Pricing plays an integral part of our lives – when we’re selling (what to price the product or service) and when we’re buying (is it the right price to buy at). A lot of businesses struggle with pricing. It’s clear that the right price can make all the difference – too low and you miss out on profit; too high and you miss out on sales. Some interesting research has been done in pricing and pricing perceptions. What is interesting in particular is not so much pricing strategies, but pricing perceptions – there is a fare bit of psychology involved and it’s not an exact science but some of the pricing experiments uncovered could be useful tools to use in business (and good to be aware of them in buying decisions too).
People & pricing – Let’s get going with some pricing psychology
Asking people how much they would pay for something rarely works. And we all do this all the time – even to ourselves as a sense check. For one thing people will tell you what they WANT to pay—which is often not an accurate reflection of the worth of the product or service. Second, and very importantly, what people say and what people do are very different things. When it comes to money, people are unable to predict accurately whether they’d pay or not. It’s much easier to spend hypothetical rands than real ones.
It’s important to remember that people really don’t know how much things are worth and what’s a fair price (which is the reason TV-shows like “The Price is Right” can actually exist).
According to William Poundstone, the author of Priceless: The Myth of Fair Value:
“People tend to be clueless about prices. Contrary to economic theory, we don’t really decide between A and B by consulting our invisible price tags and purchasing the one that yields the higher utility, he says. We make do with guesstimates and a vague recollection of what things are “supposed to cost.””
People are weird and irrational, and there’s much we don’t understand. Like why do shoppers moving in a counterclockwise direction spend on average R20.00 more at the supermarket? Now do it – think about the layout of your local supermarket and how it encourages counterclockwise shopping!
Psychology is complicated and what it means is that what will work for you depends on your industry, product and customer and the success of pricing experiments is not a given.
Here’s a list of pricing experiments and studies we can get ideas from and even test for ourselves.
Decoy Pricing
This is the phenomenon whereby consumers will tend to have a specific change in preference between two options when also presented with a third option that is asymmetrically dominated.
By introducing a third – being the decoy – option, you can increase the preference for the dominating option. Companies push customers, who usually tend to buy the cheapest product, towards a more expensive product.
Example 1: The Economist
Dan Ariely describes this famous example in his amazing book Predictably Irrational. He came across the following subscription offer from The Economist, the magazine (he also explains this in his TED talk here):
=
Both, the print subscription and print & web subscription cost the same, $125 dollars. Ariely conducted a study with his 100 bright MIT students. 16 chose option A and 84 option C. Nobody chose the middle option. Total Rev: $11 444
So if nobody chose the middle option, why have it? He removed it, and gave the subscription offer to another 100 MIT students. This is what they chose now: 68 chose option A, 32 chose option C. Total Rev: $8 012
Most people now chose the first option! So the middle option wasn’t useless, but rather helped people make a choice. People have trouble comparing different options, but if 2 of the options given are similar (e.g. same price), it becomes much easier.
The same principle was used with travel packages.
When people were offered to choose a trip to Paris (option A) vs a trip to Rome (option B), they had a hard time choosing. Both places were great, it was hard to compare them.
Now they were offered 3 choices instead of 2: trip to Paris with free breakfast (option A), trip to Paris without breakfast (option A-), trip to Rome with free breakfast (option B). Now overwhelming majority chose option A, trip to Paris with free breakfast. The rationale is that it is easier to compare the two options for Paris than it is to compare Paris and Rome.
A graph to describe this:
So if you add a slightly worse option that is similar to A (call it A-), then it’s easy to see that A is better than A-, hence many people choose that.
How you can use it: Add a decoy package or plan to your offer page, next to the offer you really want them to take.
The magic of number 9
Go to Macro and you will see prices ending with 9 everywhere. Does it really work? Surely all intelligent people understand that R39 and R40 are basically the same.
Well, in eight studies published from 1987 to 2004 charm prices (R49, R79, R1.49 and so on) were reported to boost sales by an average of 24 percent relative to nearby prices (as per Priceless).
In one of the experiments done by University of Chicago and MIT, a mail order catalogue was printed in 3 different versions. One women’s clothing items tested was sold for $39. In experimental versions of the catalogue, the company offered the same item for $34 and $44. Each catalogue was sent to an identically sized sample.
There were more sales at the charm price of $39 than at either of the other prices, including the cheaper $34. $39 had both greater sales volume and greater profit per sale.
People used to download music for free, then Steve Jobs convinced them to pay. How? By charging 99 cents.
The explanation of why numbers ending with 9 work better has been much debated over the years. Mental rounding alone can’t explain it. Seems that 9 truly is a magic number.
Is there anything that can outsell 9?
Researchers found that sale price markers (with the old price mentioned) were more powerful than mere prices ending with the number nine. In the following split test, the left one won:
Then they split tested the winner above with a similar tag, but which had R39 instead of R40:9 not so magical after all? Not so fast!
