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Retail Pricing and Behavioral Economics

A common saying about pricing is that it is an art as much as it is science. The scientific aspect involves the use of statistics, economic modeling and programming, and other pricing drivers to determine the optimum price level.

On the art side (also called the creative side), pricing experts use customers’ behavior and perceived value of product to develop a revenue model and pricing strategy. Looking at the art and science aspects of pricing, it is clear that the norms, habits, emotions, and social factors – aka behavioral economics – that influence human decision-making are considered in all pricing decisions.

In fact, behavioral economics of consumers is what drives 90% of all pricing and marketing strategies. Studies on the subject have proven that how companies present their products to buyers is the leading driver that influences most purchase decisions. This fact is confirmed by Gallup research which observes that companies

“…that apply the principles of behavioral economics outperform their peers
by 85% in sales growth and more than 25% in gross margin.”

 

8 Behavioral Economics Techniques to Improve Pricing, Sales and Profits

1. Choice Overload

The number one rule every marketer should know when it comes to dealing with customers is to avoid overwhelming them with too many choices. This instantly causes the infamous “decision paralysis,” which might lead to a customer deciding not to buy anything at all.

While online retailers can minimize the effect of choice overload by using filters on their webpage, brick-and-mortar stores don’t have this benefit. Instead, the approach stores use is to reduce the size of each product category.

eCommerce operators, in contrast, can carry as many goods as they want due to help from filters. When customers visit their website, they won’t be bombarded by zillions of products. The filter function allows customers to decide what price range, size, color, or brand of product they want to appear.

2. Decoy Effect

The decoy effect is one pricing strategy that businesses have used for years to entice consumers to choose their higher-priced options. And it works like a charm.

For instance, to make customers see their $8.99 burger and drink combo as the more attractive option, a restaurant may adopt this pricing strategy:

  • $4 – regular-sized burger only
  • $5.99 – supersized double burger + one large drink

Guess which option customers will think gives a better value for their money?

3. Overconfidence Effect

The overconfidence effect is majorly employed by service providers. All marketing efforts are aimed at making their products and services look so much easier and enjoyable.

While that may be true in the general sense or for disciplined users, others might misforecast or overestimate future service usage. For example, overconfident customers will misjudge their tolerance level or self-control and pay premium charges for gym memberships they would end up underutilizing.

4. Temporal Discounting

If given a choice between getting a reward (say $500) in five months or $300 right now, there’s a high possibility many would choose the immediate reward. Even if there’s no real urgency to get a product right away, some customers would rather opt for a smaller discount that is currently available. Compared to waiting for a bigger future reward that might be a few months away.

5. Loss Aversion Effect

Research has shown that no one wants to miss out on favorable or beneficial opportunities. Loss aversion is also seen when people take all sorts of risks to avoid losing something they have. How do retailers exploit this effect?

A retailer who wants to employ the loss aversion effect can emphasize that only a limited quantity of a particular stock is left. Other simple tactics involve running promo within a short time frame or highlighting the possibility of buying low-quality products in the market or overpaying to competitors.

Another way this effect plays out is this: Someone selling anti-breakage hair shampoo for women might frame their marketing message that hair breakage, if not tackled immediately, might lead to major hair loss.

6. Pain or Loss Postponement

The psychology of this effect is quite interesting. A customer who is on a budget might be reluctant to buy a product on the spot and would willingly pass it by for other more pressing needs.

However, when the offer comes with a “buy now, pay later” option, at least half of consumers would take up that deferred payment offer.

7. Anchoring and Framing

The anchor and framing effect works in a similar way to the decoy effect. A much more expensive product is placed right next to the product the company actually wants higher sales for.

The trick works like this: A watch seller who wants to drive sales for their $100 might put it next to a $500 watch with similar functions and features. When customers consider what a reap-off the $500 wristwatch is compared to the $100 alternative. They are more likely to consider the cheaper watch a good bargain they should snap up immediately.

8. Endowment effect

In the endowment effect, businesses offer customers a free trial for a period of time before they pay for the service. As an example, customers who are using the free version of an accounting software and saw how good it helped them keep their finances in order might be reluctant to part with the service.

When they are finally charged, they are more likely to pay than someone who hasn’t given the product a try.

Likewise, suppose a customer who has no real intention of buying is encouraged to try out new outfits. If the samples fit really well, they might be more open to purchasing the product.

 

 

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