What does every revenue manager need to know about the psychology of pricing?
NB: This is an article by Rainmaker
Dan Skodol, Rainmaker’s VP of Revenue, gave a 2020 Lightning Round Presentation at HSMAI’s 2017 Revenue Optimization Conference (ROC) in Toronto, sharing his research-based facts and tips on using psychology for insights into pricing strategy. Here are the key takeaways from his talk.
1. Humans think in contrasts, not absolutes
Our brains are wired to think in often irrational ways, which affects how people view pricing. One insight comes from research on how humans think in contrasts rather than in absolutes. For example, if you were given two bags, you could tell which one is heavier, but it’s much harder to tell the true weight of each bag, or if the bags fit within the 50-pound weight limit. Human brains are programmed to work using contrast and context.
This tendency to think in terms of contrast and context comes into play in pricing via a powerful concept known as anchoring. When estimating the value of a reasonable range, our brains will adjust upward from the low number, or anchor point, until we get to the bottom-end of that range then stop. Conversely, when we’re given a high number, we adjust downward until we get to the high-end of that range, then stop. An example of where anchoring takes place in real life can be found in home values. It’s hard to determine the actual value of a home, so asking prices and comparable prices serve as the anchors for home pricing.
Based on the concept of anchoring, the first tip is to go big with pricing! The more you ask for, the more you get. Think about how you might leverage the pent-house suite at your hotel, or present options with particularly high prices in order to affect your customer’s perception of what the true value of your products should be.
2. Reference transaction: What you think you should get & what you think you should pay for it
Perception is often reality, and when it comes to transactions, the reality can move off these transactions in two different directions. Research shows that our tolerance or aversion to risk is very different based on whether you believe that you are gaining or losing something in the process. Prospect theory indicates that we obviously like things such as upgrades and being on the gains side, but we especially dislike being on the losses side, which includes fees and downgrades.
With this in mind, sellers can influence the reference transaction. In general, the goal should be to unbundle gains and bundle losses. An example of this can be illustrated in resort fees, where you can remove the a la carte prices of each item and bundle them together and present them for a single price, or at check-in you bundle those items together with a room upgrade for a single price.
Another real-life experiment demonstrated that the same choices for a Las Vegas hotel presented in two different ways resulted in more upgrades. Ultimately, the way a pricing option is presented can influence potential customers in their purchase decision.
3. How to influence the reference transaction
As mentioned above, sellers can influence the reference price. A few ways to do this include using the past price, advertised price, purchase context, and current prices of comparable items. Something we’ve all seen is price tags with the original price slashed out and the new price displayed next to it. The first price forms a strong reference point in our mind, making displaying the original price a useful way to influence the reference transaction.
An example of purchase context is found in research demonstrating that customers are willing to spend more on their favorite cold beverage at a 5-star resort hotel than they would for the same drink at a local dive bar. The environment affects a customer’s ability to value your product. And the current prices of comparable items can be used to influence the reference transaction by introducing a new product at a new price, influencing the customer to consider the new product offering a similar value proposition at the better price.
4. Mistakes to avoid making
You know what they say happens when you assume things, and this holds true for the world of pricing. Do not assume that your customers view the product and price exactly as you or your team does. Failure to consider and craft the purchase environment can negatively impact perceptions of your price. You as the seller have control over how you frame the price point, and should take advantage of this when creating the purchase environment.
Finally, don’t quote a price upfront without using suitable description or imagery to help sell your product. For example, trying to list a room with just a price is far less persuasive to a buyer than a description of the view or other selling points that may come with the room.
