Archive for 5. Psychology

Jul
01

Psychological Pricing Is Overrated

Posted by: on July 1, 2014 | Comments (1)

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Psychological pricing is fun. In this field we get to study the effects of prospect theory (where losses loom larger than gains) to yield such odd behavior as the endowment effect (where we value what we have more than if we didn’t own it) and reference pricing (where we use the price we expect to pay in our decision making). We also have price endings, anchoring, dominated alternatives, good-better-best, and many more pricing tactics.

Psychological pricing can be defined as using pricing to take advantage of buyers’ lack of rationality. The books on this topic are quite fun to read. I recommend Dan Ariely’s book Predictably Irrational.

Experience shows that some of these tactics are pretty powerful while others are more interesting than impactful. Good-better-best and reference pricing are two that typically have a major impact. However …

Psychological pricing tactics pale in comparison to pricing for value.

Pricing for value (aka value based pricing) means understanding what your customers are willing to pay and charging as near to that as possible.  If you are not yet committed to value based pricing, then focusing on psychology has minimal effect. By far the biggest impact you can have to your profitability is to adopt value based pricing. After you’ve adopted this most powerful pricing strategy, then you can worry about the psychological effects.

 

Picture by Pixabay

Categories : 5. Psychology
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May
12

The Power of Loss Aversion in Pricing

Posted by: on May 12, 2013 | Comments (0)

lost ice creamAfter reading a short article by Cass Sunstein on The Power of Loss Aversion, the urge to translate this to pricing was unstoppable.

Loss aversion (i.e. Khanemen and Tversky’s prospect theory) indicates that people hate losses and go to great efforts to avoid them.  Prospect theory said that people hate losses much more than they like wins.  This indicates people will work harder to avoid a loss than to win.  Here is one example from Sunstein’s article:

“The District of Columbia has tried to decrease people’s use of grocery bags. One approach was to offer a five-cent bonus to customers who brought reusable bags.That approach had essentially no effect. More recently the District tried another approach, which is to impose a five-cent tax on those who ask for a grocery bag. Five cents is not a lot of money, but many people do not want to pay it. The new approach has had a major effect in reducing use of grocery bags.”

Now let’s apply loss aversion to pricing:

1.  Price increases – Whenever a customer sees a price increase, they interpret this as a personal loss.  Hence we often see extremely emotional reactions resulting in lost business.  One strategy, if possible, is to only increase prices on new customers, ones that don’t already have a history of transactions with you. Then, after you build a big enough market with these higher prices, it is much easier to raise prices on the legacy customers because they might be happy you treated them well for so long.  Besides, if they leave you it’s less painful.

2.  Reference prices – A reference price is what your customers expect to pay.  If they are forced to pay more than this they consider it a loss.  Less is a gain.  Existing customers often use the last price paid as their reference price (see above paragraph).  However, for new customers, you have the ability to influence their reference price.  We often see retailers show MSRP and then a marked down price.  This is to influence the reference price.  Alternatively, you can choose to compare your product to one that is much more expensive in hope of increasing the prospect’s reference price.

3.  Limited time offers – If Macy’s is willing to sell a jacket at 50% during a sale that ends Sunday, why wouldn’t they sell it at 50% off on Monday?  The answer is loss aversion.  If you’re on the fence about buying the jacket, you are more likely to go purchase it while it’s on sale.  Once Monday comes you have lost the opportunity.  If Macy’s doesn’t stop the sale on Monday you don’t have the extra incentive to go buy on Sunday.  Loss aversion is one factor that drives the success of sales.

What other applications of loss aversion are there in pricing?  Take a moment and think about it. Please share your thoughts with the other readers.

 

 

Mark Stiving, Ph.D. – Pricing Expert, Speaker, Author

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Photo by Big Ben (Gaijin Bikers)

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Oct
14

Teslas, Warranties and Whiners – More Pricing Lessons

Posted by: on October 14, 2012 | Comments (0)

A friend asked for my opinion on this blog – Tesla Model S Service Contract: $600/Year, Or Warranty Voided by David Noland.

David is on the waiting list for a new Tesla and found out the service contract is $600 per year. Worse yet, if you don’t buy the service contract, you don’t get a warranty.

Where to begin.

