Pragmatic Pricing

The last post discussed when you should end your prices in 99 cents.  So why would you use a round price, prices like $5.00, $8.00, $1,200 and others.

The quick answer is for high quality products.  Research has shown that consumers see products that use round prices as higher quality.  In one older study, people perceive the quality of a pair of shoes as higher when priced at $75.00 than when priced at $79.95.  Did you catch that?  A lower price with a round number was perceived as higher quality than a higher price with a “just-below” number.

This only works for higher priced products.  A $20 price for a pair of shoes would not be seen as higher quality than a $19.99 pair of shoes.  The level of the price is so low that the price ending has little if any effect.

Another reason to use round prices goes back to the “lazy subtractor” argument.  Starting with the price of a sports coat at $400, and then putting it on sale for $299 looks like a much bigger discount than starting at $399.

If you provide a service and charge by the hour (lawyers, consultants, etc.) then you should absolutely use round prices.  Someone buying multiple of your hours will not be lazy subractors, and you will look more professional and of higher quality by using round prices.

How do you decide whether to use a round price or a just-below price?  Ask yourself the following question:  “What message am I trying to give with this price?”  If the answer is this is a good deal, a low price, then you will likely want to use a just-below price.  If the answer is this is a good product and it’s worth what you pay for it, then lean toward using a round price.

Action:  Look at your product portfolio.  Make a conscious decision for each product about which price ending you should be using.

I’ve always been very curious why most prices end in 99 cents.  In fact, I was so curious that I did an entire doctoral thesis about it.  Why does it work?  Because we are lazy subtractors.

Which difference is bigger?

Recall in an earlier post that we make the “Will I?”, “Which one?” decisions.   The which one is when we compare two products.  Which one do we want to buy?  Imagine the simple scenario where you want to buy a new pair of shoes.  You’ve narrowed it down to two pair.  One pair you like more than the other, but of course they are more expensive.  The question is, are they worth the additional cost?  There is the subtraction. The only way to know the additional cost is to subtract the two prices, but we rarely do that.  Instead we simply estimate the difference because … we are lazy subtractors.

We tend to compare two prices starting with the left-most digits.  If they are different, we stop there and make our estimate.  If they are the same, we move right one digit and compare them and so on.   In example A) people will start with the left hand digits, 8 and 5.  Since they are different, they will subtract them and get 3 and estimate the difference between these prices as 30.  In example B) people compare the 7 and 5 and estimate the difference at 20.  So most people believe the difference in the prices in A are larger than in B.  (Take your time and do the subtraction and you’ll find that both differences are 25).

Example A could have been $1.82 and $1.57 and people will tend to behave the same.  They start with the left digit, the 1, realize they are the same so move to the next digit to the right.

So how is this relevant?  Notice this behavior is similar to shoppers ignoring the right hand digits.  If customer ignore the right hand digits, then why wouldn’t we use the highest possible right hand digits?  This is why we see 99 cents so frequently, and why you should consider using it.  Specifically, you should use 99 cents for any product where your customers will be comparing prices between your product and another, especially if you believe you are competing on price.

This is not a hard and fast rule, but a good general guideline.  In a future writing I’ll describe why you want to use round pricing endings ($.00) for higher priced goods and random price endings for custom products.

99 vs 95 – I’ve never heard a valid reason for using 95 instead of 99.  The most common excuse provided is they don’t want to look like they are pricing everything with 99.  My gut says this is not valid, but I’ll keep looking out for the research.  In the meantime, a bike shop I worked with several years ago changed the prices of all of their tubes from $4.95 to $4.99 and claimed to make more than $100 additional profit on tubes alone due to that decision (2,500 tubes at an additional $.04).

Action:  Identify all products you carry where your customers believe price is an important criteria for making the decision between your product and your competitors.  What price endings are you using?  Try changing some of them to 99 and see how your customers respond.

Here is an interesting Business Week article on Stuart Frankel, the guy who create the $5 Footlong idea for Subway.  He’s just a guy who owned a couple of Subway Shops in Florida, and he created this local campaign to boost weekend sales.  It worked, and it worked so well that it spread throughout Florida, and then went National. 

Being a pricing guy, I have to ask, why did this work?  It is certainly not obvious, but it works! Why?  What can we learn from this?

There seem to be two reasons.  First is the concept of a reference price.  A reference price is where the customer expects to pay a certain price, the reference price, but the actual price is lower, or a discount.  In this Subway case, people believe (rightly) that a footlong sub typically costs much more than $5, so a $5 price is certainly a discount.  Of course we like a deal and Subway is offering us one.

But that doesn’t seem to be enough to tell the story.  A lot of companies have sales.  Why don’t they work just as well?

Here is the tricky part.  It’s the $5.  A round number.  Look around and you’ll see that almost every sale price ends in .99 or .95, but not this one.  In a later blog I’ll explain why companies should use prices that end in .99 when pricing products on sale.  But this Subway sale product ends in .00.  Could this be the reason?

I would suggest that it isn’t the roundness of the number, rather it’s the special features of the number 5.  5 is memorable.  5 is impactful.  5 is a number we use frequently.  We have 5 fingers, which Subway uses in its advertisements.  It’s the number 5.  I don’t think 6 or 4 would have had the same impact.

For this campaign, price IS the message.  Using a price that is more memorable makes the message more memorable.  5 did it for Subway.

This is just my opinion.  Do you have any other ideas on why this worked?  I’d love to hear them.