Beyond the Price Tag

Pricing strategies are generally based on the “visible price”, the price stated on the label.

Behavioural Economics helps us understand that the true full price also includes a lot of hidden costs, mainly psychological. These include (1) investment cost, (2)computation effort, (3) price gap frustration, (4) self-esteem injury and (5) risk of regret.

Brands need to understand all of these components to better inform their strategy. Let’s consider an everyday example. A 15 € bouquet of flowers a person buys for the host of a dinner party. What would the hidden costs be?

Investment cost

The most obvious hidden costs are investment costs, i.e. the time and energy the buyer is required to ‘invest’ to obtain the product. Investment costs would include the time the buyer spends finding a florist, the mileage and wear and tear on the purchaser’s car, the energy to find a free parking place, and the risk to find the florist closed as they arrive late in the day.

Buyers may accept to pay a higher price if it is compensated by a lower investment cost. When the price of gasoline increases, the sales of hypermarkets decrease and the ones of proximity stores increase symmetrically.

So, marketers should consider the investment costs as part of their clients’ equation, and in case they are in disproportion with the price, make a huge effort to improve their products accessibility.

Computation effort

Purchases, whether large or small, require careful consideration of numerous details, which can be mentally taxing even if one is not consciously aware that they are engaging in these computations. In other words, decision making imposes effort. Using the bouquet example, one must first decide if this is the best gift for the host by comparing other options, such as a bottle of wine. Once flowers are selected, one must then select the type, color, and style of the arrangement. And all of these determinations are more or less demanding depending on one’s mood, stress level and available time.

Shoppers like choice, but too much choice in a given product category can become overwhelming!

Marketers have devised solutions to relieve decision making burdens and reduce computation effort. This can have a huge impact on decisions. Consider the following example where individuals were provided with the option to participate or not in an organ donation program. As reflected in the chart below, the countries that presented the option in an opt-out mode (doing nothing means you accept) had dramatically higher participation rates than the ones that presented it in an opt-in mode (you need to click to accept).

Price gap frustration

This is the gap between the real price and the “reference price”, i.e. the level perceived as normal. Within the scope of the whole price, this gap can be minor, but the related frustration can be disproportionate. If the purchaser has to pay Є20 for a bouquet he expected to be sold at Є15, the extra Є5 psychologically ‘costs’ him much more than the first Є15, which are compensated by the bouquet he owns now.

Behavioural economists explain to what extent this effect drives purchase behaviours, by comparing two illustrative scenarios:

Scenario A : You have bought a Є50 ticket for a theater play. When arriving at the theater, you discover that the ticket has been lost.
Scenario B : You go to the theater, intending to buy a ticket that costs Є50. When arriving at the theater, you discover that the Є50 bill you had kept in your wallet for this purchase has been lost.

In both cases, will you use your credit card and buy a ticket to see the play?

Both scenarios lead to the same expense, but a lot of people will refuse to see the play in scenario A and accept it in scenario B! It's because Scenario A is seen in a single frame and the question becomes “Am I ready to pay Є100 for this play?”. Scenario B is seen as two different frames; the loss of the Є50 bill is accounted for as a “general loss” and does not impact the feeling of the price of a theater ticket.

To reduce the price gap frustration, marketers should carefully manage the reference price in their category. The idea that the price people are ready to pay for a product or a service depends on how much they value the benefit of owning it, is over-simplistic: when information or music became free on some online sources (legally or not), the price people were ready to pay for music dramatically changed. The value had not changed, the reference price had.

How to manage the reference price in your category?

• Be careful with the first introduction price: When the reference price is not set in people’s mind, the first price they see becomes an “anchor” which will influence the final assessment. Consider this experiment comparing two scenarios of offer for an annual subscription to The Economist magazine.

The increase in scenario B is attributed to the fact that the new “Print only” option set a reference price for the print, and presented the print + internet option as compelling.

• A common tactic is to include a very expensive product in the line solely for the purpose of getting consumers to buy the second highest price
• Be careful with promotions. Promotions can disturb the reference price framework people have in mind. Many consumers will refuse to pay a normal price of €15 because they could have paid €10 the previous week when the brand was in promotion.

Marketers should also avoid the hidden costs. The more transparent the pricing scheme, the lower the gap between what was expected and what will finally be paid.

Self-esteem injury

Let’s return to our florist example. If at the florist there are no bouquets for less than €15, the purchaser who yet envisaged paying this price may feel a bit uncomfortable to choose the most basic option. However, if the florist adds a low end range at €8 (preferably ugly), our purchaser will proudly confirm his €15 choice. No self-esteem injury.

Risk of regret

The purchaser must finally overcome an additional layer of self-doubt about their selection. Will it prove to be a mistake? (What if they fade after one day? What if the dinner host hates daisies as they remind her with her ex-boyfriend who always chose daisies? What if another guest comes with a much bigger bouquet?)

The risk of regret can be very powerful: in high involvement categories, people may be ready to stay loyal to a brand even if they start feeling some doubts, just because switching to another brand would mean they admit they were wrong.

Marketers should evaluate the perceived level of risk in their category and manage it. They can play on the conformity effect by promoting “best sellers” or using celebrities in communication to ease customers’ anxiety. They can propose withdrawal periods or exchange plans, to compensate for any regret.

In Conclusion There exist a list of hidden costs which drive consumer choice and satisfaction, ranging from energy, mental effort, and emotional pressure to risk taking.

Marketers should identify them, manage them by trying to reduce or compensate them.

Never ignore them.

References

• Leigh Caldwell : The psychology of price, 2012
• Daniel Kahneman : Thinking fast and slow, 2011
• Cass SUNSTEIN /Richard THALER: Nudge, 2008