The psychology of product pricing

Recently I was posed the question: Given the same item, would people be more inclined to buy it if it cost:

• Option A: $13.50 with $2.00 shipping
• Option B: $14.50 with $1.00 shipping

In both cases, the item ends up costing $15.50. While this may seem like a dumb question because it still costs the same in the end, it is emphatically not a dumb question. You see, although economists argue that people are rational, psychologists know this is not so. Psychologists observe what people do — and the more we observe human behavior, the more we see of it that is completely irrational — like preferring option A over B even though they are effectively the same.

Thanks to the work of two psychologists, Daniel Kahneman and Amos Tversky, we have a lot more insight now on how people make exactly these kinds of decisions.

Kahneman, in fact, is the only psychologist to ever win a Nobel Prize. He won it in 2002 "for having integrated insights from psychological research into economic science, especially concerning human judgment and decision-making under uncertainty," according to Royal Swedish Academy of Sciences who hand out the awards.

A number of experiments have been conducted on framing, which all support the conclusion that how choices are presented matters. A classic example is the much greater proportion of people who will buy a package of beef labeled "80% lean" as opposed to "20% fat." Ahem, what do you think is in the other 20% of that beef package labeled 80% lean?

It's obvious to me why people would rather buy 80% lean than 20% fat, but it's not so obvious to me which pricing scheme is better - a higher initial price and lower shipping, or the reverse.

After doing some research on it, I located a paper that investigated exactly this sort of thing. It's called price partitioning - meaning the practice online retailers adopt of creating a separate price for the item and its shipping or other surcharges, such as the extra fees and taxes associated with cell phone use.

The researchers found that those partitioning schemes that are most effective for sales are those that are the norm for the type of product and retailer and is expected by the customer.

If the lower shipping charge is expected and is the norm, then offering option B is best. If you instead offer option A, this will have little or even a negative effect according to the study.

Unfortunately, the study didn't address the issue of free shipping. I'd guess that it's always going to better to offer free shipping and ratchet up the initial cost of the item to offset it — only if other retailers selling similar products are doing that. Otherwise, it is better to stick with the smaller initial price point so long as the shipping charge is fair.

If I were an etsy.com retailer who really wanted to know the answer to this pricing question, I'd list the same item two different ways and see which one takes longer to sell. If a large enough number of etsy sellers do this, we could determine which pricing scheme (if any) is best.