Psychological Effects on Pricing
Posted by Vovici Blog on Mon, Apr 04, 2011
Most pricing research assumes that consumers are rational actors when it comes to choosing between products or services with different prices. Unfortunately, behavioral economics and the study of the psychology of retail shoppers teach us that this is not the case. Here are some of the ways we are “predictably irrational” when it comes to prices:
- Overly influenced by shown prices (“Anchoring”) – What’s a fair price? Our perception of a fair price tends to be a function of our memory of past prices seen for a product or service category, with the initial price having disproportionate influence: other prices will seem low or high in comparison. Retailers can manipulate our recognition of a fair price by creating product lines with premium products at premium prices. Exposure to high prices of other products can even influence the price of products in unrelated categories.
- Overvaluing free – Dan Ariely devotes a chapter of Predictably Irrational to recounting experiments that show how consumers overvalue “free”. Products with prices are seen more objectively than free products, to the point that consumers will choose free products rather than spending token amounts for more valuable goods. Heaven help you if your product is competing against free alternatives; it will be hard to convince customers of the value proposition.
- Overvaluing discounts – The illusion of discounts often spurs sales. One mall jeweler was unable to sell silver chain necklaces at $19.99. Doubling the price on the price tag and then marking each chain 50% off led to the sale of the entire inventory. Another retailer found that even marking items as 10 cents off boosted sales. (See Deciphering the Psychology of Pricing.)
- Overvaluing possessions – Investors are unwilling to sell shares at a nominal loss, to avoid making an abstract loss real. This applies to selling products as well as selling investments. Loss aversion is one of the reasons housing markets take so long to correct; homeowners are unwilling to sell for less than they paid, in part financially overvaluing the home for current market conditions because they emotionally overvalue their home.
- Innumeracy – Consumers don’t see $19.99 as one penny less than $20.00 – the first digit is overemphasized. A product priced at $19.69 seems like a good value but the same product priced at $19.09 seems like it is not a deal. Since consumers can be reluctant to pay more for commodity consumer goods, leading CPG manufacturers subtly decrease the amount in a package and introduce new sizes at the inflation-adjusted pricing, knowing most consumers won’t do the math.
There are many great market research tools available for conducting pricing research: Willingness to Pay, Van Westendorp PSM, Monadic Price Testing, Sequential Monadic Testing, Conjoint Analysis, Elasticity Models and more. Remember that each method provides simplified models that can help when making strategic pricing decisions, but real-world attitudes towards prices are far more complex than our research reveals.
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