Using Psychology to Get Your Pricing Strategy Right

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There are lots of different ways of determining the price of your products or services, and lots of ways of presenting that price to your customers. Here is a crucial question though: is your pricing strategy damaging your business? You might be losing sales and you might be making less profit than you should be, because of your approach to price. If this applies to you, the answer could lie in pricing psychology.

In particular, you could use the psychological principle known as the anchoring heuristic. This describes the way our brain works when making decisions using numbers. In simple terms, we base our decision on the first number we are given – the anchor.

The Anchoring Heuristic

It is a principle identified by cognitive psychologists Daniel Kahneman and Amos Tversky back in 1974. They did a number of studies that showed the anchoring heuristic in action. In one, they asked people to do the equation 1x2x3x4x5x6x7x8 in five seconds. For most people that is not possible, so the answers given were guesses based on the first few multiplications they were able to do.

Next, the researchers asked another group of people to do the calculation in reverse: 8x7x6x5x4x3x2x1. This group also gave guesses after running out of time following the first few multiplications.

The estimated answers that each group gave showed the anchoring heuristic in action. The group that started with eight and worked down gave an average estimate that was more than four times larger than the group that started at one. In other words, because they were anchored to a higher number (the first number they saw was eight), they gave a larger estimate to the impossible calculation.

Applying This to Pricing

You can apply this to pricing in a number of different ways. In fact, you will probably already be familiar with the potential applications of the anchoring heuristic in the examples below. This is because companies use the principle all the time to encourage you to purchase more and/or to purchase higher value items.

  • Multiple option pricing – this applies to any situation where a customer has to choose from a number of similar product options. One of the most famous examples comes from a study explained by the author William Poundstone. It looked at how people chose from a selection of beers. In the first stage of the experiment, customers were offered two choices, one cheaper than the other. A third, cheaper option was then added. This reduced overall revenue by 18 percent compared to when there were two options available. Next, the cheaper option was removed and a third, more expensive option was added in its place. This increased sales by eight percent, compared to when two options were available. In both cases where there were three options available, the middle-priced beer was the most popular. This experiment showed that the customers were anchored to the first price they saw – the cheapest one. Raising it increased overall sales.
  • Pricing multiple units – research has shown that multiple unit pricing outperforms single unit pricing by as much as 40 percent. In other words, 10 for €5 instead of €0.50 each. This is because the anchor is the first number people see – in this case, 10.
  • Purchase limits – research has been done that showed a purchase limit can increase the number of items bought, even when the purchase limit was not necessary. One example is research by Wansink, Kent, and Hoch in a supermarket monitoring sales of soup. When they added a 12-per customer limit, customers who bought soup purchased twice as many cans.
  • Setting the opening price – this is the most common example. It is where you set an opening price on an item where there is going to be a negotiation before an agreement is reached. As the seller, the higher you set the opening price, the better the final price will be.

Using these techniques, and the anchoring heuristic, you should be able to tweak your pricing strategy to improve your sales and profits.
For more help or advice with your business, please contact a member of the Gilroy Gannon team today.

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