10 Sep 2021 by Dan Monheit, originally posted on CMO Magazine

  • Digital Marketing
  • Customer Experience

What Behavioural Economics Can Teach Us About Pricing

There’s been much written about the need for modern marketers to take the lead on non-promotion Ps, with ‘Price’ sitting at the top of most lists. Unfortunately, there’s been far less written about how exactly they’re meant to go about it.

Until recently, pricing was comparatively straightforward. We lived in a world where it was hard to make things but easy to sell them. If you could manage the risk and international logistics to successfully import your fax machines or pogo sticks into Australia, there was an entire generation eagerly waiting on the other side to buy them.  

From a pricing perspective, this meant manufacturers (or importers) could, by and large, take a ‘cost plus’ approach; add up all of the costs, apply a reasonable margin on the top, and away we go. 

Today, we find ourselves in the exact opposite situation. Making things is easy. Any one of us could jump on AliExpress and be importing hair clippers, puffer vests or iPhone covers by lunchtime. Selling them is a different story.  

Between the expanded retail offering of physical stores and the meteoric, Covid-19 fuelled rise of ecommerce, consumers today have infinite choice. Most pricing today is based on what the market will bear. However, the good news for marketers when it comes to price it's rarely the objective, rational answer we’d imagine. The field of Behavioural Economics (BE) has proven that when it comes to making decisions about price, customers tend to rely on biases or mental shortcuts known as ‘heuristics’, more than they rely on carefully curated lists of pros and cons for each option. 

As we gradually find our way out of the global pandemic and new normals are established all around us, CMOs have a tremendous opportunity to harness BE’s lessons as they set (and reset) prices going forward.

Anchoring

One of the best weapons in our price setting arsenal is ‘anchoring’. In the 1970s, two psychologists, Amos Tversky and Daniel Kahneman, in their Nobel-prize winning work, theorised that presenting an initial figure caused people to use that number to estimate unknown quantities. Any subsequent information we receive is weighted against the first piece, which serves as the anchor.  

In pricing, we see anchors used in a multitude of ways. Most categories have brands that set low and high anchor points, against which all other brands are measured. In auto, for example, MG has aggressively set new low anchors for the key categories it plays in (light hatches, compact SUVs and electric vehicles). Doing so helped the brand win thousands of new buyers and power through the pandemic with year-on-year sales growth of over 100 per cent. Through anchoring, MG has transitioned from deep hibernation to top 10 contender in under five years, outpacing Subaru, Volkswagen and Mercedes Benz along the way. 

The relativity of pricing means brands can also use anchoring across categories. It’s hard to know whether a $1400 premium economy ticket is too good to be true or too expensive without knowing the corresponding economy and business class prices. By the same token, the $15,000 suit in the window at Chanel makes those $500 sunglasses you're about to splash out on feel like a damn good deal, just as the $5995 barbie out the front of Barbeques Galore can make the same brand's $2298 option feel like an absolute bargain.  

Anchoring is a timely reminder that not everything needs to be priced to sell - at least not directly. Post Covid-19, many consumers are shopping categories for the first time, or at least the first time in recent memory (hello concert tickets, restaurant wine lists and hotel bookings!). As people recalibrate their bearings, a price point can be more useful as a signal than as an actual claim of value.

Value in scarcity

Another powerful heuristic at our disposal is the Scarcity Bias, which speaks to the tendency to place more value on things that we perceive to be rarer than things we perceive to be in abundance.  

As social creatures who tend to create hierarchies wherever we go, overweighting scarce objects makes sense. We love the ego boost from having something that others don’t, especially when it proves we have greater access to contacts, knowledge or money.  

Historically, many of life's necessities were legitimately hard to come by. Today, most scarcity is manufactured - though that doesn’t change our willingness to pay a premium for it.  

There are many ways to put scarcity bias to work in a post-Covid world. The first and most obvious is creating scarcity through limited supply. This is a hallmark of the sneaker and luxury goods markets, where production runs are capped long before demand is met. As the world opens up again, we already see artificially capped supply play out across everything from air travel to gaming consoles. 

Then there is limited time scarcity, in which time constraints are put around an offer, creating a sense of urgency that otherwise wouldn't be there. Telcos and gyms are all too familiar with this, offering discounts or introductory specials with arbitrary end dates that drive interest nonetheless.  

The seller's strategy here is to shift our reference point, so we compare the current ‘special offer’ price with a higher, ‘regular’ price in the future. Suddenly, not buying today is categorised as a loss for tomorrow, and our natural desire to avoid losses kicks in - especially after 12 months of losing so much. 

Anchoring and scarcity bias are just two of the dozen or so biases that impact our willingness to pay, proving that when it comes to price, there's more than just value at play.

Don't miss the opportunity to learn from Dan in the ADMA Behavioural Economics Masterclass. Learn how to build better brands and boost your career with behavioural economics, a fascinating discipline demystifying our irrational decisions about brands, buying and pricing.

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