Psychological pricing: Frame value through pricing techniques
Psychological pricing: Framing value with psychological pricing techniques
Do you study and compare consumer product prices across different brands and regularly update your pricing knowledge before you buy your weekly shopping?
Even with the help of online aggregator sites, I suspect that very few of us hone our Bayesian instinct every single time we visit the local supermarket.
Gaining acute price awareness across a broad spectrum of consumer goods takes a lot of time, focus, effort and dedication. Most people are either too busy, non plussed or even blissfully unaware of how much they are influenced by the effects of psychological pricing techniques.
We can all be price sensitive buyers. How sensitive can often depend on how we feel at a given point in time, what we are buying and when we buy it. Price sensitivity depends on a whole range of economics, cognitive, financial and emotional factors. Price sensitivity can even depend on what we are focusing on at any given moment in time (Cialdini, 2016).
In this article, I will explore the strong effect of psychological pricing on consumer buying decisions. I will discuss concepts like prospects theory, The Weber-Fechner effect, loss aversion (Daniel Kaheman Tversky) and the focusing illusion described in Nobel Prize Winners’ Daniel Kahneman’s latest research.
Throughout the article, I will give tips on how pricing and revenue manager teams can use aspects of these theories to help them frame value to boost revenue and maximise margin.
Emotional factors of psychological pricing
People like to think they make rationale purchase decisions, yet the wide variations in our own responses to product pricing demonstrates that we are largely irrational decision makers. Traditional economic theory has led us to believe (and for some time now) that we tend to make rationale purchase decision most of the time.
An ever-increasing body of neuro-marketing research, however, shows that as consumers we are all enormously susceptible to our own subconscious drives, emotions and attention deficits.
Psychological pricing research
Nobel Prize winners Daniel Kahneman and Amos Tversky, for example have advanced our knowledge on psychological pricing in their research on alternatives decisions or as they label “prospects.” A key result of their psychological pricing research is prospect theory value function, which describes how people feel about gains and losses, and more than this, the differential value we all place on gains or losses of various sizes.
There are two important aspects of the prospect theory value function which pricing teams need to know in order to frame value: 1) the connection with the Weber Fechner Law and 2) the connection with loss aversion.
Psychological pricing principles
Weber Fechner Law is an established and reliable psychological principle. It postulates that there are “diminishing returns” for the mental effects of a stimulus.” In other words, each additional unit of external stimulation will add less to the mental effect of the stimulus than its predecessor.
Applying the Weber Fechner Law to psychological pricing would go as follows: adding a dollar to the price of an inexpensive item we make us feel more pain than adding a dollar to an expensive item.
The same pattern occurs for losses: Taking away a dollar from an inexpensive item will give you more immediate pleasure than subtracting the same amount away from the price of an expensive item.
The diagram above shows how Prospect theory builds on the Weber-Fechner Law with the loss portion of the prospect theory value function equation. If you look at the loss portion of the prospect theory curve (above), you can see the curve sloping downward much more sharply than the gain portion of the function curves upward. The sharp downward slope is key to psychological pricing because it represents the moment we (as consumers) feel loss aversion.
What is loss aversion?
Loss aversion is our tendency to view a loss as more painful than the pleasurable feeling of an equally-sized gain. For example, if your annual salary as a pricing manager is $150K AUD and the company increases your base salary by $10K, you would feel pretty good. However, if your salary is $150K and the company decreased it $10K, you would feel bad, frustrated, confused and upset to the point of looking for a new job. This is because the loss of $10K in salary would physically give you more pain than the pleasure you would get from receiving a $10K increase in salary.
Loss aversion is a critical tenant of psychological pricing because it shows us the pain of paying – or how much it hurts us to pay a price – and since pricing teams cannot know the pain consumers feel from paying a particular price level from price elasticity analysis alone, loss aversion helps pricing and revenue manager teams to interpret unusual price responses in certain groups of consumers based on their feelings of pain or pleasure.
The impact of focusing illusion on psychological pricing
Nobel Prize winner who coined Prospect theory value function has recently built upon loss aversion with his latest work on the focusing illusion (described in Cialdini’s latest book “Pre-suasion”).
The rationale of focusing illusion is that people only really attend to things that they think are important. More interesting still is that latest research by Kaheman finds that when we attend to things, they automatically become greater in importance than they actually may deserve.
Research by Bizer et al 2001, for example, supports this assertion by showing how our brains organise our thoughts and feelings so that the attitudes we focus on most readily are the ones that are most important to us. Similarly, Lim et al, 2011 find that when we focus our attention of a consumer product, the item’s worth increases.
The discussion on why people over value what they focus on in-the-moment, comes back to how our brains naturally priorities our feelings and attitudes in real-time (or as we feel as we think). In other words, when we look at an item, our brains will imbue more worth and value to that item. When we are not looking at the item our brains will not imbue the same level of worth and value to that item as it did before – i.e., the focusing illusion.
Even though Kahneman has not devoted much concentrated study to the focusing illusion, support from the consumer arena for Kahneman’s assertion can also be supported by a range of other consumer studies.
One such consumer study by Atalay et al, 2012 investigates why items placed in the centre of an array of brands on store shelves tend to be purchased more often. Key learning for pricing and revenue management teams may be that products in the centre of a shelf get more visual attention, particularly in the moment just before a choice is made and that central positioning predicts purchase decision.
Knowing what we now know about how our brains actually manipulate our thoughts and feelings in real time (or as we focus on a given object or item): Do you think pricing teams have an opportunity to understand price responses in terms of high cognitive and emotional functioning / or attention deficits? Do you think there will be a time when our limited attention, emotion and natural brain functioning will eventually be used against us to get us to buy more without feeling the effects of loss or pain?
Customers and consumers are not as rational as we like to think they are. More often than not, we are driven by unconscious thought processes that are easily influenced by our surroundings (without even realising it).
We are all very susceptible to our emotions and feelings when we make a purchase. I think pricing teams sometimes forget to consider how much we are all constrained by our emotions, assumptions about the worlds and higher order brain functioning capacity.
Many pricing teams fall into the trap of thinking that consumers think of prices like they do (see everyday low pricing). There is a tendency for pricing and revenue management functions in large businesses to think they can only anticipate consumer’s response to price changes in terms of rational price related decision making capabilities (i.e., their level of price knowledge, awareness and/or internal reference price or beliefs about prices).
It is likely that an overemphasis on logic, economics and competitive tension is created by a reluctance to explain emotionally based value drivers to the executive leadership team. However, even though irrational consumer behaviour is a difficult one to explain or prove, the secret to driving sustainable growth and profitability resides in the unpredictable territory of human emotion and risk aversion.
See our blog on pricing page best practice to see how leading companies are using research in online models. We also review the interesting introductory book Priceless – by William Poundstone here: Market based pricing.