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  1. Business
  2. Pricing
Business

The Psychology of Pricing

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Do you want to know how to price your products more effectively?

Choosing the right price is a common problem for business owners, particularly in new or rapidly-changing fields, where prices are not set in stone. A popular approach is just to copy or try to undercut your competitors, but there are smarter ways.

Academics have done a huge amount of research into how consumers respond to different types of prices. Some of the results are distinctly counter-intuitive, and by equipping yourself with the right data, you can profit from some interesting cognitive biases. Did you know, for example, that reducing the number of syllables in the price you quote can make people think they’re getting a bargain?

Paying a little attention to the details of pricing could make a big difference to your bottom line. McKinsey & Company has estimated that fewer than 15% of companies do systematic research on pricing, and yet studies have shown that small variations in price can raise or lower profitability by 20% or more.

So in this tutorial we’ll take you through some key findings about the psychology of pricing, and show you how you can use them to set your prices. You’ll learn how to reframe the value of your products or services, how to use price anchoring, how many options to offer your customers, and how to profit from some strange numerical quirks.

1. Reframe the Value

When we evaluate prices, we’re not always strictly logical. How you frame the value of your products and services can make a huge difference to what people are prepared to pay.

Daily, Monthly, or Yearly?

Imagine that you’re trying to sell some high-end software at $1,000 for an annual subscription. You try to justify that high price by telling people all about your software’s wonderful features, and what it will do for them, and why it’s better than your competitors’ offerings. But still no sales.

Try reframing the value, on the other hand, and you might generate a lot more interest. Say your software costs just $2.99 a day. For the price of a cup of coffee, you can get complete peace of mind (or simplify your life, or whatever your software does). 

Doesn’t that sound more compelling?

A smaller amount is not only easier for customers to rationalize; it’s also easier for our brains to process. A neuroimaging study found that high prices activated neural circuits involved with anticipating loss. Even before we start logically evaluating whether $2.99 a day is a good deal, we’re already more likely to accept it than a high price like $1,000.

And the best part? $2.99 a day actually works out to slightly more than $1,000 a year.

Use Obvious Words

If you’re trying to sell a DVD subscription, it shouldn’t really make much difference whether you say it has “a $5 fee” or “a small $5 fee”, should it?

Actually, it makes a big difference. In a Carnegie Mellon study using exactly this scenario, trial rates for the DVD subscription increased by 20% when the word “small” was added to the messaging.

You may think it’s obvious that $5 is a “small” amount, but these little words trigger our buying impulse. Pay attention during the commercial breaks on TV, and you’ll hear these little words all the time: “small”, “low rate”, “bargain”, and so on. They’re obvious, but they work. Put them in.

2. Use Price Anchoring

When you’re offering more than one product, their relative prices can greatly distort the perceived value of each individual product. When people are faced with multiple choices, they often make surprising decisions, so here's what the research shows about how to price multiple products effectively.

How to Make an iPad Seem Cheap

When Steve Jobs first introduced the iPad back in 2010, he gave a masterclass in an important technique called price anchoring.

Remember that before his presentation, nobody had ever bought an iPad before, and nobody had a clue how much it should cost. So it was up to Jobs to set expectations.

“What should we price it at?” he asked the audience. “If you listen to the pundits, we’re going to price it at under $1,000, which is code for $999.”

Having established that $999 figure in our minds, he then made the big announcement that iPad pricing would start at “just $499.” It felt like a deal. We were getting an iPad for half price.

The launch, of course, was a huge success, and since then, Apple has gone on to sell 225 million iPads. That’s not all down to a single presentation, of course, but setting those expectations certainly helped.

The important point is that if Jobs hadn’t given us that “price anchor” of $999, we’d have found our own, and it may not have been to Apple’s advantage. We might have compared the iPad to an iPhone, for example, making the $499 seem expensive in comparison.

So be aware that your customers are making comparisons all the time. You can take control of those comparisons by positioning your product next to something more expensive. If you don’t, your customers will probably find comparisons of their own, and you may not like them.

3. Understand the Effect of Consumer Choice

In a TED talk a few years ago, behavioral economist Dan Ariely talked about a mysterious advertisement he’d noticed in The Economist.

The magazine was offering three subscription options:

  1. Web only: $59
  2. Print only: $125
  3. Print and web: $125

Option 2 seems ridiculous, doesn’t it? Who would choose to pay $125 for the “print only” option, when they could get print and web for the same price?

He ran a test with his students at MIT, asking them which option they’d choose, and the results were roughly what you’d expect, with nobody choosing option 2:

  • 16% chose web only.
  • 0% chose print only.
  • 84% chose print and web.

But when he took option 2 out of the equation and ran the experiment again with only two choices instead of three, something interesting happened:

  • 68% chose web only.
  • 32% chose print only.

With only two options to choose from, people were attracted to the cheaper option. The nonsensical middle option had served a purpose after all. It made the more expensive “print and web” option seem like a better deal.

In your business, try running experiments as Ariely did with his students. Offer your customers different combinations of pricing options, and track the effect on sales. As the Economist example shows, the logic behind consumer choice isn’t always obvious. Even offering an option that nobody wants can sometimes have a positive impact on your revenue.

