Pricing and Economic Relativity

Posted July 9, 2015 in Ideas, Research


I’m usually not one for non-fiction, but the times have changed. I’m currently reading Predictably Irrational: The Hidden Forces that Shape Our Decisions by a cool dude named Dan Ariely. In short, we humans are constantly influenced by “hidden forces” that cause us to make decisions that don’t always make logical sense. Can’t say I’m surprised.

I’m only about a third of the way into the book but the content is super applicable, particularly if you deal at all with pricing. I’m so excited about it, in fact, that I’ve regressed to college student mode and wrote a nice, summary/commentary of a few points for your reading pleasure. First up:

The Decoy Effect

I like this one. Here’s a chart:

decoy
Credit to the book for this, and to me for recreating it.

Imagine you are choosing to go on a romantic vacation to either Paris or Rome (something I am not doing, unfortunately). They are both very romantic locations with delicious food and drink, and it would be hard to choose between the two. Say you have three options for hotels:

  1. Rome, breakfast included (A)
  2. Rome, no breakfast (A-)
  3. Paris, breakfast included (B)

There should still be no difference between Paris and Rome but because of how we respond to relativity, the Rome without the breakfast package makes the Rome with a breakfast package more attractive, and Paris is cast aside. This is completely irrational; the decision between Rome and Paris should still be as challenging.

The lesser Rome is the “decoy”, or the A- option, and exists to make A look better. But then there’s B (Paris) or the “comparison” option. It may be of the same quality as A, but has slightly different characteristics. The relativity of A to A- makes A the most attractive option. If B had a decoy, or a B-, a similar effect would take place.

How this relates to pricing

My eyes immediately turned into dollar signs as I was reading this. I’m an avid listener of the Businessology Show, where they always recommend including three pricing options. Instead of thinking about three unique options though, we could apply this relativity phenomenon, and only have two unique options. The third option would then be the decoy, or the lesser version of one of the two. I haven’t tried this per se, but it might look something like this:

pricing-decoy1

  1. Custom WordPress site with branding, $10.5k
  2. Custom WordPress site, $9k
  3. Branding, $5k

I normally would make the prices of options 1 and 2 further apart, but by upping the decoy (2) to be similar in cost to A, it makes looks like that option look like a deal; branding is included for only $1.5k vs. $5k. I’m not sure I’m entirely down with this – it feels a little manipulative – but as long as the costs are justified in your estimates for the project, it could be a great strategy.

Next up:

The impact of FREE!

We’re all familiar with this one. Buy two, get one FREE! So you end up with three when you only needed one to begin with.

The author did an experiment where he sold Lindt truffles for ยข15 and plain old Hershey’s Kisses for ยข1 to a group of students (that’s my kind of experiment). At this price, most study participants went with the Lindt, but when, for a different group, he changed the prices to ยข14 for the fancier Lindt truffle and FREE! for the Kiss, the majority went for the Kiss. The price difference is exactly the same, but the allure of FREE! caused participants to make an irrational decision, opting for FREE! instead of what they would actually enjoy more.

How this relates to pricing

The tech industry has obviously caught onto the FREE! phenomenon. In fact, we are so used to FREE! that it’s quite a feat to create a tech product people actually pay for!

Back to pricing websites, though. There are small services we can include for FREE! like maintenance plans, training, or design revisions. Of course, it wouldn’t really be free – you would be best to bake this time into the initial cost – but you can make these services appear to be that way. Compare these:

  1. Website for $6,000 with option of a three month maintenance plan for $200/mo.
  2. Website for $7,000 with 3 months of FREE! maintenance.

The latter sounds much more attractive, even though the cost is actually $400 more. Sounds good to me!

In conclusion…

Read the book! It’s good. Like I said, I’m only part way through and I’m sure there will be many more applicable tidbits (like anchoring). Either way, I’m definitely realizing that my addiction to cold-brew iced coffee is quite irrational. Oh well, pick your battles.

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