The Psychology of Pricing

 

Deciding on a price point is an important part of the success of your business. Marketing and great customer service will do no good if the product or service isn’t in the range consumers are willing to pay. There is another side of the pendulum that involves pricing your product so it appears valuable to consumers and sets it apart from the competition. This can be especially true in markets that are commoditized.

Price too high and sales will be slow.

Price too low and customers will be wary of your value.

Price the same as your competitor and customers will stick with what they are used to.

There are several formulas for selecting the correct pricing but generally the rule is:

Materials + Labor + Expenses + Profit Margin = Wholesale x 2 = Retail

Pricing Strategy Gross Profit

But in reality pricing is much more complicated and involves deep strategic thinking before just choosing a price and going with it. Here’s a gross profit calculator you can use to easily see how changes in expected quantity and price can have an impact on total profit.

Many other factors affect your customer’s decision on whether to purchase or not. The science of human decision making is called neuroeconomics, studies the social, cognitive, and emotional factors in understanding economic decisions while also incorporated new approaches from theoretical biology, computer science, and mathematics.

There is what is known as the Pricing Placebo Effect where the price point that customers pay is in direct relation to the value of a product or service, and also how effective they believe the product or service is. In a study by Baba Shiv of Stanford, they gave an energy drink to 2 groups of participants. One group paid full price for the product, while a second group was given a discount. After participants in each group drank the energy drink, they were given a series of word puzzles to solve. The group that was given a discount actually solved 30% fewer puzzles. This percentage held true for every experiment thereafter. Their opinion of the product directly correlated to the price they paid.  Of course this is true of just about every single medical study, the placebo effect (sugar pill) has been demonstrated to cause real improvement for people. Numerous studies on the physcology and neuroscience have reinforced this finding that isn’t just a false perception but is a real experience that is affected by our expected perception.

Pricing Research

Multiple studies have also found this with wine, giving participants multiple glasses of wine at different price points and then getting their reaction to it. In the studies people found the more expensive wines more pleasurable and even brain scans showed more stimulation from the more expensive wines, despite the fact it was the same cheap wine used.

Use the basic retail pricing formula as a starting point but consider these other factors before setting your price.

Finding The Price

Pricing just a little lower than your competitor is a smart marketing decision but when customers are faced with a lower price they wonder what will be lacking from the product/service as compared to the product/service that costs a little more. The focus should be on why prices are less with your company. Explain why your price is lower whether it be how you save on advertising costs or “the middleman” and how you are passing the savings on to the customer. Very few companies can realize large margins involved in a highly commoditized price cutting market, so many successful companies go for a middle ground that gives them a little more margin but still reasonable prices and allows them to invest in marketing, R&D and quality – all these which increase the value proposition of the brand and set them apart from the competition. In order to find the right price you must first understand your costs, the demand for your product and how unique your value is versus the competition. The starting point for price should always first reflect how much competitive separation your product has versus the competition. 

Value

A classic case study from Robert Cialdini’s book called ‘Influence’ describes how a jeweler sold out of turquoise jewelry because although they meant to mark it down 50%, it was accidentally priced at double its initial price. Shoppers, seeing the high price automatically found ‘value’ in the turquoise jewelry as opposed to the ‘regular everyday’ gems. In a matter of context, the regular gems will look like a bargain next to the higher priced turquoise, thus all jewelry sold well. Restaurants use this context method on their menus by placing the expensive seafood listing close to the basic chicken whereas the $30 chicken plate looks like a bargain next to the $50 seafood plates.

The decoy effect has been understood for sometime now and was best illustrated by this experiment from The Economist which offered the following plans:

  1. Web Subscription – $59
  2. Print Subscription – $125
  3. Web and Print Subscription – $125

The presence of a $125 print subscription served only to make the last offer more valuable and in turn led to a total sales increase of 30% just from adding a second option that made the third look better.

In a similar study by Northcraft and Neale, an experiment was setup to evaluate the effects of this context method, researchers asked subjects to estimate the worth of a home for sale. Flyers included information about surrounding houses; some had average prices and others had high prices. The results showed that a group of undergraduate college students and a selection of real estate experts were swayed by the flyers with the higher prices.

