Pricing Risk and Uncertainty

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.

You may have saw the Hyundai ad during the Superbowl, where it is offering customers up to one year to give back their cars in case they are laid off at no cost, and with no hit to their credit rating. As the New York Times article points out:

Last fall Hyundai began testing the idea of a return policy rather than simply piling more discounts onto its already low-price vehicles. The program covers every buyer of a leased or financed vehicle who involuntarily loses a job; becomes physically disabled; loses a driver’s license for medical reasons; is transferred to another country; is self-employed and files for bankruptcy; or dies in an accident.

The guarantee covers the difference between the value of the car and the amount the buyer owes, or negative equity, up to a maximum of $7,500.

“It doesn’t matter how many zillion dollars you put in rebates, or what A.P.R. you give them,” Mr. Zuchowski [Hyundai’s vice president for sales] said. “If people are worried about their job, they don’t really care and they’re just not going to get off the fence. But we had to walk a really fine line. We wanted to make sure we didn’t come off as panicked or distressed.”

The result of this strategy so far? According to the article:

The company’s market share nearly doubled last month as sales rose 14 percent, the largest year-over-year increase that any big automaker has posted in the United States since last May.

I hope Hyundai was smart enough to change it’s pricing strategy along with this offering. In any event, there is a great lesson here for PKFs. How can you reduce, or mitigate, your customer’s risk and uncertainty?

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 seven types of customer risk:

  • Performance risk is the chance the service provided will not perform or provide the benefit for which it was purchased.
  • 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.
  • Time loss risk refers to the amount of time lost by the customer due to the failure of the service.
  • Opportunity risk refers to the risk involved when customers must choose one service over another.
  • 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.”
  • 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; the 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 like Hyundai did, creating a new competitive innovation that is likely to be imitated in short order. But don’t let that stop you. PKFs are far slower to duplicate competitive advantages than industry in general.

As the old actuary axiom says: There is no such thing as bad risks, just bad premiums.


  1. July 18th Show Notes: The Second Law of Marketing: All Prices are Contextual

    In our July 11 th show we discussed The First Law of Marketing: The Value of Value . The Second Law

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