This had the strongest effect of all.
Even further to that could effect of this price tag could be increased by reducing the font size of R39. What?
Marketing professors at Clark University and The University of Connecticut found that consumers perceive sale prices to be a better value when the price is written in a small font rather than a large, bold typeface. The thinking is that in our minds, physical magnitude is related to numerical magnitude.
At some high end stores you don’t see any prices ending with a 9. The subliminal message here is “expect to pay”.
Anchoring and the contrast principle
Do this test at home. Pour water in 3 bowls. Fill one bowl with cold water, the second with hot water and third one with lukewarm water. Now stick one hand in the cold water and the other one in the (not too) hot water. Keep them there for 30 seconds or so. Now put both of your hands into the lukewarm bowl. One hand will feel the water is warm, the other one that it’s cold.
It’s about the contrast. The same principle applies to price. Nothing is cheap or expensive by itself, but compared to something.
Once you’ve seen a R150 steak on the menu, R90 sounds reasonable for a burger. At Ralph Lauren, that R16,995 bag makes a R1400 T-shirt look cheap.
What’s the best way to sell a R20 000 watch? Right next to a R12 000 watch.
This mental process has a name. It’s called anchoring and adjustment.
Anchoring
In the 1970 two psychologists by the names of Tversky and Kahneman theorized that suggesting an initial figure to a test subject caused that subject to use that number as a starting point for estimating unknown quantities.
In their study test subjects were told the number 65 and then asked to estimate what percentage of African nations were members of the UN. The average response was 45%. They then tested a second group but told them the number 10 and their average response was 25%. Amazingly the group that was primed with the number 65 estimated nearly twice the true answer (23%) while the group primed with the lower number estimated a lower percentage (much more accurately).
How can anchoring be used: Start throwing out high numbers. Add some very expensive products to the selection (that you don’t even intend to sell). If the final price of your service / product is a result of negotiations, start high. If you’re competing on price, state how much others are charging before revealing your price.
Offering 3 options
The old truth about offering 3 pricing options holds water. Here’s a pricing experiment in selling beer – again from W. Poundstone’s amazing book Priceless.
People were offered 2 kinds of beer: premium beer for $2.50 and bargain beer for $1.80. Around 80% chose the more expensive beer.
Now a third beer was introduced, a super bargain beer for $1.60 in addition to the previous two. Now 80% bought the $1.80 beer and the rest $2.50 beer. Nobody bought the cheapest option.
Third time around, they removed the $1.60 beer and replaced with a super premium $3.40 beer. Most people chose the $2.50 beer, a small number $1.80 beer and around 10% opted for the most expensive $3.40 beer. Some people will always buy the most expensive option, no matter the price.
You can influence people’s choice by offering different options. Old school sales people also say that offering different price point options will make people choose between your plans, instead of choosing whether to buy your product or not.
How to test it: Try offering 3 packages, and if there is something you really want to sell, make it the middle option.
Price perceptions
You probably know the classic “rands-a-day” effect: “it costs less than R1 a day!” When you ask people to donate by joining a rand-a-day club, the donation seems quite reasonable. Contrast that with what would happen if they asked people to join their “R365 a year” club.
Neil Davidson writes this about price perceptions on software pricing:
“People base their perceived values on reference points. If you’re selling a to-do list application, then people will look around and find another to-do list application. If they search the internet and discover that your competitors sell to-do list applications at $100 then this will set their perception of the right price for all to-do list applications.”
If your product is more expensive than the common reference points, you need to change the perception of the category you’re in.
How did Starbucks get away with starting to charge $3 and more for coffee, when most other cafes were charging $1 or so? They changed the experience of buying coffee, so the perception of what people were getting, changed. It was like a different category product.
They also changed the name. Not just coffee, but Pike’s Place brew or Caramel Macchiato.
If you’re creating a new category, there’s no price reference and people are much more likely to accept any price you name.
How you can use it: If you want to charge more than the market average, look at the competition: how they package their offering; what’s the user experience like, and change that. If you look like a new category, people are more likely to pay up.
On the other hand, if you can profitably sell something much cheaper than the other guys, great. Use their pricing as the reference point and you’ll win.
Combine research from this article
It seems that you could combine a lot of the research covered here into a single pricing experiment. How about this:
You create 3 different plans/packages, and intend to sell mainly the middle one.
The first plan is a decoy. It’s similar to the middle plan, but offers visibly less value while costing almost as much. Think of it as A- (as per The Economist example).
Second plan, the one you want to sell, offers good value for money. The price ends with 9. Maybe it even shows that it has been reduced from a previously higher price or it’s a sale (either way, it has to be true / ethical).
Third plan is to serve as a contrast to the middle one, its role is to anchor in a high figure. Make it much, much more expensive than the middle plan. You don’t actually intend to sell it, but there always the type that wants the most expensive plan – so make sure you can actually deliver on it.
If you decide to give this a try, let us know the results