Conventional economic theory tells us that prices reach a level where demand and supply are in balance – what economists call, an equilibrium. In the real world, however, rather than via some unseen hand, changes are usually made by marketers in response to the way in which consumers react to prices. But just how do consumers make a judgment as to whether a price is good value or not? And how can the marketing team help them to make a meaningful comparison?
One solution comes from a relatively young branch of economics. Behavioral economist, Dan Ariely, has examined the importance of relativity in understanding how consumers come to a judgment about whether the prices they are being charged are good value or not. Behavioral economics is a field that utilizes psychological insights from various studies of human behavior, with a specific focus upon economic decision-making. And Ariely’s research gives some useful insights that may be of value to marketers in setting the right level of prices for goods and services. It emphasizes the importance of providing consumers with something that they can make a valid comparison to assist them in evaluating those prices
The Case of the Economist
Take a look below at the prices for various subscription packages for the Economist magazine.
Which would you choose?
The first one for $59 offers the subscriber the Internet-only option for a year – which seems reasonable at first glance. By comparison, however, we then see that a one-year subscription for the print edition costs $125. A quick mental evaluation by the consumer might suggest that the higher price is justified, because of the costs of printing, postage, and packing.
Intriguingly, though, we then see that there is a third option, which is both a print and web subscription and this is also priced at $125. As a consumer I soon realize that I am getting the benefit of both of the previous options, but I am only paying the same as the print subscription. The third option seems instantly more appealing!
So is this a misprint, or is there something else going on here?
The Importance of Relativity in Pricing
For most people, having read all of the options, the value in selecting the third one is a ‘no-brainer’: why would I elect for the print-only version, when for the same price I am receiving the additional benefit of the Internet edition too?
In answering that question, Ariely realized that the clever people at the Economist had discovered something fundamentally important about consumer behavior:
humans rarely choose things in absolute terms. We don’t have an internal value meter that tells us how much things are worth. Rather, we focus on the relative advantage of one thing over another, and estimate value accordingly.
What this means is that we need a context with which to make a judgment about something: we need to test drive a car to get a feel for how it compares to the other vehicles we have driven. Or we choose a new tennis racket because we saw Novak Djokovic using it at Wimbledon, so we automatically think it must be good in relation to the others on offer. Or we pick the mid-priced TV, because the top-of-the-range model looks too expensive and the cheaper one too basic. In the same way, the marketing team at the Economist have given consumers a context with which to judge the various options in relation to the other choices available.
How Does this Help Marketing Managers?
This technique is often referred to as the ‘decoy’ effect, for obvious reasons. When setting your prices, you need to be able to give consumers something with which to compare and assess the value of your offering. This is often why you see businesses giving their customers a choice between the Platinum, Gold and Silver options. Platinum is usually all the ‘bells and whistles’, whereas the Gold is the level of service that the marketer hopes the consumer will select. Silver, on the other hand, is the basic package that looks relatively unattractive when viewed against the Gold.
So as a marketer, next time you are setting your prices, try to provide some way of giving the consumer an easy method with which to make a meaningful comparison. Or, if you are a consumer, see how you think the marketing team are trying to influence your decision by giving you a context with which to judge the various price packages on offer. While the Economist example gives a clear illustration of the importance of relativity in pricing, there are many other imaginative and effective ways of harnessing the power of context in setting prices, but the decoy method is a common technique.
So remember, next time you are comparing prices, it’s all relative!
Will Trevor is Faculty Program Director for Marketing at Excelsior College
Title Picture: Price is Right by Kevin Spencer: https://flic.kr/p/7n9MRf (Creative Commons); Picture 1: Ariely, Dan, Predictably Irrational, (2008), New York: HarperCollins
Ariely, Dan, Predictably Irrational, (2008), New York: HarperCollins
Opinions expressed are solely my own and do not represent the views or opinions of my employer.
Read other posts in Featured, Marketing | Posted on August 1, 2016.