The Placebo Effect: Why Price Shapes Consumer Expectations

September 1, 2011 Leave a comment

Imagine you’ve been getting these terrible migraines. Desperate for the pain to stop, you visit the doctor. He tells you that he has the perfect treatment, a pill that has been proven to eliminate migraines in 95% of patients. You fill the prescription and your migraines disappear. What if you found out the pill your doctor prescribed was simply a sugar pill that has no effect on migraines? Your migraines vanished, but how?

The reason is this—you expected to get better after taking the medication, so you did. This phenomenon is called the placebo effect and it is responsible for helping thousands of sick and ailing people every year. The placebo effect is what happens when a person’s condition improves after he or she takes a medication that has no proven therapeutic effect for that particular condition. The person’s perception and belief that the medication will help is what improves their condition, not the medication itself.

In this post, I am going to dig into this concept of the placebo effect, but with a focus on the role that price plays.

Price & Placebo Effect in Marketing

Price is the de facto placebo effect in marketing. It plays a very important role in influencing how people perceive a product and, in the end, shaping their expectations. This is why designer jeans fit so perfectly, why Nike’s make us run faster and jump higher, and why $5 Starbucks just tastes better.

It turns out that price affects not only perceived quality, but actual quality as well.

Research published in the Journal of Consumer Research explored whether marketing actions (such as pricing), can actually alter the effectiveness of the product.

In a series of experiments, researchers had participants drink SoBe Adrenaline Rush, a drink that claims to improve mental ability. To determine the effect of the drink on people’s performance, the researchers had the subjects perform a series of puzzles (unscramble words).

Participants were exposed to two variables. First was information about the effectiveness of the drink. The high expectancy group was told that drinks such as SoBe Adrenaline Rush create large improvements in thinking. The low expectancy group was told that the drinks provide only slight improvements in mental performance.

Participants were also given information about the cost of the drink. Half of the participants were told the regular price of the drink ($1.89), while the other half was told that the drink was purchased at a discount ($0.89).

The results (below) are surprising; those who got the discounted drink performed worse than those who received the full-price drink.

Takeaway

The takeaway from this study is the role that price can play in the experience customers have with your product. Price shapes expectations. When people pay more for a product, they find greater enjoyment because they believe and perceive that it will give them more satisfaction—the placebo effect. With this in mind, maybe you should consider raising your prices, it just might make for happier and more satisfied customers.

If you enjoyed this article, you may be interested in some others from the Understanding Customer Thinking series:

Filed under Consumer Behavior, Customer Experience, Marketing, Pricing Tagged with , , , , ,

The Anchoring Effect in Marketing

August 10, 2011 Leave a comment

Anchoring is a term used in psychology to describe the tendency for people to over-rely on specific information when making decisions.

Anchoring was first theorized by Amos Tversky and Daniel Kahneman. They found that giving people a “starting point” can influence their decision making. They performed an experiment to demonstrate the anchoring effect:

Subjects were asked to guess the percentage of African countries in the United Nations. They were first given a percentage; they were then asked whether or not their estimate was higher or lower than that given percentage and to make a guess as to the correct value.

  • The group that was asked “Is it more than 10%?” guessed that 25% of Africa’s countries were in the UN.
  • Those who were asked “Is it more than 65%?” estimated that 45% of African nations were in the UN.

This study is a perfect example of the anchoring effect. The researchers were able to influence the subjects guess simply by adjusting the “starting point” number.

Familiar Products

Once we buy a product at a particular price, we become anchored to that price. Maybe you won’t pay more than $30 for a pair of jeans or $2 for a loaf of bread, this is the effect of anchoring. We use anchor prices to evaluate future decisions for that product or product category—it’s how we gauge whether or not we are getting a fair deal. In Predictably Irrational Dan Airely describes how people who moved and immediately bought a new home tended to spend the same amount on housing as they had before…even if this meant buying a home that was much bigger or much smaller than the one they left. They were anchored to the initial price of their home.

Lesson

Because customers have purchased the product before, they have an anchor price. This anchor price is the measuring stick which they will evaluate your offering against. If your price is lower than the anchor price, then customers should be attracted to your product. If you are priced above the anchor then you will need communicate why it is more expensive in order to disassociate that product with the anchor price.

