Price Competition is Not A Big Deal

Price Competition is Just A Myth

Here is the fact: consumers don’t make rational decisions based on price and marketers need to stop pretending they do.

There is a common assumption among marketers in some categories that consumers buy on price. Sadly, it’s just a myth. The truth is customers make decisions on perceived value, where value is what they get divided by what they pay. This would be true if we were all rational but of course we’re far from it. It’s in understanding how we really decide where we can win the pricing game. It’s actually the exception to the rule when we simply decide on price, and it is generally in true commodity markets. However, we can default to price when it gets too hard to compare, in this circumstance price can be equated with quality so being highly priced can work to your advantage. However, before you decide to blindly raise your price or initiate a price war let’s go back to the start and explore how consumers assess value and price.

Essentially humans are lazy. People don’t like to waste energy, and thinking takes a lot of energy. Trying to assess multiple products with different features, benefits and prices requires a lot of thinking, so consumers use shortcuts to make it easier. People think they are rational around price. However, our initial perceptions get locked in, stick around and can cloud our judgment. The classic is a TV that ‘was’ priced at $5000 is now ‘only’ $2000 and at more than 50% off we just cannot seem to walk away.

But what’s really interesting is people think they are “immune” to this type of pricing stunt, when actually they are not. It’s been demonstrated in many independent experiments, the famous one is the 2006 Dan Ariely and Drazen Prelec’s MIT Auction.

Take a look at this case study. If you were asked for the last two digits of your social security number (e.g. 53), then asked whether you would pay this number in dollars (i.e. $53) for a particular bottle of Côtes du Rhône 1998, would the mere suggestion of this random initial price influence how much you would subsequently be willing to spend on the wine? Of course you’d say, ‘no’. Experiments on purchasing items from wine to computer trackballs prove without a statistical doubt that in fact this initial random price would influence your willingness to pay.

In a first stage of the experiment students wrote down their social security numbers and were asked if they would buy a range of items for that price, a simple ‘yes or no’ for that price. Then the MIT class held a second price auction. And the results were simply staggering. Students with high social security numbers paid up to 346% more for items. For example, students whose two digit numbers ranged 80-99 offered $26 to buy a trackball vs $9 for students with last two digits in the 0-19 range. This effect is called arbitrary coherence; where a seemingly random reference point is used to subsequently rationally justify decisions as we fail to ‘adjust’. It can be seemingly random triggers that can set the range, and then related purchases are made to match-up.

So if our customers are using reference points, how can we introduce references that help them make favourable decisions? This is where the decoy effect can come into play. Ariely asked another question. “Would you prefer a honeymoon in Paris including a full breakfast or Rome with the same deal?” Statistically it was hitting around 50/50. Then in his experiment he introduced a third option Rome but you have to pay for your own breakfast. Now the full Rome package became far more popular than Paris. It’s called the asymmetric dominance effect and it’s because there are now two very easy options to assess Rome with breakfast vs. Rome without breakfast. Which sees Paris fall early in the decision making process.

The point is crystal clear: You don’t want the first encounter your customer has with you to be a deep-dive discount. It will make it unlikely for them to pay top dollar in the future. So let’s learn from all the restaurants that Groupon, Spreets and the group deal co-ops put out of business.

The formula for smart pricing goes like this: value comes first and it’s up to you to fight for it. Then make sure you show your most expensive offering first as this will set a higher reference point. Start including an easy to compare option that’s similar, yet slightly inferior to your preferred option (see asymmetrical dominance). And before you discount first see how you could hold your price and add a bit more value.

The point is, let’s stop pretending customers are buying on price, rather let’s focus on helping them make simpler, quicker and better buying decisions.