Along with economics and statistics, psychologies and another important aspect and we need to understand psychological aspects of pricing as we make pricing decisions. Psychologists have studied pricing in great depth and there are many key findings. Let's start with the first one which is very popular. That's 9 price endings. In much of the US and many parts of the Western world, you will see prices ending in either a 9 or a 5. There are many experiments and studies that have been done to illustrate the effect of 9 price endings. So here is one. This is a very popular study that was done many years ago, a price of margarine in a field experiment. The regular price of margarine 83 cents , unit sales 2,817. Lower the price in the field experiment to 63 cents, sales increased by a 194 percent. So a 20 cent reduction in price increase sales by nearly 200 percent. But the next four cents which is going from 63 to 59 increase sales by over 400 percent. So what does this study trying to say? The first 20 cents even though it is larger had a much lower impact on sales than the next four cents. But the next four cents involves adding the price at 59 cents which is 9 ending. So this is an example of a 9 ending being effective in terms of increasing sales. Here's another interesting study that has been reported in journals which is in a catalog setting. These researchers sent out in a catalog setting the same dress to different consumers but it was priced differently depending on who received the product or who received the catalog. In one case, the price was set at $34, in the other case at $39, and in the third case at $44. What you would expect is that the sales would be the highest at $34. Why? Because it's the lowest price. What did this study find? That the sales were higher at $39 as compared to $34. One would expect sales at $39 to be higher than sales at $44 because 39 is lower. But then you would have expected the sales to go up at 34 because 34 is lower than 39. But somehow the 9 ending is perceived as a sale. So sales were highest at that. So these two studies illustrate why 9 endings often lead to higher sales than non 9 endings. It is also a case that there are many studies that have not found this effect. But the practice continues because there is not much evidence to change this practice. So we still continue to use 9 endings and 5 endings especially in the United States. Another very interesting psychological finding when it comes to price is, we often refer to as the Weber Fechner ''law''. I will put the word law in quotes because this is really not Newton's law or Charles law that we see in physics. Is more of an empirical generalization based on many studies put together. So what did these two researchers find? What they found was, consumers reacted to prices more in percentage terms as opposed to absolutes. So in simple words what does that mean? What that means is a typical consumer will be happy to drive five miles to save $5 on a product costing $10. But the same consumer will not be happy to drive the same five miles to save $5 on a $1,000 product. Now, If a consumer rational if you are willing to drive five miles to save five dollars it shouldn't matter whether the product is $10 or product is $1,000. But we're really find empirically is that consumers are reacting more to a percentage price change as opposed to an absolute price change, and you can look in your heart whether you'll be consistent with the consumers in this study. Will you also be driving more likely to drive five miles to save five dollars on a $10 product versus five dollars on a $1,000 product. My sense is most of you will be consistent with what the subject in this study did. Another very interesting effect that psychologists have found and is labeled as what we call as endowment effects. It's a big word for something simple which is a sense of ownership increases the customer's willingness to pay. I have often conducted this experiment in my class many times, and it's just very simple. I asked the students a very simple question. I put them in this hypothetical setting that end of the course I will be distributing mugs. To one group of students I tell them you are fortunate enough to get the mug. At what price will you be willing to sell it to someone who was less fortunate than you? To the other group I tell them you are not fortunate you didn't get the mug. I asked each of these groups a, what will you be willing to sell the mug at? That's the first group. The second group I asked them, at what price will you be willing to pay for the mug? Consistently what I find is that those who were put in the hypothetical situation that they own the mug are asking more for the mach than those who are willing to buy the mug. Even though both groups are told that the list price of the mug is 750. What is also important here is to know that neither one of them actually has the mug. They are just made to assume that either they have the mug or don't have the mug. So endowment effects don't rely on actual ownership but a perception of ownership. So what of the implications? The implications for this is, make consumers feel they own the product before they buy. So if you look at car test drives, many years ago if you went for car, test driving a car, usually the salesperson actually sat down with you and then was there with you all the time when you test drove the car. These days when you test drive a car they just take your driver's license in many settings. Even though it's an expensive car they let you and your spouse drive the car on their own. You just bring it back. They know that you have to collect your driver's license anyway. But what's the benefit? The salesperson doesn't have to spend time, but b most importantly is, you are in the car yourself without the presence of anyone. It creates a sense of ownership. The belief is that if you can create a sense of ownership, people will be willing to pay more for their car or and therefore are more likely to buy it. Another very interesting and powerful effect that psychologists have found is what we call as reference prices. Most of us do not look at a price in isolation. We compare it with some reference price we have in our mind and ask ourselves is the price we are going to pay it today better or worse than that some reference price we have on our mind? Most of the time these reference prices are based on the past history or prices. So if I've seen higher prices in the past and today I'm seeing a lower price, I have a reference price in mind. I compare today's price with that price. Now, how do you manipulate reference price? One way you can manipulate reference price or increase it is by comparing your today's price against a list price, or oftentimes you will see in an infomercial people will start with a very high price to create that as a reference price and then slowly go down to make it sound like a deal. Very interesting effect that psychologists have found in terms of pricing is what they call as context effects. What it really means is what is the impact of the choice set that is offered to a consumer on their buying decisions. So look at two possible settings. We have in one setting consumers go to a store and they see two cameras on the shelf. One priced at 169, and the other priced at 239. Think of another set of consumers who go to a store where they see three cameras on the shelf. One priced at 169, other at 239 which is the same as the other consumers. But one price much higher, say at 469. What do you observe in these cases? What you observe in these studies in a very robust way is that when you add the higher priced option, consumers are more likely to gravitate towards the intermediate option. Normally, what you would expect is, if I added a camera that is costing 469, much of its sales will come from the camera that was costing 239 as opposed to the camera that was costing 269. What do you actually find is the higher price camera draws more from the lower price camera, and in fact oftentimes boost the sales of the intermediate option. So in this case what you are seeing is something that you would not expect in a pure rational setting. But we see this many times. This is really the foundation of what we call as companies offering good, better, best strategy. What do we mean by good, better, best? Instead of offering just two versions of a product good and better, offer three versions of the product good, better, and best and more people are likely to buy the better version which is the middle version than the highest or the lowest version. So if we reflect back on our module on pricing what do we conclude? Effective pricing captures value and leaves as little as possible on the table. It's not that hard to get that extra one percent once we know how to do these things better. Consumer price sensitivity is a major input into your pricing decisions. We learnt in this module what are the drivers of price sensitivity, and we also learned how to actually measure price sensitivity and price elasticity. I think it's also important to keep in mind that consumers and not purely rational, and incorporating psychological effects into your pricing decisions can also improve profitability.