Unfamiliar Products

But what about unfamiliar or rarely purchased items where we have little or no anchors? We often accept the first price that we see because we really have no idea what it costs. Let’s say you go to the electronics store because you are thinking about buying a 3D TV. You see a 60” one you like that costs $2,500. Though you may not purchase that particular TV, that $2,500 now becomes the anchor price against which you will measure all other 3D TV’s in the future.

Lesson

Start with a high price point. Don’t get fooled into thinking that you will be able to up-sell customers after luring them in with low prices. The more effective (and profitable) strategy is to establish a high anchor price. Introduce new customers to your higher priced offerings. Once you have established a high anchor price in their minds, lower-priced options will be much more attractive.

If you enjoyed this article, you may be interested in some others from the Understanding Customer Thinking series:

Filed under Consumer Behavior, Customer Experience, Marketing, Pricing Tagged with , , , , ,

Decoy Pricing — Helping Customers Make the ‘Right’ Product Choice

August 2, 2011 2 Comments

In today’s post I will be looking at decoy pricing. As the name infers, decoy pricing involves adding a ‘decoy’ item to your product lineup, which leads customers to purchase the option you want them to buy.

ADD AN INFERIOR OPTION
In his brilliant book Predictably Irrational, author Dan Ariely shares a great example of the effect of decoy pricing. He ran an experiment using subscription offers to The Economist magazine. Participants were given one of two offers.

Offer A
$59 – Economist.com subscription (16% chose)
$125 – Print subscription (0% chose)
$125 – Print & web subscriptions (84% chose)

Offer B
$59 – Economist.com subscription (68% chose)
$125 – Print & web subscriptions (32% chose)

The results from this experiment are quite stunning. The only difference between the two offers is the inclusion of a third “decoy” choice print subscription in Offer A. No one chose the decoy item, but its mere presence made the print & web subscription option look like a no-brainer. Offer B takes a bit of thinking, whereas Offer A made the decision easy by giving consumers a default option. This experiment is one of many that show that presenting one option as a default option increases the chance it will be chosen.

ADD AN EXPENSIVE OPTION
In the above example, adding an inferior, but similarly priced product (print only subscription) helped increase sales of the more attractive print & web subscription by reinforcing its value. Another decoy pricing strategy is to add an expensive option.

Let’s say for example you sell watches; $100 for the basic and $200 for the premium version. Some people buy the premium option, but most elect for the basic. You could add a decoy super-premium option priced at $500. Shoppers probably aren’t going to buy it, but it will boost sales of the $200 option because it suddenly seems like a great value.

TRADE CUSTOMERS UP
Steve Jobs and Apple are genius when it comes to decoy pricing. Let’s take a look at pricing for the iPad:

A shopper goes in thinking an iPad will only cost them $499 because 16GB is all they need. But for $100 they can get double the storage amount and $200 more will get them 4x more storage. Many end up with the most expensive 64GB option because it would be silly to purchase one of the other options. Apple’s decoy pricing strategy trades shoppers up by making the most expensive version the “right choice”.

If you enjoyed this article, you may be interested in some others from the Understanding Customer Thinking series:

Filed under Consumer Behavior, Customer Experience, Marketing, Pricing Tagged with , , , , ,

The Two Sides of the Deals & Discounts Story

June 22, 2011 Leave a comment

Deals and discounts are a big draw for customers, but at what expense to retailers?

Kohl's Department Store

A while back I wrote The Double Edged Sword of Discounting in which I warned brand marketers and small business owners about the danger of relying on discounting to attract customers. In short, deals and discounts will breathe life into your short term sales, but can lead to detrimental long term effects.

My perspective on discounting, though, is continually challenged by the consumer in me. You see, I have this whole Dr. Jekyll & Mr. Hyde thing going on. As a marketer, I am a big proponent of adding value (as opposed to discounting). But as a consumer, I am always on the lookout for coupons and deals.

No one brings out the Mr. Hyde “Deal Hunter” in me quite like Kohl’s department stores. To say the retailer is highly promotional is putting it mildly:

  • New charge card customers are offered 20% off entire purchase the day they open an account.
  • Kohl’s offers extra discounts to charge card holders ranging from an extra 15% – 30% off all regular, sale, and clearance merchandise.
  • Regularly send “$10 off everything” coupons.
  • Frequently offer $10 in Kohl’s Cash for every $50 spent.

