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The psychology of pricing
Determining the optimal pricing for products may seem like alchemy and simply asking consumers what they think is unlikely to get you the correct results because there are so many competing factors at play. But how can we get to an optimal price point, and what role do discount strategies as well as ranging play?
Firstly I’ll explain the psychology of pricing, including why discounting works.
There are a number of cognitive biases that explain why discount / sale strategies are often successful.
Anchoring: Consumers tend to rely heavily on other values they are shown when evaluating a price point. This means that setting a higher initial price can make subsequent lower prices seem more appealing, but also shows that the competitive space and their price points make a big difference.
Price framing: The way a price is presented or framed can significantly influence consumer behaviour. For example, presenting a price as a discount or sale can make it more attractive, even if the actual price remains the same. Additionally, emphasising the value or benefits associated with a higher-priced option can make it more appealing compared to a lower-priced alternative.
Loss Aversion: This cognitive bias is often at play when people are determining value. The principle is that shoppers are more averse to the pain of losing out on something than they are pleased to gain something. So, £10 saved is better than £10 gained. Examples of loss aversion being applied include limited time or or limited quantity offers. If shoppers don’t buy now, then they lose out. A countdown timer can leverage the scarcity principle and make customers have a sense of urgency.
Price endings: The way prices end can influence consumer perceptions. For example, prices ending in 9 or 99 (e.g., £9.99 or £99) are often perceived as lower than round numbers, even if the difference is minimal. This strategy, known as charm pricing, leverages the belief that prices just below a round number represent a better deal. Studies have shown that there is a left-digit bias in most cultures because they read from left to right and are more likely to register the first number and make an immediate conclusion as to whether the price is reasonable.
Exclusivity: Ending with a 9 doesn’t always work though when consumers judge the prices ending in 99 versus rounded ones. Context is important. If you want to convey that products are luxury or premium (where there is less price sensitivity), then round prices are considered to be a sign of high quality. The terminology used for price incentives for luxury items needs to be different using terms such as member-only prices, VIP status or via a loyalty program.
Missing digits can also convey exclusivity. You are increasingly likely to see prices in restaurants that want to signal that they are upmarket in pounds without pence, such as £12 as opposed to £12.00 or a digit missed off £12.5. This signals that you are not interested in pocket change.
Another tactic to get people to pay more is to leave the £ sign off completely. A Cornell University study showed that diners given a menu with only numbers spent significantly more than those who received a menu with either prices showing dollar signs or prices written out in words.
Considering range strategy
Pricing perceptions are not only based on the price point itself, but also on other options around it. This can be utilised in a number of ways:
Decoy effect: The decoy effect occurs when additional, less attractive options are added to a set of choices, influencing consumers to prefer a particular option. By strategically introducing a decoy, businesses can steer consumers towards a target option that may have higher profit margins.
Price bundling: Offering products or services as a bundle can influence consumer perceptions of value. Bundling can create the perception of a discount or provide additional incentives to make a purchase. Consumers may feel they are getting more for their money, even if the individual components of the bundle would cost the same or less when purchased separately.
Consumer spending during the cost of living crisis
When consumer spending power is limited, there are several changes in consumer behaviour.
Trading down: Consumers may opt to “trade down” by choosing lower-priced own-label alternatives or less expensive brands. People who are more price-sensitive look for more affordable options.
Reduced consumption frequency: Consumers might reduce the frequency of purchasing treat of premium products to align with their budget constraints. Instead of purchasing products regularly, they may reserve them for special occasions or limit consumption to a few key events.
Home consumption: Restaurants and bars are struggling to make ends meet in the current economic climate. This is because consumers tend to shift their drinking habits towards more home-based consumption during times of limited spending power and eat out less. This behaviour reduces costs associated with dining out or visiting bars.
Focus on value for money: Consumers become more value-conscious and seek products that offer the best quality for their money. Cost is a very rational function and when you ask people what’s most important to them when buying products, they will invariably say cost but the real focus is on value for money: Consumers become more value-conscious and seek products that offer the best quality for their money. In many of the studies we have conducted over the years, we see that value for money is a bigger driver of purchase than simply offering the cheapest price. You can see what specific factors influence consumers to purchase one product over another by conducting a Purchase Decision Hierarchy review.
Why do people on limited budgets still buy treats and luxury products?
While individuals with limited budgets may generally cut back on discretionary spending, they may allocate a portion of their budget for occasional indulgences or luxury items.
Psychological reward: Treating oneself to an occasional luxury item or experience can provide psychological rewards and a sense of pleasure. Even with limited resources, individuals may prioritise these indulgences as a form of self-care or to alleviate stress.
Perceived value: Consumers on limited budgets may perceive occasional luxury offerings as providing exceptional value for their cost. They may carefully choose when and where to splurge to maximise the perceived benefits and long-term satisfaction associated with the luxury purchase.
The perceived value of a product can be simply described as the expected benefit minus the perceived cost. If someone believes a product is valuable they may well be willing to pay more for it. Price sensitivity varies from person to person but there are critical drives that influence price sensitivity such as brand value, product life cycles, available alternatives and the intensity of competition.
Social factors: Social influence and peer comparisons can also play a role as do Aspirational consumption, special occasions or milestones.
Using research to determine optimal prices
The Van Westendorp pricing model or the Gabor-Granger model are both popular techniques to determine prices but, used on their own, they have limitations such as missing the context in which buyers evaluate prices. In addition to offering these types of tools, we can also test pricing in a way that more closely reflects the shopping experience and taps into people’s intuitive reactions.
At Mindlab, we have developed a pricing paradigm that uses the principles of implicit testing to measure the intuitions that consumers have about price points. It combines our virtual marketplace environment with some of the latest statistical techniques to capture the complex decision-making that goes on inside consumers’ minds when making even small purchases.
We begin by working closely with you to create a carefully designed set of scenarios that address pricing, format and discounting in a competitive landscape. We then create a virtual shopping experience online and invite participants to select products or services to purchase. Our testing system puts participants under time pressure to make these selections, which allows us to explore the gut feelings that largely drive consumer behaviour.
By varying prices in a systematic way over hundreds of trials, we can discover how demand varies with price for different products or services under different pricing and discount scenarios.
What insights do you get?
We help you to identify the contexts in which a price increase is feasible and those where it is not. We can also identify discounting plans or seasonal offers that will increase total demand without hurting profitability.
Another valuable insight is that we can identify price points for different variations in your product or service that will maximise total revenue when a variety of different options are marketed together.
In conclusion, determining an optimal pricing strategy relies on understanding the psychology of how people see prices and, as they say, context is king.
Duncan Smith
