When it comes to pricing, there is one constant to keep in mind. People do not know how much things are worth.

We will reiterate that point because it bears repeating, people really do not know how much things are worth.

The fact that a game show such as The Price is Right can actually exist definitely bears out that point.

William Poundstone, the author Priceless: The Myth of Fair Value says this:

People tend to be clueless about prices. Contrary to economic theory, we do not really decide between A and B by consulting our invisible price tags and purchasing the one that yields the higher utility, he says. We make do with guesstimates and a vague recollection of what things are “supposed to cost.

Not only do people not know what things cost, there are any number of oddities that exist with regard to shoppers, spending and pricing.

Shoppers that move in a counterclockwise direction spend an average of \$2.00 more at the supermarket than shoppers that shop in any other direction and removing the dollar signs from prices (35 instead of \$35) increases sales.

"Great", you might be thinking, but in your online store, no one is moving in any direction and you are not quite ready to remove all the dollar signs from your website.

Is there anything useful among the oddities? As it turns out, there is actually quite a lot of proven pricing data out there that can help boost your bottom line. Have a look at some of the information and examples collected here and decide for yourself which practices are relevant to your particular situation.

## The Economist and decoy pricing

In his book, Predictably Irrational, Dan Ariely used the following advertisement to illustrate his point:

He conducted a study using 100 MIT students and asked them to choose a subscription. Sixteen chose option A (the package for \$59) and 84 chose option C (the combo package for \$125). Nobody chose the middle option.

Ariely then asked, "If nobody chose the middle option, why bother offering it?" He removed it and gave the offer to another 100 MIT students. Thirty-two chose the expensive option and 68 the cheaper option.

Turns out that the middle option was far more useful than it seemed, it helped people make a decision between two similarly priced choices.

It seems that when offering three choices, it may pay to set them up as A, A- and B, rather than A, B, C. The A- choice reinforces the value of the "A" choice and keeps attention away from the B choice altogether.

A graph that describes this can be found below:

So if you add a slightly worse option that is similar to A (call it A-), then it is easy to see that A is better than A-, leading many people to choose that option.

## Anchoring and the contrast principle

Nothing is cheap or expensive by itself, it is only in comparison to something else. After seeing a \$250 hamburger on a menu, a \$65 steak seems quite reasonable. An \$89 T-shirt looks cheap next to an \$18,000 bag.

What is the the best place to sell a \$3,000 watch? Next to a \$15,000 one.

This mental process, which turns an otherwise "high" number into a reasonable one, is called anchoring and adjustment. Anchoring has proven to have an effect on pricing and a study done by William Poundstone demonstrates just how effective anchoring can be even among "experts".

Real estate experts and undergrad students needed to appraise a home for sale. The normal information a buyer would have as well as what the seller has listed the house for was provided. Then they split into groups, each group was given a different listing price and then asked to give their appraisal.

These were the results for each listing price given:

 Listing Price Avg Estimated Worth by Students Avg Estimated Worth by Experts \$119,900 \$107,916 \$111,454 \$129,900 \$120,457 \$123,209 \$139,900 \$123,785 \$124,653 \$149,900 \$138,885 \$127,318

As it turned out, all of the real estate experts "got it wrong" and seem to have tied their appraisal value to the listed price (all four "listing prices" were given to four different groups for the same house).

Setting anchor points for your products can mean introducing very expensive items that you may never intend to sell, but they serve to establish a baseline for the "adjustment" that will make your "regular" items more appealing.

## Price perceptions

In his book, Don’t Just Roll the Dice, author Neil Davidson writes the following about price perception:

People base their perceived values on reference points. If you are selling a to-do list application, then people will look around and find another to-do list application. If they search the internet and discover that your competitors sell to-do list applications at \$100 then this will set their perception of the right price for all to-do list applications.

This point seems to have much in common with the concept of anchor points that we discussed earlier, however our focus here is not on setting an anchor, but on indentifying your product correctly.

If you intend to price your product higher than the common reference points, you need to change the reference points and the perception that people will use for your product.

Using Starbucks helps clarify this point. How did they manage to convince anyone that paying \$3 for a cup of coffee was "worth it", especially considering most other cafes charged around \$1?

Using price perception, this should have led people to stay away since \$1 would have been the reference point for coffee.

Starbucks changed the reference points. They reinvented the experience of buying coffee so the perception of what was being sold had changed.

There was no longer a reference point with "other cafes"; they had successfully created a new category. If you can look like a new product category, you can set the price and people are more likely to pay for it.

## Context set perception

In a pricing experiment conducted by Richard Thaler, the following scenario was used.

Two friends are on a hot beach. One offers to buy his friend's favorite beer for him, but asks him how much he would be willing the pay for the beer.

Two choices were given. In the first, the beer was being bought from a local run-down grocery store and in the second, it was being purchased from the bar of a fancy resort hotel. In either case, the beer would be drunk on the beach. In nearly all cases, people agreed to pay more when the beer was coming from a fancy hotel.