End the price in 9

In the book Priceless by William Poundstone, he discusses the power of ending your price with 99 cents. Eight different studies showed that on average, they increased sales by 24% if .99 was used instead of .00. An experiment by MIT and the University of Chicago tested a standard women’s clothing item on prices of $34, $39, and $44. The clothing sold best at $39, even more than the $34 price. Customers who are making a purchase decision tend to think of “odd prices” as being significantly lower than they actually are and tend to round down to the next lowest unit. A 1997 study published in the Marketing Bulletin announced that an average of 60% of prices in advertising material ended in the digit 9.

Pricing Physcology Example 9

End the prince in 0

If you do use a round number in your pricing, leave off the comma and .00 on your flyers and website. In a research paper published in the Journal of Consumer Psychology, researchers found that when looking at prices, the more syllables customers saw, the more the prices seemed drastically higher to consumers. $50 seems a smaller amount than $50.00 or $1055 seems smaller than $1,055.00.

Differences in Prices

Use different price points for slightly different products even if your costs are the same. Studies show that consumers will put off making a decision if the product prices are the same. Even a difference of a few cents is enough to motivate a decision. “Analysis paralysis” is a term used when both products are priced the same and the customer becomes overwhelmed with trying to find the pros and cons to each in an effort to decide. Too many options can be demotivating to consumers and they end up putting off a decision.

Pricing As Example To Determine Value

 

Raising Prices

When it comes time to raise your price be sure to do it slowly. Studies show that somewhere around 10% is noticed but accepted by most customer without much complaint. This is called the Just Noticeable Difference (JND). Raising prices in small increments is best to keep your clients from purchasing elsewhere. So better to raise the price 5% each year rather than wait 6 years and raise 25%. Among food products it’s preferred to slightly shrink the portion size which is even less noticeable than a small price increase.

From a marketing standpoint…

When laying out your website or flyers, consider these other studies in pricing.

Time is more important to customers than money. Saving time or using time wisely is foremost attractive in the lives of your customers. A study done by Aaker & Mogilner set up a lemonade stand. Three different signs were used to advertise.

  1. “Spend a little time and enjoy C&D’s lemonade”
  2. “Spend a little money and enjoy C&D’s lemonade”
  3. “Enjoy C&D’s lemonade” (neutral)

The sign that mentioned “time spent” attracted twice as many people and they were even willing to pay more.

Research published by Stanford University’s Jennifer Aaker shows that consumers tend to remember positive memories of a product when they are asked to recall time spent with the product/service, not the money they saved.

Descriptions

Customers will pay more for a $299 “multimedia course” rather than a $2.99 eBook, even if it is the exact same product. In a Vanderbilt University study published in the New York Times Magazine, they found that customers were willing to pay higher prices for an exact same product if they knew it was coming from an upscale hotel versus a run-down grocery store because it somehow has more value. Use a descriptive word in front of your price. Studies show that the words “only” and “small fee of” put the idea in the minds of your customer that your price is good. A $5 fee sounds like a penalty whereas “for a small fee of $5” sounds like a bargain.

If you want to command higher prices and greater margins (price leadership) then it’s key that your brand and products have competitive separation. Whether it be some special features that no one else has, or your great quality or customer service – these help set you apart and avoiding being equally compared with your competition. When companies have similar offerings it’s a match that will almost always go to the company with the lowest price and even they may experience little gross margin. Psychological pricing will help your customer’s decision to buy through inducing an emotional response thus increasing sales for your business. People tend to spend money if it will save their time or make their time more pleasurable. Price your products strategically to get not only the most profit but also to improve sales. In some cases, a higher price will be more beneficial and in other cases a lower price that is well defined. Many factors should be considered to get the best result but make sure to consider the long-term implications of your pricing strategy. Lowering prices can change perceptions of the product and brand and raising prices too drastically can cause consumers and dealers to backlash. 

Further reading:

http://www.nickkolenda.com/psychological-pricing-strategies/

https://blog.kissmetrics.com/5-psychological-studies/

http://www.huffingtonpost.com/gregory-ciotti/10-classic-academic-studi_b_6182498.html


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