3 Pricing Myths busted by Behavioural Economics
Behavioural economics looks at economic decision making from the lens of how people behave in real life. It has established that consumers do not make rational decisions, but rather are subject to a range of psychological biases and heuristics (rules of thumb, educated guesses, and the like) when making choices.
Here are 3 Pricing Myths that behavioural economics busts:
1. Customers always want the lowest price
The compromise effect is the tendency to shy away from extremes and choose a middle option. Most people are risk averse, and the choice of a intermediate option avoids the risks associated with extremes - the middle ground is safe.
2. A Buyer’s reference point is the last price paid for the service/goods
Studies show that people are influenced by whatever number they are initially exposed to , which then serves as a reference point and influences subsequent judgements. But that number may be entirely irrelevant to the price now under consideration. Most people are unable to remember the last price paid, and therefore that is not their reference point.
In 1994, a damages case against McDonald’s made headlines around the world when a jury awarded Stella Leibeck $2.9 million in damages after she spilled a hot cup on herself which she had purchased at a McDonald’s drive-through. The plaintiff originally asked for $20,000, so how did she end up with a damages award 145 times higher ? Anchoring. In his address to the jury, Ms Liebeck’s attorney asked the jurors to penalise McDonalds the amount of one or two days of the company worldwide coffee sales, telling them that that amounted to $1.35 million a day. The jury did the maths and awarded two days’ worth of sales.
3. People process information completely and accurately
People are influenced by how information is presented (framed). The classic example of framing is the hypothetical situation where participants were asked to choose between two treatments for a deadly disease.
In the first instance, participants were given the following information about each treatment
Treatment A - "Saves 200 lives"
Treatment B - "A 33% chance of saving all 600 people, 66% possibility of saving no one."
72% participants chose Treatment A.
In the second instance, participants were given the following information about each treatment
Treatment A - "400 people will die"
Treatment B - "A 33% chance that no people will die, 66% probability that all 600 will die."
78% participants chose Treatment B.
People experience losses differently from gains. Losses hurt more than gains feel good, with research showing people experience about twice as much pain with a loss as they experience pleasure with a gain. So, we are loss averse, and our decision making will try to avoid loss.
People make decisions on the basis of the potential value of gains and losses rather than the final outcome. So, what becomes important is how the decision is framed – as a loss or a gain? We tend to avoid risk when a positive frame is presented and seek risk when a negative frame is presented.
Behavioural economics teaches us that, for most clients, price plays a minor role in the decision to retain a professional, and is only a major feature when it is the client it is the only feature against which other options can be compared.
If we give clients choices, and structure those choices in a way which makes it easy for a client to decide, we increase the likelihood a client will choose us over other competitors, and that price will not be an issue.