Pricing Risk and Uncertainty

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We often discuss the fact that profits originate from risk, which is a supply-side viewpoint.

But what about the demand side--that is, what about the customer's risk? If a firm lowers a customer's risk, or uncertainty, it should be able to command a price premium over the competition.

In tough economic times, everyone likes to bemoan how their offering is becoming more and more commoditize. We hear this across all sectors, and it's truly disheartening, since there's no such thing as a commodity.

I've recently finished a presentation with that very title for an actuarial conference, arguing that no insurance product need be a commodity. But how do you de-commoditize your offering? The answer is with marketing and your value proposition.

One method to achieve this is by analyzing customer risk and uncertainty and devising ways to shift that risk to your firm. Your firm is in a far better position to absorb risk than your customer, since you can spread the risk across many customers at once.

Understanding Customer Risk

Any purchase entails risk. Professional services are relatively more risky than products, since they cannot be evaluated until after experiencing them, sometimes long after. This is one reason why there is greater loyalty to service providers than products manufacturers.

There are six types of customer risk:

  1. Performance risk is the chance the service provided will not perform or provide the benefit for which it was purchased.
  2. Financial risk is the amount of monetary loss incurred by the customer if the service fails. Purchasing services involves a higher degree of financial risk than the purchasing of goods because fewer service firms have money-back-guarantees. 

  3. Time loss risk refers to the amount of time lost by the customer due to the failure of the service. 

  4. Opportunity risk refers to the risk involved when customers must choose one service over another. 

  5. Psychological and social risk is the chance that the purchase of a service will not fit the individual's self-concept. Closely related to psychological risk is social risk, which refers to the probability a service will not meet with approval from others who are significant to the customer making the purchase. Services with high visibility will tend to be high in social risk. Restaurants and hair stylists are examples of service industries that are perceived to have a high level of social risk. Even for business-to-business marketing, social risk is a factor. Corporate buyers are concerned that a service they purchase will meet with approval of their superiors. Thus, IBM's famous slogan: "No one ever got fired for choosing IBM." 

  6. Physical risk is the chance a service will actually cause physical harm to the consumer.

Of course, there are many ways of reducing customer risk. The more common ones are offering fixed prices. Just as with fixed-rate mortgages that command a premium over Adjustable Rate Mortgages, this will command a price premium; providing a 100% Money-Back Service Guarantee; a Price Guarantee, whereby the customer never has to pay an invoice that they did not pre-authorize; unlimited access so the customer can call or meet with you anytime to discuss any matter, similar to having an attorney on retainer, offering peace of mind.

But what about the factors listed above? How else could you reduce your customer's risk? Think about it from the customer's perspective, since these are perceived risks, not necessarily actual risks.
As the old actuary axiom says: There is no such thing as bad risks, only bad premiums.


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