Avoid Option Overload

But in case you’re now tempted to start cramming in lots of new subscription options, be careful. “Option overload” can put a real damper on sales.

Have you ever spent ten minutes standing in the supermarket aisle, gazing at 24 different types of jam and finding yourself unable to pick one? Don’t worry: you’re not alone. In fact, you were suffering from a common complaint: option overload. You had too many choices, and you couldn’t perceive the difference between them, so you did nothing.

Researchers have studied this very phenomenon, believe it or not. They gave shoppers 24 different flavors of jam to sample, and found that only 3% of them went on to make a purchase. But when they reduced the number of flavors to six, suddenly the purchase rate jumped to 30%.

So if you want your customers to make a decision, offer three or four clear options, not nine or ten.

4. Profit From Numerical Quirks

We all know that $19.99 seems significantly cheaper than $20, even though it’s only a one-cent difference. But there are more numerical quirks to be aware of. Here we’ll take it one step further, and look at some less well-known ways to set your prices based on the way our brains process numbers. 

The Rule of Nine

First of all, does that $19.99 trick really work? Yes, it does.

Researchers at MIT and University of Chicago had a national mail-order company mail different versions of their clothing catalog to randomly chosen customers. In one, the prices all ended in nine, and in the other two, the prices were raised or lowered by $5. So, for example, the same dress would be $39 in one catalog, $44 in the second catalog, and $34 in the third.

The results were astonishing: the catalog with the prices ending in nine resulted in 40% higher sales than both of the others.

The fascinating thing is that the $39 dress not only outsold the $44 dress; it also outsold the $34 dress. Remember, it’s the same dress in each catalog.

It seems we’re so culturally attuned to prices ending in nine that we respond to them, even when it means the product is more expensive. The "nine" price outperformed both its cheaper and more expensive competitors not only at $39, but also at $49, $59 and $79.

Bottom line: it works. Make your prices end in nine.

There’s just one exception. Companies selling more high-end items often avoid prices ending in nine. They want to come across as exclusive, and appeal to customers who don’t need to hunt for bargains. If you want to buy a Gucci bracelet, for example, it’ll set you back an even $10,900. You won’t see any 99-cent tricks here. It’s the same at a high-end restaurant, where your filet mignon will almost always cost $40, not $39.99.

Say it Out Loud

But what about those other quirks I mentioned?

First, think about the number of syllables in the price you’re quoting. In a 2012 paper, researchers found that “consumers non-consciously perceive that there is a positive relationship between syllabic length and numerical magnitude.”

Translation? If a price takes longer to say out loud, people think of it as more expensive.

That’s why on the car commercials on TV, they always say “from ten nine nine nine” instead of “from ten thousand nine hundred and ninety-nine dollars”. It’s exactly the same price, but five syllables sounds cheaper than 13.

So when you’re writing prices on your website or marketing materials, imagine your customers saying the price out loud. If you write a price as “$1,599”, for example, people will say, “one thousand, five hundred and ninety-nine” in their heads. Remove the comma, so that it’s “$1599”, and they’re more likely to read it as “fifteen ninety-nine”. You might just make some more sales as a result.

Other Quirks

Here are a few more surprising research results to consider:

One piece of research at Cornell found that diners in a restaurant spent more money when given a menu with no dollar signs on the prices (for example, when the price of a steak was written as “32” instead of “$32”). Deleting dollar signs from your website could confuse people, though, so be aware of the context!

Another study found that if you want people to pay attention to a sale price, you should write it in a small font. This probably runs counter to your instincts, and is certainly the opposite of most marketing practices, but the research found that “in our minds, physical magnitude is related to numerical magnitude.” In other words, a bigger font makes us think it’s a bigger number.

And still on the subject of sales, try to make the math as easy as possible. Reducing a price from $10 to $8 is actually a better idea than reducing it to $7.97. With the $8 price, we can instantly calculate the $2 saving; when it’s $7.97, it takes our brains that bit longer to process. So we see $8 as the better deal, even though of course $7.97 is cheaper.

Next Steps

So now you’ve learned what the research says about the psychology of pricing. You’ve learned how to reframe the value of your products and services, how to use price anchoring, and how the choices people are given can affect their buying decisions. You've also seen examples of how the human brain responds to numbers in sometimes surprising ways.

The next step is to put all of this into practice in your business. Don’t be afraid to experiment here. While major price changes should of course be carefully thought through, you can easily make minor tweaks without alienating your customers. And you can present them as special sales or promotions, to run for a limited time, so that you can always go back to your initial pricing if things don’t work out as you’d planned.

For web-based businesses, it’s even easier. You can easily vary the prices, bundles and offers on your website, and track which ones perform the best. And of course with some of the strategies, like price anchoring and reframing the value, you can even keep your prices the same, and just vary how you communicate them.

So why not get started? Make a plan for how you can start using these insights into consumer psychology to boost your business’s bottom line.

Resources

Graphic Credit: Brain designed by Blake Ferguson from the Noun Project.

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