Classical pricing theories assume that customers behave rationally and have access to complete information regarding cost-benefit ratio. According to those theoretical principles, the pain of payment should be identical for every penny spend (customers want to obtain as much for their money as possible). Those theories are based on the hypothesis that customers act rationally. However, in real life, many factors influence the way consumers value money and how much pain they feel upon spending it.
Classical pricing models do not take into account the fact that customers do not always behave rationally. Through behavioural economics research, we now know that customers evaluate a particular price or price range with regard to multiple factors, such as the reputation of the company/brand or their own capital. Also, they do not behave in a linear fashion. They may cancel or delay their product search and return to it later. They can’t remember prices, they often don’t know what they pay for and do not always make accurate comparisons.
Utilizing smart pricing when selling products and services is a must if a business wants to succeed in an ever-competitive marketplace, and to do so companies must understand how customers make their decisions and the role played by price.
1. Price anchor – ‘Price Anchor’ refers to the tendency of customers to rely on the initial piece of information offered to them when making purchasing decisions, or it can be set by previous experience.
The first price or cost to be mentioned will have an effect on the perception of all future prices. For example, if we start with $200, then $100 will seem cheap, but $1000 seem expensive. But if we start with $10, then $100 will seem expensive.
In a study researcher asked a group of people made of students and real-estate agents, to estimate the worth of a sample home. The group was provided brochures that included information about the surrounding houses; some had normal prices and others had artificially inflated prices. The study found out that anchoring price effected also professionals.
‘it does seem clear from these studies that decision biases and heuristics are more than just parlour tricks and that they should play an important role in our understanding of the everyday decision behaviour.’ [Gregorey B. Northcraft and Margaret A. Nele “Expert, Amateurs and Real Estate: An Anchoring – and – Adjustment Perspective on Property Pricing Decisions]
A product is truly never “cheap” or “expensive”; it’s all relative. People love to compare products values and having an anchor price allows them to do that. Companies can take advantage of the price anchor’s strategy by offering different versions of their core product at different prices.
2. Choice overload – Too much information may result in choice overload. If too many options are available at a given point of time, both customers and sales representatives tend to become overwhelmed. In one of the experiments involving jams, customers were more likely to make a purchase if only 6 options were offered versus 24.
“It is a common supposition in modern society that the more choice, the better – that the human ability to manage, and the human desire for choice is unlimited.” Research from three experimental studies challenge this implicit assumption that having more choices is necessary more intrinsically motivating than having fewer. The experiments, which were conducted in both field and laboratory setting, show that people are more likely to purchase gourmet jams or chocolates or to undertake optional class essay assignments when offered a limited array of 6 choices rather than a more extensive array of 24 or 30 choices. Moreover, participants actually reported greater subsequent satisfaction with their selections and wrote better essay when their original set of options had been limited.”
[Sheena S. Iyengar and Mark R. Lepper, “When Choice is Demotivating: Can One Desire Too Much of a Good Thing?] To help combat choice overload, businesses should make the most desirable option the default choice. Most luckily customers will use the default option as a reference point to make their purchasing choices.
3. The 9 ending factor – Ending prices with the number nine is one of the oldest ‘marketing trick’, but does it actually work? Various studies are suggesting that the answer is yes.
In a study, a company who sells moderately priced women’s clothing via courier agreed to manipulate the price of 4 dresses by using the 9 ending. Researchers found out that the 9 ending yielded a demand increase of approximately 40% of those for dresses. The items with the price ending in 9 were able to outsell even when customers could choose lower prices for the same product.
“The data yield two conclusions. First, use of a $9 price ending increased demand in all three experiments. Second, the increase in demand was stronger for new items than for items that the retailers had sold in previous years. There is also some evidence that $9 price ending is less effective when customers use ‘Sale’ cues. Together, these results suggested that $9-ending may be more effective when customers have limited information, which may in turn help to explain why retailers do not use $9 price ending on every item” [Eric T. Anderson and Duncan I. Simester ‘Effect of $9 Price Endings on Retail Sales: Evidence from Field Experiments’]
Business should consider adopting the 9 ending technique especially when they are pricing new products and services on their catalogs.
4. Price comparison – When developing pricing strategies, it’s also important to understand how people view losses.
While shopping at supermarkets, customers may see signs that invite them to compare the price of the store’s brand of cereals against a popular brand. Studies showed that customers might not go for the cheapest option. Instead, they may choose the famous brand because it is perceived as a less risky choice. Or they may not buy anything at all.
Previous research by S. Kresge Professor of Marketing at Stanford GSB showed that in comparisons, consumers tended to put greater focus on the comparative disadvantages rather than advantages of each option. If it’s not done correctly, a low-price policy can lead to low sales results.
The Prospect theory demonstrates that people evaluate options based on reference points and that they are loss-averse – they dislike loss more than equivalent gains.
5. The power of context – Businesses should contextualize the environment on which the buying decision is taking place when positioning their products in the market.
Researches showed that people are happy to spend more money on a product sold by some up-scale retailers, even if they know that they could buy the same product cheaper from an ordinary shop.
A research conduct by Economist Richard Thaler revealed that customers were willing to pay higher prices for a Budweiser if they knew that it was coming from a luxury hotel versus a run-down grocery store. ‘The perceived prestige of the up-scale hotel allowed it to get away with charging higher prices’.
6. Price tag– The brain has a universal conceptualization of size. There is an obscure overlap between visual size and numerical size. That’s why customers perceive prices to be smaller if the price is displayed in a smaller font size.
As Coulter and Coulter explain in ‘Size does matter: The effect of magnitude’, if you position a large element around your price, those elements will reinforce a smaller visual magnitude, which will reinforce a smaller numerical magnitude. The reverse works for discounts. Since companies want to maximize the size of discounts, they should display the numbers in a large font size.
Also, researchers find out that removing commas (e.g., $1,499 vs $1499) can make your price seem lower. That happens because when the comma is removed people reduce the phonetic length of the price.