The behavioral economist guide to influencing consumer behavior using psychological pricing
The behavioural impacts of discounts seem simple enough after all, everybody loves a cheeky discount. However, the underlying pricing psychology extends beyond the mere satisfaction of jumping on a hot deal and actually serves to influence consumer behaviour. The real (Intelli)gem for ecommerce store owners is in optimizing pricing strategy so that browsers convert to buyers. One way of achieving this is to incorporate psychological pricing into your arsenal. If you’re an ecommerce store owner, chances are you’re probably already using psychological pricing without even realizing, but do you know why it works?
Let’s first take a step back. To capture the essence of psychological pricing, we need to understand Prospect Theory. In a nutshell, gains and losses in expected utility are defined as deviations relative to some reference point, rather than in absolute figures. Stemming from this is the notion of “Loss Aversion” which suggests that people react stronger to losses than gains of equivalent size. Additionally, Prospect Theory is characterised by its diminishing sensitivity, in other words, its value function (the curve on the diagram below) is concave for gains, and convex for losses.
In the same way, transactions are evaluated with respect to a reference point, and a psychological pricing strategy called framing can be implemented to take advantage of consumer behavior. Let’s use a pizza parlor as an example: a typical transaction would be paying the price of a pizza and getting one pizza in return. This transaction will take us down the steep part of the loss function because it feels painful handing over the money, but on the other hand, receiving the pizza also takes us up the steep part of the gain function – everything is balanced.
Two for the price of one
Now let’s find out how a “two for the price of one” sale might impact consumer behavior. In this case, the negative loss function remains the same but the gain here is doubled, so we move further into the shallow part of the gain function, and our utility begins to diminish. Because of the concave and diminishing nature of the gain function, a consumer’s utility plateaus when they gain a large sum all at once. We have doubled the quantity of pizzas received, but not the utility. Therefore, a “two for the price of one” sale doesn’t feel twice as good as a normal pizza purchase.
Buy One Get One free
However, when we segregate the equivalent gain into two smaller gains as in a Buy One Get One free discount, consumers don’t move onto the more gradual and less steep part of the function, but instead, get to experience the initial steep part twice when receiving the second pizza (for free). As such, consumers experience greater perceived benefit for the same gain by simply framing it as two separate gains. This is an incredibly subtle psychological pricing strategy yet dramatically increases conversion rate.
Finally, let’s look at bundle deals. When purchasing a holiday package, we hand over all the money to an agency who will sort out our flights, hotels etc, saving us the trouble of having to purchase everything separately. The two options of purchasing the holiday package or purchasing the individual elements separately produce identical gains, however, the difference is in the loss function. When we book all the separate components ourselves, it hurts to pay that first $500 for the flight, and it will hurt again to pay another separate $1,000 for the hotel and so on – every time a payment is made, we travel down the initial steep part of the loss function. Compare this to purchasing a packaged deal where we are going twice as far down the loss function (and into the shallow part) rather than going down just the steep part twice. Because we have aggregated all the small losses into one big loss, we have made use of the less painful, shallow part of the utility curve, and consequently, we are much more willing to convert and enjoy the holiday!
Making full use of psychological pricing to influence consumer behavior is an extremely overlooked strategy for ecommerce merchants. If you’re interested in learning more about how the team here at Intelligems can help supercharge your business through pricing, feel free to fill in this Typeform, and we’ll be in touch!