Pricing psychology – or ‘know your client’

Introduction

The conventional economic model argues that every individual or organisation acts rationally in their own best interest at all times, having weighed the advantages and disadvantages of the options presented. And when they get their decisions wrong, market forces swiftly set them back on the path of rationality.

Behavioural economics takes a different view. Repeated observation of the way people actually behave suggests that not only are we as often as not irrational in our decisions making, but in fact predictably so. ‘Predictably Irrational’ is in fact the name of one of the key works in this field (Dan Ariely, Thorsons, 2009).

Pricing psychology is a sub-set of psychology or the study of the mind and how it works, especially in the area of behaviour. It’s something that we see at work most readily in the fields of sales and marketing. For example, our tendency to ‘anchor’ the first piece of information we get then sees us overweight that when ‘adjusting’ and the shop that has a suit in the window at £599 often puts one at £299 right next to it – a bargain!

There are all kinds of biases (since cognitive biases were first documented in the 1970s, over 100 of them have now been identified) and heuristics at work in how humans make decisions. One well- known cognitive bias is ‘confirmation bias’ or remembering and interpreting information in a way that conforms to one’s own preconceptions. Sport provides an easy example: in the Premier League, each month the manager of a team that has had a particularly good month is crowned ‘Manager of the Month’ (MOTM). It is part of footballing folklore that the same manager will lose the next game his team plays! ‘The curse of the MOTM’ is a cliché for fans and pundits alike. Of course, there is no evidence that statistically, a MOTM winner is any more likely to lose the first game after receiving their award than any other game. Heuristics are rules of thumb or mental shortcuts that we use to find quick (but often imperfect) solutions to difficult problems. For example, when asked ‘how happy are you with your life?’ it’s quite a challenge to answer. But when asked ‘what is your mood now?’, answering that leads to a belief that the first and more tricky question has been answered too.

Why do these things matter in the pricing of legal services? Putting it simply, understanding how your clients might actually behave, rather than how you think they might behave, enables the lawyer to frame pricing options that will work for those clients.

Below I look at just a handful of the psychological techniques that lawyers can use to make more money –  while having happier clients (sic).

Choice effect

In my opinion, simply the most powerful tool in the pricing toolkit! Offering clients choice – even where all options work for the law firm and all might be above firm’s standard rates – psychologically empowers clients and brings at least a veneer of collaboration to the pricing conversation.

Giving a client two choices (better still, as we’ll see, three) moves the discussion on from initial push back (‘that’s more than I expected’) to an exploration of the choices offered, usually resulting in one of them being selected as ‘just right’. [You guessed it, it’s called the ‘Goldilocks effect’.] The change in atmosphere from an ‘I charge £425 per hour’ conversation to one which asks ‘How would you like us to price the work for you? We can price it this way at our risk, this way at your risk, or we can share price risk this way?’ can readily be imagined.

Anchoring

Dan Kahneman and Amos Tversky’s famous ‘United Nations’ experiment in the 1970s gave us the term ‘anchoring and adjusting’. In that experiment, they asked two cohorts a simple question: ‘How many African countries as a percentage do you think are in the United Nations?’ The first group then watched a ‘wheel of fortune’ spin and stop, as it was fixed to do, at 10. The second group saw another wheel spin and stop, as planned, at 65. They were then invited to answer the question. The  group that had seen the number 10 on average guessed 25%; the other group which had seen 65 averaged 45%.

When I recount this (and many other stories like it) to lawyers I am not at all surprised by their scepticism. They are highly intelligent people and so are many of their clients. They wouldn’t fall for this kind of nonsense! But highly educated, rational people also behave in predictably irrational ways. In Germany, judges with over 15 years’ judicial experience on average were presented with a pre-sentence report on a woman shoplifter. They were then individually given a loaded dice that would land on either 3 or 9. The question they were asked was: ‘would you sentence her (in months) to a number higher or lower than on the dice?’ Those who had rolled a 9 sentenced her on average to 8 months; those who had rolled a 3 said 5 months.

What does this mean for law firms? Simply, anchoring can be used to manage proactively client fee expectations. For example, the firm thinks the fee for a job should be £12,000. Instead of defaulting to the lawyers’ favoured weapon of choice, a fee range set cynically low such as £8,000-£12,000, suggest the client budgets for a fee of £12,000 to £15,000. If the fee ends up at £12,500, you’ll have a very happy client on your hands, but if the lower range had been given, starting with an 8, then even a fee of £11,500 is likely to be more than the client had bargained for.

Decoy effect

The ‘asymmetric dominance effect’ or decoy effect is an example of cognitive biases in action. It is hard to choose between two things because thought is required. It’s far easier to choose things in relative rather than absolute terms, especially if one of the choices requires no thought at all.

Professor Joel Huber at Duke University asked a group to choose between a meal at a 5-star restaurant 25 minutes’ drive away, or a 3-star restaurant just 5 minutes’ away. It’s a ‘quality versus convenience’ dilemma, and the group, though finding the choice hard, decided on personal preferences.

Then the Professor introduced a third choice: a 4-star restaurant 35 minutes’ away. Suddenly the 5-star option becomes hugely more attractive – it beats the 4-star for both quality and convenience. Another group were given the same original choices, but the new, third option introduced was a 2-star restaurant 15 minutes’ away. And obviously for this group the 3-star became their chosen restaurant.

This a pricing tactic that’s been used for years by The Economist and Apple, to name but two of the more famous examples.

What’s the practical application for law firms?  Ideally, I recommend offering clients three pricing options. From the lawyer’s perspective, they should all work and be equally acceptable. So, for example a commercial property purchaser might be offered these three choices:

  1. A fee range based on hourly rates, estimated at £10-12,250, or
  2. A fixed fee, but with the same scope, assumptions and exclusions as the fee range, at £14,750, or
  3. A completely fixed fee (‘we’ll do whatever it takes’) at £19,750.

Those options are all about how much price risk the client is willing to take and the law firm isn’t invested in the outcome. But what if the firm wants the client to choose the fixed fee of £19,750? It simply raises the price of the tightly scoped fixed fee from £14,750 to, say, £16,450. ‘Just’ an extra £3,300 for complete certainty now seems quite attractive. Or if it wanted the client to choose the fee of £14,750, it moves the higher fixed fee further out of reach, above £20k.

Deal effect

Sometimes it’s as much about perception as the price. We’re all familiar with fast food bundles, where the individual items ordered separately might cost 20-30% more than the premium ‘big box’ package. For law firms, bundling is one of the obvious practical applications. A Will might be £550, and two LPAs for the same client might be £750. But all bought together could be £1200, saving the client £100.

It’s equally important to bear this in mind when packaging the constituent parts of a job. Lawyers could be forgiven for thinking it’s only the total that matters to the client. Wrong! Clients are interested in the price of each aspect of the job, and if they believe the law firm is ripping them off in just one area, then however much the overall price might suit, the law firm is straight into damage limitation territory.

Conclusion

That brief dip into the waters of pricing psychology will have been enough, I hope, to have persuaded even the most sceptical of lawyers that there might be something there that could work for them – and for their clients!

In my pricing training, this ground and much more is covered, as the topic touches not just on price but on the equally vital areas of sales and negotiation. And in my teaching, behavioural economics and pricing psychology constitute a full quarter of the pricing course I teach on the MLB at the College of Law, Australia.

There’s more to knowing your client then you might think. And pricing, at its optimal, is all about knowing your client.

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