Tuesday, February 26, 2008

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.

13 comments:

Alasdair said...

Well, I *am* an Etsy seller, and though I can't say I did a proper experiment, I do note that when I switched to free shipping, I got my first (and all of my subsequent) sales.

I didn't raise my prices, though. I just figured that I'm charging enough as it is to afford to send the item gratis. Maybe it helps I use recycled shipping materials...

JuneBugBaby said...

personally I would rather pay the $2 for shipping and feel like the item is less. Not sure why, it just looks more appealing that way. I think people expect to pay a shipping price but the item cost catches my eye if it's a good deal for the item!

JuneBugBaby said...

personally I would rather pay the $2 for shipping and feel like the item is less. Not sure why, it just looks more appealing that way. I think people expect to pay a shipping price but the item cost catches my eye if it's a good deal for the item!

yellowfish said...

hello! I got blog-tagged and am passing it on to you if you want to play! (hopefully thats ok!)

(this post is a great topic, by the way)

Mrs.Kwitty said...

Very interesting! I think I would opt for # 1--but only if the shipping fee was reasonable (like $2) If the item was 10.50 and the shipping was 5.00, I wouldn't buy it--finding the shipping rate turns me off the buy--even if there was the same item offered for what you stated and they all ended up costing 15.50. I guess most just want a reasonably priced item with an equally reasonable shipping fee. Not cheap either way nor expensive either way.

Little Lovables said...

I agree with mrs.kwitty. Like on ebay, so many people sale an item for cheap, and have like, $10 shipping... I think it's a way to avoid fees.

Barbra said...

If the shipping isn't reasonable I don't buy, plain and simple. Subsequently I try to price my items reasonably. Free shipping does seem to draw in people...who knows?!

With You In Mind said...

very interesting!

ingermaaike said...

Now ther is an interesting experiment I will play with...

Liz (made in lowell) said...

I love this topic, I heard a discussion of the psychology of economics on NPR the other day. Personally I want the shipping to be fair, not more than a dollar over actual shipping costs. And I have definitely decided NOT to purchase something because I thought the shipping was too high, because it made the seller seem dishonest.

lauren bacchus said...

great article and very interesting study. I know this is a fairly heated topic. I personally, am currently offering free shipping.

littlecraftwonders said...

Great article I think I will go and adjust some items to try this out Thank you for the tip

Desiree said...

This is so fascinating. Does the .50 make a difference? Isn't it more psychologically appealing to see a round number and not a half or other percentage?

When it comes to my bank account, and my pay pal account, I prefer even numbers. Less calculations and estimations on my part, less math. At Fashion Bug, they often ask me if I'd like to round my purchase up to the nearest dollar, and donate the change to some charity. I agree whole heartedly to do so, because I like my even numbers!

However.. there's also the idea that, in adding the additional percentage of change, that the seller put more thought into the price of the product. That they actually calculated the materials and time. Perhaps it appears more professional, and therefore one might be more apt to buy from them, as opposed to someone who just estimated, rounded up, and slapped a price on.

Oh my gosh... so much to think about!