First, David spends much of the article estimating the true costs of servicing the vehicle, pointing out it is much less than $600. Apparently he thinks Tesla should be pricing service contracts on a cost-plus basis. We’ve mentioned this before, customers think we should use cost plus pricing. If we don’t, they think we are gouging them. David gives us an example of this. Tesla probably wishes David hadn’t pointed out the cost vs. the price. However, as long as this theme isn’t picked up by lots of media, not that many customers will think this way. In the end, Tesla can charge whatever their customers are willing to pay.

Second, hooray for Tesla. It wouldn’t surprise me if we see more high end car companies doing this. Why? They are selling complementary products. Keep the price of the decision product (the Tesla) as low as possible and make profit on the add-ons and accessories. It’s like paying shipping and handling on an Internet purchase, or buying an HDMI cable for your new DVD player, or baggage fees on airlines. These high margin add-on purchases are rarely considered by customers when making the initial purchase decisions.

Finally, hooray for David. He is proactively considering the cost of the add-on, the total cost of ownership. The cost of the service contract may make him change his mind. It may not. Regardless, kudos to him for investigating all the costs so he can make an informed decision. Also, it’s wonderful that he’s sharing his opinion of it with all of his readers. This information may change some minds of readers who were struggling to afford a Tesla, but I would bet most Tesla buyers simply grimace and write the $600 check.

Tesla hasn’t responded to David (and why should they?). It is very possible that they have done extensive analysis on battery failure rates and $600 is a “fair” price.

In the end, companies get to make their own rules on how to sell their products … and for how much. Consumers get to decide whether or not to buy. I’m a strong proponent of informed consumers, but not whiners. On the other hand, if businesses make decisions that cause customers to whine, they are asking for trouble. What happens if a large portion of the media pick up this story? Tesla may find this pricing tactic hurts their brand.

Pricing – sometimes, it’s a balancing act.

Mark Stiving, Ph.D. – Pricing Expert, Speaker, Author

photo by jurvetson

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Jul
08

Pricing is … Information

Posted by: on July 8, 2012 | Comments (0)

A price is the amount of money someone has to give up to acquire a product or service.  Duh.  Everyone knows this. But what seems to be irrational is that customers also use price to infer characteristics of the offering.

We expect customers to analyze the quantity and quality and then decide if it is worth the price.  However, many of our customers use price to help them determine the quality.  This seems wrong.

We’ve seen that pricing can be a signal of quality.  When people see higher prices, they infer higher quality.  Does this make sense?  Yes.  Shoppers have probably not thought about this logically, but they have experienced unlimited examples of where they could get more quality if they were willing to pay more.  It’s all around them, so they subconsciously learn that higher prices mean higher quality.

If they wanted to justify their behavior, they would probably think something like this when looking at a higher priced product: “The manufacturer (or the retailer) knows this one is better so they priced it higher.  Besides, many other people who know more than I do have done the analysis and think this one is worth more.  Otherwise nobody would buy it and the company would lower the price.” And most of the time they would be right.  Higher quality products have higher prices.

Customers have subconsciously learned other meanings from observed prices.  Prices that end in 99 are considered to be good deals because sale prices are usually priced with 99 endings.  Prices that end in 00 are considered higher quality.  The lowest and highest prices seen by the shopper bracket the quality levels under consideration.  The higher the high price point, the more the customer will expect to pay.

But in every case, this only applies for non-expert customers.  The shoppers who are looking for clues, don’t want to become an expert in the field.  True experts know the real value and use price for the purpose it was intended, what they have to give up to acquire the product.

As you can see, price is more than just what the customer needs to buy your product or service.  It is also telling the customer more about your offering.  Take care that your prices are telling them what you want.

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Mark Stiving, Ph.D. – Pricing Expert, Speaker, Author

Photo by Onkel Wart

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Mar
15

You Are Training Your Customers – Do It Wisely

Posted by: on March 15, 2012 | Comments (0)

I ordered the New iPad on the day it was released.  I never do this, but after watching Apple’s pricing over the years I’m confident they won’t be lowering their price for a year or so when they release the next version.  Why not buy immediately?  Apple has trained me what to expect.

An attendee in a presentation last night described her experience with Banana Republic.  She said, “I used to shop at Banana Republic and sometimes buy at full price.  However I signed up for their email list and I get coupons in the mail every few days.  Now I don’t buy anything there unless I get a discount.”  Banana Republic trained her to only buy with coupons.

