Why selling cheaper doesn’t mean selling more.
We take it for granted that lower prices generate more sales. Indeed, it’s covered in the first few weeks of any economics course. Yet we tend to forget the assumptions on which it relies: that we’re knowledgeable and we’re smart. These are what economists call conditions of perfect information and perfect rationality.
In the real world, of course, consumers don’t know everything and we’re not so smart. We face conditions of imperfect information and bounded rationality.
And this changes everything.
Cutting prices might actually result in fewer sales
First, if a prospective customer doesn’t know much about you or your products then they’ll make inferences based on what they do know. In fact, that’s a reasonable strategy. The point is that, in some cases, the only thing that your customers do know is how much you charge. And the lower the price, the lower the perceived quality. Price is thus an indicator of value.
This effect is reinforced by what psychologists call confirmation bias. This is where we do our best – without realising it – to fit new information into our existing view of the world.
Much of the time, the first thing someone learns is the price of your products. And this will frame anything that your brand later adds – whether a sales call or glowing review.
Even if they are revealed later, prices are such influential data – they somehow seem unbiased, inarguable, objective – that they can create cognitive dissonance if they don’t track with our understanding of the brand.
And when they don’t match, it’s far easier to disregard judgments of the brand – after all, aren’t these opinionated, debateable, and subjective?
Secondly, there are cases where price actually determines, or at least influences, the enjoyment that someone gets from our good or service. This happens when part of its value is down to prestige. For once, economists chose a simple name for this: the ‘snob effect’.
It’s easy to think of examples in the luxury sector – Bulgari, Hermès, Leica – but it’s also quite easy to find mass market case studies. Would Apple, Nike, Waitrose, to name but a few, be as popular if they cut their prices and thereby lost some of the exclusivity and aspiration?
There are lots of reasons why firms carefully pick distribution channels, but one is that it has a direct impact on price. Any business has to keep a firm eye on pricing, because it establishes their place in the market and, ultimately, their profitability in the real world; not just as a case study for economic theory.
Thirdly, studies have shown that price can also directly impact the efficacy of a product. Consumers get more enjoyment from a bottle of wine with a higher price tag, students are more alert if they spend extra on an energy drink, and it has even indicated that patients suffer less if they take painkillers that cost a little more.
In each experiment, the product – and even the packaging – was identical. All that had changed was the price. This is not a phenomenon that is solely confined to food, drink, or medicine.
Clients tend to benefit less from consultancy if it is offered at a low price. Simply because lower price influences customer perceptions of value – and consequently their level of input, degree of engagement, and extent of implementation. In other words, sometimes you’ll listen more to people you’re paying more to.
So, price matters
It’s high time we realised that – in the words of Richard Thaler, who won the Nobel Prize in Economics in 2017 – our customers are ‘humans, not econs’.
Customers don’t know that much about our brand, so they infer a great deal from price. Colleagues, friends, and family make similar inferences when they judge us on what we spend. Even our minds and bodies do it, which is why we get more out of expensive goods and services.
For me, however, the clinching argument is this: if we don’t value ourselves very highly, how do we expect our customers, our distributors, or our staff to do so? Right now, whether they work for a big brand or are conducting freelance work, marketers need to know the value of price, because, more than ever, it underpins how you approach a difficult market. If marketing plans are to succeed, then there has to be an added emphasis on the psychology of pricing.
The article was originally published on The Chartered Institute of Marketing Blog