This discounting strategy has helped Kohl’s cope better in the recessionary environment than many of their competitors (see below)

Source: NRF 2010 Top 100 Retailers ¹

Kohl’s success, however, has come with a steep price.

As a consumer, I love the deals. But as a marketer, I am concerned for the retailer’s future. Why? Kohl’s has essentially made discounting and price promotions their sole marketing strategy, which, as history shows us, is neither smart nor sustainable. The retailer has trained their customers to shop on price….and that’s never a good thing.

¹ 2010 Top 100 Retailers

Filed under Branding, Marketing, Pricing, Strategy Tagged with , , ,

How to Raise Prices — The Smart Way

April 11, 2011 Leave a comment

Prices are going up everywhere you look; the gas pump, the grocery store, and now on main street. At least that’s according to the latest small business owner survey conducted by the National Federation of Independent Business. They found that more than a quarter of small business owners have either increased prices or plan to do so in the near future, which is the highest amount in 28 months.

Despite an improving economy, such price hikes could spell trouble for those who have resorted to discounting during the recession. Why? Because these “discounters” have trained consumers to shop on price. As a result, price has become one of the most influential factors in making a purchase.

According to SymphonyIRI’s latest MarketPulse Survey, 64% of consumers state that price has become a more important consideration than convenience in brand purchases. Another SymphonyIRI report released in late 2010 found that 77% of consumers were making store choices based on which retailer offered the lowest price on needed items.

What if you are one of these “discounters”? How are you going to increase prices without losing all of your customers? Here is how to raise prices the smart way.

1. Be Honest

If you are losing money on every sale, be upfront with your customers. Sure you may lose a few, but the majority of customers understand that the point of a business is indeed to make, and not lose, money. Five Guys Burgers & Fries employs a pricing model where they set their food prices to reflect their costs. “If the mayonnaise guy triples his price, we pay triple for the mayonnaise! And then we’ll increase the price of our product” explains founder Jerry Murrell.

Honesty is key here. If you tell customers that you are increasing prices because your costs are going up, but you have ulterior motives (such as padding your profit margin), then you are certainly going to reap what you sow.

2. Tell Customers

Some may disagree with me on this point, but whenever you increase prices, I think it is always a good idea to communicate the price increase to your current customers. First, no one likes a surprise price hike; if you increase prices overnight with no warning you are likely to piss off a lot of people. You need to make sure you give your loyal customers plenty of advance warning that prices are going to be increasing in the future.

You also need to explain why prices are increasing. I was a loyal State Farm customer for 8 years. I never had any issues with them and was completely satisfied with my auto insurance. But that changed very quickly. Despite never being in a wreck or getting a ticket, my premium gradually got more and more expensive; Over the course of two years, it went from about $400 every six months to over $600 every six months. I asked my agent why and he couldn’t give me a straight answer. No problem, I switched to All State. Please don’t make the same mistake of communicating the why.

3.Add Value

An increase in price should be accompanied by an increase in value whenever possible. Adding additional value to your product or service will help customers justify paying the new, higher price. Some examples of ways to add value are:

  • Free or upgraded shipping
  • Offer educational ‘how-to’ classes and videos
  • Risk-free return policies
  • Complementary service (sell dress shoes? Offer free shoe shines for life)
  • Include a warranty

In each of these examples, you can see that the value to customers is much more than the cost to provide that value. For example, a 30 day no-questions-asked return policy on a piece of software may be worth shelling out an additional $50 to customers, whereas it costs you basically nothing to provide this policy. The great thing about adding value is that it has a halo effect (increased profit margins, product differentiation, word of mouth, etc.)

Summing It All Up

Of course, when it comes to pricing, you will also want to consider competition, customers, costs, and external factors such as the economy. However, over-relying on any one of these would be a mistake. The key to setting your price is understanding—and shaping—the value that your product or service creates in the lives of your customer.

Well executed price increases will not only help you retain your current customer base, but by adding value you will better differentiate your brand and attract more customers in the future.

Filed under Business, Pricing, Strategy Tagged with , , ,

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