Ivan Fox, the Chairman of InvoiceFair shares how your pricing strategy should mirror human behaviour

Mainstream economics portrays an individual as a rational utility-maximising self-interested actor, focused on achieving the maximum attainable level of a pre-determined objective while incurring the lowest possible cost without regard for the welfare of others.

In reality, humans are emotional, sentimental, full of superstition and biased. We are not wired to achieve efficient utility maximising decision-making.

We get confused. We get scared. We get carried away.

Your marketing and pricing strategy needs to take account of the true reality of human behaviour.

Behavioural economics offers rich insights into how to better influence the decision-making process. Here are four useful pointers based on its principles:

1. Anchors Aweigh

Economists assume that everything has a price i.e. your willingness to pay may be higher than mine, but each of us has a maximum price we’d be willing to pay. How a company positions a product, though, can change the equation. People have a predisposition to rely heavily on the initial piece of information that they observe when making decisions. In behavioural economics, this is known as anchoring.

Before making a purchase, consider what prices you’ve recently seen, because they’ll influence your perception. You may see a shirt for €65 as inexpensive simply because the shop has a lot of €100 shirts. Whereas, if most of the shirts in the shop are €25, you’ll find the price expensive.

The power of this kind of relative positioning explains why companies sometimes benefit from offering a few clearly inferior options. Even if they don’t sell, they may increase sales of slightly better products the shop really wants to move. Similarly, many restaurants find that the second-most-expensive bottle of wine is very popular—and so is the second cheapest. Customers who buy the former feel they are getting something special but not going over the top. Those who buy the latter feel they are getting a bargain but not being stingy. Sony found the same thing with headphones: consumers buy them at a given price if there is a more expensive option – but not if they are the most expensive option on offer.

2. Feel no Pain

In almost every purchasing decision, consumers have the option to do nothing. They can always save their money for another day. That’s why the company’s task is not just to beat competitors but also to persuade shoppers to part with their money in the first place. According to the economic principle, the pain of payment should be identical for every euro we spend. In marketing practice, however, many factors influence the way consumers value a euro and how much pain they feel upon spending it.

Retailers know that allowing consumers to delay payment can dramatically increase their willingness to buy. One reason delayed payments work is perfectly logical. The time value of money makes future payments less costly than immediate ones. However, there is a second reason, less rational basis for this phenomenon. Payments, like all losses, are viscerally unpleasant. But emotions experienced in the present – now – are especially important. Even small delays in payment can soften the immediate sting of parting with your money and remove an important barrier to purchase.

Another way to minimize the pain of payment is to understand the ways “mental accounting” affects decision-making. Consumers use different mental accounts for money they obtain from different sources rather than treating every euro they own equally, as economists believe they do, or should. Commonly observed mental accounts include windfall gains, pocket money, income, and savings. Windfall gains and pocket money are usually the easiest for consumers to spend. Income is less easy to relinquish, and savings the most difficult of all.

Technology creates new frontiers for harnessing mental accounting to benefit both consumers and marketers. A credit card company, for instance, could offer a web-based or mobile-device application that gives consumers real-time feedback on spending against predefined budget and revenue categories. For example, green signifies below budget and red for above budget, and so on. The budget-conscious consumer is likely to find value in such accounts (although they are not strictly rational) and to concentrate spending on a card that makes use of them. This would not only increase the issuer’s interchange fees and financing income but also improve the issuer’s view of its customers’ overall financial situation. Finally, of course, such an application would make a genuine contribution to these consumers’ desire to live within their means.

3. The Power of Default

The evidence is overwhelming that presenting one option as a default increases the chance it will be chosen. Defaults – what you get if you don’t actively make a choice – work partly by instilling a perception of ownership before any purchase takes place because the pleasure we derive from gains is less intense than the pain from equivalent losses. In rough terms, we dislike losses twice as much as we like gains. When we’re “given” something by default, it becomes more valued than it would have been otherwise – and we are more loath to part with it.

Smart companies can harness these principles. An Italian telecom company, for example, increased the acceptance rate of an offer made to customers when they called to cancel their service. Originally, a script informed them that they would receive 100 free calls if they kept their plan. The script was reworded to say, “We have already credited your account with 100 calls – how could you use those?” Many customers did not want to give up free talk time they felt they already owned.

Defaults work best when decision makers are too indifferent, confused, or conflicted to consider their options. That principle is particularly relevant in a world that’s increasingly awash with choices – a default eliminates the need to make a decision. The default, however, must also be a good choice for most people. Attempting to mislead customers will ultimately backfire by breeding distrust.

4. Avoid Analysis Paralysis

When a default option isn’t possible, companies must be wary of generating “choice overload,” which makes consumers less likely to purchase. In a classic experiment, some supermarket shoppers were offered the chance to taste a selection of 24 jams, while others were offered only 6. The greater variety drew more shoppers to sample the jams, but few made a purchase. By contrast, although fewer consumers stopped to taste the 6 jams on offer, sales from this group were more than five times higher.

Large in-store assortments work against companies in at least two ways. First, these choices make consumers work harder to find their preferred option, a potential barrier to purchase. Second, large assortments increase the likelihood that each choice will become imbued with a “negative halo” – a heightened awareness that every option requires you to forgo desirable features available in some other product. Reducing the number of options makes people likelier not only to reach a decision but also to feel more satisfied with their choice.

In conclusion, positioning your product or service may not be straightforward and there are a lot of variables involved. However, using these tried and tested behavioural principles can work to ensure your product or service is positioned for success.

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