Are You Rational Enough?-Psychological Pricing

Published by MBA Skool Team, Published on March 22, 2013

Teleshopping advertisements looked strange when I watched them for the first time in my life. They featured products priced at $99.99 and the anchor of the show kept repeating the price “$99.99 only” at the end of every sentence. This advertisement kept me wondering as to why the products have such a pricing system. Isn’t it easier to price it simply as $100 instead of $99.99? Rounding off the amount would make it lot easier for transactions and accounts maintenance. Despite the good reasons, why do marketers still advertise it at such a price?

The increasing price war between giant retailers, lower cost of manufacturing and sluggish economy have forced competitors to set prices which attract large number of customers. Assigning a price to a product such that it is acceptable by people and still managing to make a profit out of it is indeed a herculean task. Optimal pricing is an art. It is the most important feature of marketing mix. If applied with the precise strategy, you can win the market else you go down the drain.

Deciding a price is based not only on the demand, cost-profit and competition but also on the emotions of the customer. Appropriate pricing is a signalling factor which determines the purchase decision of the customers. The signalling theory states that due to the asymmetrical information between sellers and buyers, customers tend to doubt the quality of the product. However, the pricing mechanism sends pre purchase signals to the buyers and they use pricing as an indicator when the markets are unfamiliar for them.

There are many types of pricing – demand pricing, penetration pricing, target pricing, limiting pricing, dynamic pricing, skimming strategy etc. In this article I would like to focus on an interesting strategy – “Psychological pricing”.

Psychological pricing is the art of pricing products believing that prices have a psychological impact. Though the exact rationale behind psychological impact of pricing has remained a riddle for more than 60 years, few researchers have put forward that it is based on the theory that customers make relative judgements and not absolute decisions. This psychological pricing is based on factors which act as signals of product quality, price points and customer’s perception of fair price. Indeed, psychological pricing has led to price points where demand is relatively high compared to other prices.

Many consumers show a typical behaviour when they look at the price tag. They assimilate the price using the left hand side of the digits and leave out the other digits. This is popularly known as the ‘left-digit anchoring effect’. Hence a product which is priced at $900 will be viewed similar to a product priced at $999. Any price within the range of $900 - $999 would be looked with a similar perception. But a 1000$ product will be viewed as a costly product. The perceived price barrier makes customers assume that $999 is cheap whereas $1000 makes it look costly.

An article published in the Marketing Bulletin in 1997, showed that in many advertisements 60% of the prices ended with ‘9’, whereas just 7% ended with the ‘0’digit. 30% of the prices ended with ‘5’whereas the remaining end digits accounted 3% approximately. This strategy is popularly known as odd-even pricing or charm pricing or fraction pricing. Odd pricing is usage of 5, 7 and 9 as end prices whereas even pricing mostly ends with a 0.

Price endings signal quality. A product which is priced as $100 signals that it is costly and is of high quality. Products which have been priced at $99 are considered to be cheap and inferior quality. Values ending in 5 are used by medium quality firms.  This separating equilibrium is still puzzling for market researchers.

Retail stores and restaurants have contributed greatly to the interesting study. Restaurants which value quality offer dishes which are priced ending with “00”. Whereas restaurants which claim to have value worth the money often give products ending with “99”

As it is very well known that consumer emotions influence the purchase decisions, many successful retailers have followed different pricing tactics to attract the impulse buyers. The pricing strategies are framed based on the fact that demand increases when customers are perfectly rational.

  • A tricky pricing system is advertising 10 chocolates for 10$. This sends the signal that you should always buy in bulk to save your money. Though 10 chocolates are unnecessary, consumers believe that they are rational and buy the package
  • If a retailer wants to offer 15% discount, simple round off prices say 50$ is used to show price discounts of 50$ reducing to $42.5 instead of $46 being discounted to $39.1. Customers do not value offers when they cannot easily calculate the difference in discounts
  • Recent research shows that prices with $ sign attached to it reduces customer spending. So many restaurants have designed menu cards which shows just the price without the $ sign. This makes the customer to spend more without any second thoughts
  • There are few who do not fall for this odd even pricing trick. These clever people have the right digit effect and this is a counter attack on the marketers. However another common tactic to deal such people is the reduced font size. The menu card shows the names of the dishes in big font whereas the price would be very much smaller.

In the book, The Strategy and Tactics of Pricing, Thomas Nagle and Reed Holden have mentioned 9 factors that affect the consumer’s perfection of a given price and how their purchase decisions are affected by the same.

They are:

  1. Reference Price Effect – Customers often tend to compare price using reference points. The reference point may be the past price of the same product or competitor’s product price. The buyer’s sensitivity increases when higher the product’s price relative to perceived alternatives.
  2. Difficult Comparison Effect – Buyers are not interested in comparing prices of products for which they couldn’t find suitable alternatives. They tend to become price insensitive
  3. Switching Costs Effect – For a specific product when the switching costs are high, consumers tend to become less price sensitive and are happy to continue with the same product despite the variations in the price
  4. Price-Quality Effect – Customers usually perceive that higher price implies higher quality. Often products which are obtained for free, makes the buyer believe that it is of poorer quality
  5. Expenditure Effect – When the expenses account for a larger percentage in the available budget, customers tend to become more sensitive to prices.
  6. End-Benefit Effect – When buyers are very sensitive about the end benefit of a product, they become price sensitive. Also, the smaller the contribution of the product to the end product, the less price sensitive they become. Eg. When a computer mouse is purchased separately, buyers are not sensitive even though they may be sensitive to the total price of the personal computer.
  7. Shared-cost Effect – when the customers are the consumers, they are less price sensitive when they contribute to a small  portion of the purchase price
  8. Fairness Effect – Buyers would have a temporary “fair” price range for each of the product. When the price exceeds this range, they turn to be price sensitive
  9. The Framing Effect – Price sensitivity decreases when the product is purchased as a bundle rather than separate products. Customers are more sensitive when they perceive the product as a loss rather than foregone gain.

So, next time when you come across some advertisements showing attractive prices, think twice before you buy the items. Ensure that you are rational enough to differentiate and decide. Beware! There is a 99.99% chance that you may fall for the wrong prices.

This article has been authored by Harini A from IIM Ahmedabad.

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