Earlier this month Turing Pharmaceuticals raised the price of Daraprim from $13.50 to $750.00, an increase of more than 5000%. There were immediate outcries of price gouging from customers who take the anti-malarial and HIV drug, insurers, doctors and politicians. In the wake of the backlash, Turing reversed course last week and returned the drug to its previous price. Although I believe it is important to price products according to their values and I have defended Gilead’s very high pricing of Sovaldi, I think Turing was wise to change course. It is usually not a good decision to piss off your customers. Once they get angry, it is easy to lose them for good.
In general, customers will pay for perceived value. If one product works better than another or improves the customer’s results, that purchaser is nearly always willing to pay more for the better product. How the customer determines the value of the better product is important. One key item is the reference price in the mind of the customer. With a new product like Sovaldi, there may not be a reference price or the reference is for a completely inferior product, allowing significant freedom on the price of the new product. In the case of Daraprim, the reference price for each customers was whatever they were already paying for Daraprim. With a new price so much higher than their reference price, customers just got angry.
Another thing to consider is emotion. Plenty of companies have underpriced their products in the past. Using rules of thumb and target margins, they have set prices significantly below the value the products deliver. When the companies realize they are underpricing products and want to align them more with value, it means the customers will experience a price increase. The larger the price increase, the more emotional customers will become. By any measuring stick, 5000% is a huge increase and emotions would be strong.
That emotion can be tempered somewhat when the supply is very low relative to the demand, and price is used to allocate the available product. As an example, customers generally accept surge pricing by Uber and higher prices for the Super Bowl compared to regular season games. However in the case of Daraprim, there was no change in supply or demand. Customers just interpreted the huge increase as a case of the manufacturer taking advantage of them. Their emotions and the much lower reference price never allowed a discussion of value to take place.
So what should companies do when they determine the value they are delivering with their products is much higher than their price? Well, if that gap between value and price is large, companies must begin to articulate a more compelling value story, and raise the price over time – not all at once. As an example, Disney has experienced continued growth in visitors and determined the value customers were willing to pay exceeded their prices. So for the past few years, Disney has been increasing prices 5% to 7% annually. Those increases exceed Disney’s cost increases and improve margins, but do not cause strong emotional reactions from their customers. Similarly, many Major League Baseball teams have begun to price single-game tickets dynamically, charging more than normal prices for the most popular games. Customers understand those increased prices and do not get angry about them.
In 2007, there was an article in the Wall Street Journal, Seeking Perfect Prices, CEO Tears Up the Rules. The article discussed the efforts of Parker Hannifan CEO Donald Washkevicz to move from cost-plus, rule-of-thumb pricing to something more strategic. Many products were determined to be underpriced and had prices increased. However the average increase was only 5% with the largest increase being 60%. While the larger increases received more customer resistance, and a small number of customers switched suppliers, nothing experienced the anger that a 5000% increase causes.
Lastly Amazon raised the price of Amazon Prime by 25% in 2014. While that may seem like a high increase, it is nothing compared to the Daraprim increase. In addition, Amazon had been adding features to Prime membership raising its value. Amazon also did a great job of articulating to their customers all of the benefits and value of a Prime membership. They probably received some complaints, but not enough to slow their growth.
All companies should regularly monitor the value they deliver to customers compared with their prices, and they should adjust prices which are not aligned with value. However, they should also do it in a smart way that avoids strong emotional reactions. It is too difficult to recover the goodwill from a pissed-off customer.