Points of View
5 psychological mechanisms to increase the effectiveness of your pricing strategy
“In everything, one thing is impossible: rationality”
Humans can’t think rationally every single time. This is because pure logic isn’t a reliable guide in the reality we live in, which is characterized by profound uncertainty. As humans, we have a hard time being rational decision-makers all the time, and we easily let psychological factors influence us when making buying decisions. When evaluating prices and making purchasing decisions, we are heavily influenced by a multitude of factors such as our perceptions, our past experiences, or even our environment. This is why the use of psychological mechanisms can be beneficial for companies when optimizing their pricing strategy. In this article, we will talk about some of those mechanisms.
How come when you go to the grocery store, you see so many products with a price ending with .99? A MIT study shows that 30% to 65% of all retail prices end by 9, due to price charming. Charm prices – prices ending in 9, 99, 95, etc. – are known to make items appear cheaper than they really are. This is due to the fact that people read left to ride, meaning that when a t-shirt is sold at €5.99, the digit 5 is read before the rest and sticks to us in our perception of the pricing.
However, charm prices are known to be effective only when the price is heavily considered (think of food in the grocery store, for example). Indeed, when looking at other, more expensive products, customers would prefer to buy products with round prices because they are perceived as having a higher quality. Having a non-rounded price on a high-quality product would then diminish its perceived quality in the eye of the customer.
So, how to decide which price to communicate? When the purchase decision is driven by logic, charm prices are more appealing, whereas when emotions and higher price ranges are driving the purchase decision, rounded prices intensify the positive judgment related to the product. While most FMCG companies are selling products that are bought based on cognition and elementary needs, luxury brands are clearly selling their product based on emotion. That is why many products you will see at your local grocery shop will have charm prices while a brand like Louis Vuitton will only show round prices.
Anchoring: use high numbers to put your product in perspective
It is human culture to compare things. Whether we want to choose the tastiest restaurant, the prettiest jacket, or the best smartphone on the market, we are constantly using points of reference to help us in our decision process, and prices are not an exception. A company can then easily influence the way its customers compare prices of different products they sell or between different flavours of their product or even their original price to their promotional price, and this is when the anchoring effect comes into play.
According to the Harvard Law School, the anchoring effect is a cognitive bias that describes the common human tendency to rely too heavily on the first piece of information offered. When you have little to no other context, this information will serve you as an anchor, and, in a business context, our buying decision will be adjusted based on that reference point. An excellent example of this mechanism is seen in 2012 in the American restaurant Serendipity 3 and their Guinness book $69 hot dog called Haute Dog. Now the question is, who would eat a $69 hot dog? Well, not many people, actually. But what is certain is that next to that, their $17.95 cheeseburger looked way more affordable, which is precisely the reasoning behind the anchoring effect. It is no secret why the sales of their cheeseburger rocketed after this.
Having a higher offer that is used as an anchor will help you guide your customer to pick the product you want them to choose at the price you want. Look at the following example found on Apple’s website. You can see that their IPhone 14 Pro is compared to 3 other versions of the IPhone, all cheaper. Next to the €1329 of the IPhone 14 Pro, the 3 other versions look more accessible and the purchase might seem more reasonable.
Decoy effect: add a third option
How many times have you been in the following situation? You go to Starbucks to buy your favorite coffee, and you get to the difficult part of choosing which size you want. You end up picking the large size because the small size is not enough, and the medium size is only hardly cheaper. Well, in that case, you just encountered the decoy effect. The decoy effect describes how the decision you take when choosing between two alternatives is influenced when a third one, less charming, is added. In the Starbucks example, many people would not opt for the large size if they had to choose between small and large only. But by adding a third, less attractive option, the medium size (way smaller but only barely cheaper), the large option looks like a way better deal.
In an experiment run by a Professor of psychology and behavioral economics, Dan Ariely – the explanation can be found here; the results show that adding a decoy option can increase the turnover by more than 40%. The fact that companies like The Economist, The New York Times, Apple, or even your local theatre use the decoy effect in their pricing strategy is not a coincidence; it has shown strong efficiency in the overall results.
This principle can be used in another variation also: you don’t add a “medium” option to increase the perceived value of the “large”, but you could also add a third option as a far more expensive one than the two existing ones. That way the middle options suddenly looks affordable in stead of expensive.
How come so many platforms offer a free trial of 3 days, one week, or even a month? It is probably not due to an outpouring of generosity but because they want more conversion, and they use the endowment effect to do so. It’s a phenomenon describing how we tend to perceive a higher value from what we already have, regardless of its objective market value. In other words, whenever we are enrolled in a free trial on a platform, we value our subscription at a higher price than if we were not enrolled. This happens because of loss aversion. As human beings, we prefer not to lose what we have rather than gain something new, which leads us to overvalue what we have.
To show the impact that this phenomenon can have on your pricing strategy, let’s see the example of the following experiment. In a first group, participants had a pizza of €5, to which they could add extra ingredients for €0.50 each. In a second group, participants had a pizza of €11 with all 12 ingredients, and they had the possibility to remove ingredients for €0.50 each. The results showed that people from the second group spent significantly more money than people from the first group. This happened because people from the second group felt that they “owned” the ingredients, so they didn’t want to lose them.
So when you are thinking about your pricing strategy, try to develop a sense of ownership from your client to what you give them, they will be more willing to pay for it if they feel like they already own it and that they don’t want to lose it. This phenomenon also led to marketing techniques like free trials, “try before you buy”, or even “buy now, pay later” that you can use in your strategy.
The rule of 100: percentages vs. absolute discount
When running a promotional activity, while the amount of discount you give is definitely important, the way you communicate it also has a role to play in the overall result of the promotion. Sometimes, discounts are expressed in percentages and sometimes in absolute amounts of euros you save. Is there one thing better than the other? Well, it depends, as we saw repeatedly, everything is relative. Whether a discount seems larger as percentage off or money depends on the original price.
The rule of 100, as explained by Jonah Berger in his book Contagious, Why Things Catch On, explains that for products that are priced below €100, a discount expressed as a percentage will be more effective, whereas, for products that are priced above €100, showing the absolute value of the discount will show stronger results. When a €25 book is being sold at €20, the discount percentage of 20% will look much bigger than the €5 discount. But when a €1500 TV screen is sold at €1200, the same discount percentage of 20% will look smaller than the €300 discount. So when deciding how you should express your discounts, think of the rule of 100.
Overall, having the right pricing strategy requires more than using psychology to sell your product or service. Whether it’s comparing what is your competition doing on checking what is your customer willing to pay, there is a multitude of factors to take into account to develop the best strategy. Contact us if you want to know how we can support you in your pricing strategy.