JCPenney is trying very hard to retrain their customers.  Customers used to wait for sales.  JC Penney wants to give them good pricing every day and make their customers confident in these prices.

Here’s the point.  You are training your customers with your pricing behaviors.  Whatever you do frequently, your customers will come to expect.  Do you have frequent sales?  Do you hold price?  Your customers learn your behaviors and use that to help them make their best decisions.

This is not a bad thing.  It’s a fact.  You are training your customers.  The question is are you training them to behave in the manner you’d like?

Mark Stiving, Ph.D. – Pricing expert, speaker, author

Photo by skycaptaintwo

Categories : 5. Psychology
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Feb
05

Pricing is … Psychological

Posted by: on February 5, 2012 | Comments (0)

If people were rational, well, economic theory would work.  Buyers would make purchase decisions based solely on the value of the acquisition relative to the price.  But we know people aren’t rational in many ways, including price. 

For example, if people were rational, why would so many prices end in 99 cents?  (Because we are lazy subtractors.)

Why would people assume a product is higher quality just from the price?  Shouldn’t they know the quality first and then decide if it is worth the price?

Why do people get so upset when they see “unjustified” price increases?

We can manipulate consumers choices by offering good, better, best product offerings.

We can confuse them with too many choices.

We can get them excited about and move them to action with a sale.

They will pay more (or less) for the exact same object depending simply on what they expect to pay.

Pricing is psychological.  Consumers are much more effected (make more irrational decisions) than companies, but companies do it as well.  Corporations have buyers, and these buyers are normal people with the same emotions as the rest of us.  They have been trained to be more rational, but in the end they are people.

If you are a B2C company, you absolutely must pay attention to the psychology of pricing.  It is not an option.  If you’re B2B, you should be able to focus more on delivering real value for the price, and justifying it with rational arguments.  Even so, don’t be surprised when your customers exhibit irrational behavior based on pricing psychology.

Mark Stiving, Ph.D. – Pricing expert, speaker, author

Photo by Thomas Thomas

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Jan
22

Too much choice

Posted by: on January 22, 2012 | Comments (0)

My nephew, third year at The Ohio State University, is taking a psychology class.  He wrote to me:

“The professor suggested that life is so complicated that the complete freedom to make any choice about, say life insurance for example, is in reality less freedom because people feel overwhelmed and end up making a poor choice. He thinks people have an optimal amount of choice, and that at a certain point fewer options are better.”

The psych professor is kind of right, people do feel overwhelmed. I don’t necessarily agree that it makes people make poorer decisions that if they had less choice, but people do take much longer to decide when faced with tons of alternatives.

Too many options overwhelm decision makers.  As businesspeople, here is how this effects us.  Confused consumers postpone their decisions.  If you have a customer in your retail store, and he is confused, he is likely to postpone the decision.  That means he walks out of your store and may end up buying on-line or at another store.

If you are a manufacturer and you have 20 different models of your product, your customers will have a hard time deciding and will postpone this decision.  During this delay she may end up changing her mind, buying something else.

As a businessman, you want to offer choice, just not too much choice.  If you are at all in doubt, go back to the tried and true, proven to work pricing strategy of Good, Better, Best.  Three choices.  Simple enough for your customers to understand, but enough choice that they may not need to go look at more options.

The key takeaway, you can have too many options.  Talk to your customers to see how hard it is for them to make a decision.  If they are postponing the decision while they figure out what is best it may mean you are offering too many choices.  Make it easy for your customers to decide.

Mark Stiving, Ph.D. – Pricing expert, speaker, author

Photo by Orin Zebest

Categories : 5. Psychology
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Jan
17

The Dollar Store and Subway

Posted by: on January 17, 2012 | Comments (1)

“In April 2010, Colin Sharp changed the names of his chain of pound shops in Wales from Famous £1 Shop to Famous £1.20 Shop.”  This was in a BBC article titled “Will All Pound Shops Have to Raise Prices?” 

Reading this created an Aha! moment.  Remember the $5 footlongs from Subway?  This was an interesting price because most companies who are advertising a low price end that price in .99.  So why did Subway use $5?  We postulated it was because the round number was more memorable, and since the price was the leading attribute, making it memorable would bring in business.

