Tuesday, May 31, 2011

What you don't know about Pricing

A few years back, I read an article about Pricing Strategy @ Joel on Software, and I learned a few practical tips about pricing.
  1. The need for Basic, Professional and Extreme version of products, are different groups of buyers are willing to pay different prices for almost the same product (maximize the price buyers are willing to pay).
  2. Once the sales start to plateau and go downwards (capturing buyer willing to pay the “fair” price), reduce the price by one notch to capture the buyers who wanted the product, but would prefer a cheaper price (“bargain” price). And repeat the cycle until it can’t get any cheaper in order to capture all the potential buyers.

After reading Priceless by William Poundstone, I learned a few more goodies, and never to base pricing on cost.
  1. Anchoring - Whenever we try to estimate a numerical value, we are unconsciously influenced by related numbers just considered. A ridiculously expensive item next to a merely expensive one causes the lower priced item to be perceived as a bargain, and increases its sales. i) $200 LV iPhone cover is a bargain when put beside the $20K LV bag. ii) Restaurants in New York City will advertise a $100 hamburger, no one would pay that kind of price, but will buy a nice steak dinner for a somewhat inflated price ($40).
  2. Extra high and low prices existing simultaneously on the shelf with low prices unconsciously influence choice. i) If a person is choosing between soups that cost $1, $3, and $5, they are more likely to choose the $3 option. If they are choosing between soups that cost $3, $5, and $17, they will likely choose the $5 option. ii) Starbucks has three cryptically named sizes of coffee: Tall, Grande, and Venti. Puzzled or indecisive customers tend to pick the middle choice, Grande. This is a classic example of what psychologists call “extremeness aversion.” When uncertain, everyone instinctively favors the middle option, figuring it’s safer. In fact, the Grande is 16 ounces — meaning that you’ve just ordered a pint of expensive coffee, rather than what used to be a normal size cup.
  3. Every time a company raises its price, some shoppers switch brands. Manufacturers have been lowering package sizes for things like cereal and keeping the prices the same. i) Skippy’s peanut butter now has a dent in the bottom of its jar. It holds less peanut butter, but the price is the same.
Pricing Concept and Psychology
  1. Poundstone argues that much of what we think of as "fair" pricing is nothing more than a collection of cognitive fallacies and biases. The most important of these fallacies are the contrast effect (pricing taking on significance from neighboring prices) and the anchoring effect (we are drawn to a particular number). i) It's all in the comparison. A $50 gift from Aunt Marge for your wedding is wonderful, unless you were expecting her to give you $200, like she did your sister.
  2. Shoppers moving clockwise through a supermarket spend about $2 more per trip than those moving clockwise. One holds that shoppers think of their carts as cars and “drive” on the right of aisles. This makes it slightly easier for the right-handed majority to toss impulse buys in their cart.
  3. The gross profit margin of the 99 Cents Only Store is twice that of Wal-Mart. Dave Gold, founder of the 99 Cents Only chain, discovered that he could get rid of slow-moving merchandise (priced at 79 cents) by raising the price. At 99 cents, the same items sold quickly.
  4. Women seem to be less price-sensitive than men about health and beauty products. Political correctness hasn’t deterred retailers from taking advantage of that. You’ll find that many products are offered in “women’s” versions that cost more. Barbasol shaving cream for men is about $1.69. The women’s version costs $2.49 — and comes in a skinny can holding less
  5. Most people would rather buy a $1,000 flatscreen TV with a $200 rebate rather than an $800 set with no rebate. They assume that a $1,000 TV has to be better (even when its only extra “feature” is a rebate coupon).
  6. Based on the price of cell phone bandwidth, the “fair” value of a text message ought to be about 1/1000 of a cent. Instead, the average consumer pays over 20 cents a text, and usage continues to zoom. Needless to say, kids send most texts, their parents pay the bills, and those parents haven’t a clue what they should be paying.
  7. The new Apple iPad’s 3G plans run $14.99 a month for up to 250 megabytes of data, or $29.99 for unlimited usage. Obviously, since it’s a new product, few can predict how much data they’ll use. But that 250 MB limit creates anxiety: What if I exceed the limit? Won’t I get socked with a huge bill? This leads to what behavioral economists call “flat-rate bias.” Consumers prefer the security of a flat rate, even when they’re better off without it. It’s a safe bet that the $29.99 rate will be popular and that many of those taking it would have paid less with the cheaper plan.
The Ultimatum Game
  1. The ultimatum game is a game often played in economic experiments in which two players interact to decide how to divide a sum of money that is given to them. The first player proposes how to divide the sum between the two players, and the second player can either accept or reject this proposal. If the second player rejects, neither player receives anything. If the second player accepts, the money is split according to the proposal. The game is played only once so that reciprocation is not an issue.
  2. A moment's reflection will show that the second player ought to accept any offer at all, and that the first player ought to divide the sum in such a way as to give himself the most money; for instance, assuming the ten dollars can be divided into dollar units only, the first player ought to give himself nine and offer one the the second player, who then ought to accept it. That would be the way of rationality.
  3. The surprising thing about the ultimatum game is how seldom this occurs. The average split, according to some of the studies, was 50-50, and other results showed that most of the second players would reject any offer below three dollars.

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