Their reason was that it strikes them as "unfair" to pay the same. This violates the bedrock principle that one Budweiser is worth the same as another, and it suggests that people care as much about being treated fairly as they do about the actual value of what they are paying for.

Thaler considered what his imaginary grocer could do to boost beer sales. He advised “investing in seemingly superfluous luxury or installing a bar”. This would raise expectations about what the proper price of beer would be, resulting in more purchases.

The appearance of the place of purchase will have a significant impact on the prices people will be willing to pay. Investing in a high-end web design can yield more than just "looking good" to your bottom line.

Published 23 April, 2013 by

Ari is the co-founder of HomeShare and Zent , Graduate of the GSB Stanford Ignite program, and a contributor to Econsultancy.

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My question is about shipping costs. We have been adding the cost of shipping into the cost of our products, but his raises the price of the products.
Is it better to tie shipping costs into the total product cost, and then offer free shipping? Or to charge shipping separately?

Great article. It's amazing how counter intuitive we are - rather then testing, testing and more testing to let the results guide us down the right path. You nailed it here! Thanks.

Fascinating article. It mirrors other theories of pricing, how price is easily influenced and how groups are led by others.

Try this test with two separate groups of salespeople.

Ask the first group these two questions.

Q1. Is this the Mississippi River shorter or longer that 300 miles?
Q2. If you believe it to be shorter or longer than 300 miles how long do you think it is?

And the second group.

Q1. Is this the Mississippi River shorter or longer that 3,000 miles?
Q2. If you believe it to be shorter or longer than 3,000 miles how long do you think it is?

The average answer comparing the two groups can vary by as much as 1,500 miles. What it shows is how easily influenced those responsible for pricing services, projects and products can be - often to its detriment.

We use a variety of principles such as these with our staff and clients to remove some of the influences that can lead to underquoting, over-quoting and soft pricing.

Oliver Springate

A really good article. It's amazing just how much goes into our buying process, and I would recommend reading the whole of Dan Ariely's book for anyone who is involved in conversion rate optimisation.

Deri Jones, CEO at SciVisum Ltd

Arie

Nice article: but a couple of concerns.

Firstly that Economist subscription example: there may be more things going on than just pricing: some UI issues.

For example: the advert mixes jargon for the same item: it doesn't list:

In the first line ' economist.com' is used, whereas in line 3, that has been renamed 'web subscription'.

That's got potential usabilty issues of it's own.

In addition: is the fact that line 2 has it's price 'tucked to the left' so it no longer lines up with the 1st and 3rd item pricing. Again, this may have an impact.

Lastly: your company offers a 'real-time repricing engine ': there is an interesting discussion to be had about the psychological impact on buyers when the price for a fixed item can vary day to day.

Will that reduce trust in pricing altogether, and thus consumer behaviour may change away from what it was in past surveys?

Arie

Thank you for pointing out some of the techniques that affects the price perception. While decoy pricing strategy is quite easy to implement, changing the reference point is much more complicated and involves capitalising on brand awareness. In case of Starbucks it’s more about selling branded vs unbranded goods.

Ari Shpanya, co-founder at HomeShare.com

Brian, thank you for your question. Offering free shipping is a good idea, but does not work for every business. It is best to do some testing and research on the specific industry. there is no clear answer to your question, since it can depend on the industry. For some product purchases people expect to pay shipping charges, while for other products people are hesitant to pay any shipping charges.

Many retailers will offer free shipping even without adding to the price of the product simply as a marketing expense to gain market share. If you can offer free shipping without adding to the price of the product and still make a good profit, then that is the best case scenario. However, in competitive markets that is usually not the case. Therefore, you will find retailers will offer free shipping with some threshold offer that is designed to drive more units per transaction.

The key with pricing is to test. The answer can be different for different retailers and different product lines.

Ari Shpanya, co-founder at HomeShare.com

Thank you for the comments everyone. Michael, I really like your analogy and thank you for sharing it.
Deri, I agree that it's not just the pricing that could affect the decision, but also the wording used. Thank you for pointing that out.

Regarding changing pricing day to day, it is not uncommon for any online or physical store to change its prices. I believe pricing may be an ethical issue when it comes to offering the same product at a different price to different people at the same time. There are online retailers that will display a different price based on the city or zip code your are browsing from. This can reduce trust in retailers.

Maggie Tolliday

The product, location and time of day can be the same; the customers may be similar, but the motivation for the purchase can affect the perceived value. My family were discussing Venice; my mother complained that the prices for coffee in St Mark’s Square were too much for a quick break from sightseeing. I thought that they were good value, beautiful setting, great people watching and some music thrown in. My brother disagreed; he thought it was a bargain. He was there attending a conference and needed to work on his paper; a quiet booth in the cafe overlooking the square, with good coffee in a beautiful historic setting, was the best work place you could imagine.
How do you build utility into a pricing model for something as simple as a cup of coffee? I was happy with the listed price, my mother probably would have been happier with half that, my brother probably would have paid double that or more.

However scientific a pricing strategy, the subtleties and complexities of individual customer motivation which for consumer goods can change during the course of a day, sometimes make me feel it can be a lottery.