A storefront titled “Famous £1 Shop” is memorable.  “The Dollar Store” is memorable.  These guys all make the feature of low price memorable.

In the Subway blog we asked what would happen when the recession ended and Subway had to raise their prices.  Boy, that was nothing compared to the question what happens to “The Dollar Store” when inflation hits?

Well, we don’t really care.  But what we do care about is learning from the markets.

So what can you take away?  If you have a sustainable price advantage, you may want to prominently advertise a round price, just to make it memorable.  However, remember most low prices end in 99 or 95, and most businesses wisely aren’t chasing the lowest priced products.  You’d better be sure that you want your customers to remember your very low prices before using this tactic.

Mark Stiving, Ph.D. – Pricing expert, speaker, author

Categories : 5. Psychology
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Dec
09

Cost Plus Buying

Posted by: on December 9, 2011 | Comments (1)

One trick that professional purchasing organizations commonly use today is to tear apart your product, calculate how much it costs to make, and then negotiate with you starting at your cost.  This makes it challenging to sell value.

Interestingly, as consumers we do the same thing.  When you buy a car, do you try to find out the dealer’s invoice price to help with your negotations?

In fact, we assume that companies price using cost plus.  For example, when a company tells you they have a fuel surcharge because the price of gas has gone up, this implies cost plus.  When Hershey’s says the price of chocolate is going up because sugar prices go up, we think cost plus.  Every time we see an announcement that oil prices have gone up, gas prices go up instantly.  This implies cost plus.

How about when a disaster hits an area and the store sells bottled water at a price much higher than normal.  The store owner is selling value, but we’re upset because we believe he should be cost plus.  (I’m not suggesting you gouge customers during a disaster.  Just using this as an example.)

I once consulted with a couple guys doing consulting.  They knew they wanted to use value based pricing, so when a client asks them what they charge, they used to say, “we have to wait until we understand how much value you get out of this.  Then we can give you a price.”  They were effectively telling their potential customers there were going to “gouge” them.  Ouch.

The point is buyers assume you price using cost plus.  Although it is much more profitable to use value based pricing, you want to allow your customers to continue to believe you use cost plus.

All you people selling software, you have this easy.  There is no variable cost, so everyone assumes you are selling value (or development costs).  Cost Plus Buying only applies to products where there really is a cost.

The lesson: use value based pricing, but look like you are using cost plus pricing.  Just another reason why pricing is … secret.

Mark Stiving, Ph.D., Pricing expert, speaker, author

Photo by Gavin St. Ours

Categories : 5. Psychology, Costs
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Mar
28

Simple Pricing

Posted by: on March 28, 2011 | Comments (1)

The New York Time recently announced their new pricing strategy.   Several people have pointed out that it is way too complex for mere mortals to understand.  I especially enjoyed this blog post from John Gruber where he emphasizes that when pricing is complicated for customers to understand they are less likely to purchase.  I absolutely agree.  John also held up Apple as an example of nice simple pricing.  A great example.

However, this does not mean that you should not segment on pricing.   Let me restate that sentence without the double negative.  You should still segment on pricing.  The lesson from the New York Times and Apple is that we want to present simple pricing to our customers.  When customers see simple pricing they are more likely to make a decision, resulting in a sale.  When they see complex pricing they are less likely to make a decision, meaning no sale.  However, presenting simple prices and price segmentation are not mutually exclusive.

Even though Apple’s pricing appears simple, they are still segmenting.  Apple is clearly segmenting on price using the versioning technique.  They may also be segmenting in ways we don’t see.  Are they offering bulk purchases to some companies at discounted prices?  Are they offering lower (or higher) prices in other regions of the world?

Think about shopping for something on Amazon.com’s web site.  What you see is the item and a price.  Very simple.  Amazon may have extremely complex algorithms that look at their customer’s purchase history, their zip code, maybe even the credit limit on their credit card to determine what price to charge each customer, but in the end Amazon shows only one price to their customer.  Complex segmentation, simple price presentation.

The New York Times seems to have violated this keep it simple stupid (KISS) rule for their pricing.  The lesson we should learn is that we need to follow KISS when presenting prices to our customers.  Don’t take the wrong lesson.  Continue to segment on price.

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