Today I want to try and give a little food for thought about your pricing and sales strategy by talking about one of my favorite subjects: pricing psychology. A good understanding of pricing psychology is a powerful tool for dealers because it shows that in the end it’s not the price that drives the customers behavior, it’s the perception of the price. In a sense, every pricing manager is also a perception manager.
There are two principals of pricing psychology that are well known, well established, and well researched, that I want to share with you in this post. For the first, we'll start off with an example.
Not long ago, a business school did an experiment with several groups. Half of the groups were given the choice between two products: a low-end camera and a mid-range camera. All the participants are given the price and features of both the cameras and given a chance to familiarize themselves with the product. They are then asked to make a choice between the two as if they were going to purchase one today. Consistently about 25% went for the low-end camera, and about 75% opt for the mid-range.
The other half of the groups are presented with three options: again, the low-end and the mid-range but also a third at the top level. This camera is very expensive, but not better. In other words, the third option made no sense. Rationally, after being given the specs no one should choose to buy it. Amusingly however, about 5% do go for the higher option, mostly due to a brand perception or as a desire to simply own the “best” product, (i.e. the most expensive.)
There was another more interesting trend though. When the top-end product was introduced, about half of those who would have normally chosen the low-end, now buy the mid-range. This is known as The Decoy Effect.
The Decoy Effect is changing customer preferences by introducing a third, (higher-priced) option.
The moment you introduce a top-end product, the mid-range product looks better. Again, from a rational perspective, this makes no sense, but this is the way our mind tricks us into thinking that the second camera looks better by proximity to the more expensive camera.
The second important effect in pricing psychology is Loss Aversion.
Loss Aversion is a theory that states people prefer avoiding losses to acquiring equivalent gains.
To make it more practical, if I'm buying a car, options that you “take away” from me have a higher value than options that you “give” to me.
For example, let’s say I'm in the market for a BMW, (which is a dream because I don't have a BMW). I go into the dealership, and I see all the beautiful BMW’s in front of me. The car salesman starts, if he knows this theory, with the most expensive one within my budget**. We talk about our families, kids, dogs, and where we spend our vacation, and then we get down to business and he takes me to the most expensive car.
**Car must be within budget or this approach simply drives away the customer.
It's a 2018 BMW X5, xDrive, with leather seats, moon roof, XM radio, Harmon Kardon Surround Sound Audio system, and 4.4-liter TwinPower Turbo V-8 engine.
I fall in love. It’s absolutely fantastic. But it's expensive. So, I say, “What else do you have?”
He shows me the next car, which is still a very good car; 270 PS, no moon roof, but leather seats, still nicer than what I am driving now.
Then he goes to the next car, and the next. Every time we go from one car to the other, we go down in price, but also in the options, and I suffer emotionally. My heart is bleeding because every time I give up something that I really liked - the moon roof, the leather seats, the engine power. Eventually there's a point where I say,
“OK, I don't wanna go further down. I'm hurt enough. So, let me sign the contract.”
Now, let's think if he started at the other end.
He shows me a couple and we start working up from the bottom. We get to the second car and he tells me it has 170ps.
I ask, “How much is 170 PS?”
He replies, “Well, you can still drive uphill, but you know, with a family it's not as powerful.”
As we progress from one car to the other, my heart is kind of happy because I get a better car, but I feel the pain now in my wallet instead of my heart.
Every car he shows me is more expensive than the one before, and if we were rational, it wouldn't matter whether he starts from the top going down, or from the bottom going up. But because we are not rational beings, we know from studies that if you start selling high and go low, you sell more options than if you start low and move upward. Why? Because of Loss Aversion.
The moon roof, you take away from me, has a higher value than the moon roof you put in for me.
If I go from high to low, my heart suffers. If I go from low to high, my wallet suffers. You always want to have the pain on the heart, not the money, because when it comes down to it most shoppers are going to spend the money to avoid that sick feeling of losing.
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