Thank you very much.

Bjorklund: Dr. Sarah Maxwell is the author of The Price is Wrong, co-founder of Fordham University’s Pricing Center and associate editor of the International Journal of Pricing. Paul Kilduff is a reporter for AllBusiness. You can send your feedback on this show to podcasts@allbusiness.com. We welcome your suggestions and ideas for future guests. I’m Chris Bjorklund. Thanks for listening.