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The Risks and Benefits of Price Partitioning

A technique that is very common but often misused

Definition


When setting the price of a product, service, or solution, one of the decisions that the company needs to make is how to apportion the price. That means to say, which components of the price should be presented in a single fee or charge, and how much of it should be separated into different costs or charges.

For example, when buying an industrial equipment, besides the actual initial cost of the equipment, the company is usually also faced with the cost of support, maintenance and warranty, among other fees. Additionally, features and upgrades may also be presented as part of the initial price or as an added cost.


Psychology


From a human psychology standpoint, the general understanding is that when it comes to positive outcomes, like making money, humans prefer to have multiple “wins” instead of one large one (for example, winning a lottery twice for a million dollars results in more happiness and satisfaction than winning once for $2 million).

On the other hand, for unwanted circumstances, psychology dictates that individuals handle one large loss better than multiple consecutive losses. And price is usually viewed in this category as a loss, because companies and individuals would rather not pay, or pay the least possible for a product or service.

Therefore, at first glance, one might believe that it is better to present all costs upfront as a bundle.

Sticker Shock and Competitive Forces


However, that is not the only consideration. A high initial price can lead to sticker shock, which is the initial disappointment that customers have when faced with a higher-than-expected price.

That shock is a weakness that can be exploited by competitors who offer a lower initial price.

Budget Constraints


Buyers, especially in B2B environments, may have strict limitations as to how much can be spent on a solution. Depending on how the costs are calculated by the company,

separating charges may allow a solution to be considered, while a large initial charge can be blacklisted by the buyer as above the acceptable range.


Timing

The timing of the charges also plays a role in the buying decision. Extending the costs over a longer period may increase the chances of getting selected by the buyer in some cases.

In other cases, a lower long-term cost may be a preferable choice.


Nickel-and-Diming


Dissecting the price into separate components, however, may result in a negative perception by the buyer.

This is referred to pejoratively as nickel-and-diming, which is when the seller is perceived to intentionally add numerous fees to an existing product or service. The solution to this problem is to not overdo the price partitioning, as well as provide rational explanations of why those fees are not bundled with the initial price.


Upgrades

One example of a rational reason for price partitioning is when it is used to upsell premium features, services or upgrades.

In other words, if a company offers a basic solution for one or a few charges, and leaves out some extra features as additional charges, customers may accept the price partitioning more favorably. The reason is that customers are more likely to understand that those features are optional, and therefore it is a valid reason for price partitioning.


Conclusion


As with many other pricing issues, price partitioning involves many interrelated issues. The appropriate application of it, however, can not only result in increased sales but also in a stronger market presence.



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