9 Laws of Price Strategy Based on Customer Psychology

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Pricing can be a bit tricky until you get the hang of all the formulas that help you decide what each item costs. But what about when you add psychology to it all? Thomas Nagle and Reed Holden, authors of The Strategy and Tactics of Pricing, determined the nine principles, or "laws," that affect consumers' psychology in regards to their purchase decisions. With these laws, you can better adjust your price strategy knowing the psychology of your customers.

1. The Framing Effect Customers are more aware, or price sensitive, when they consider the price as a loss instead of a worthwhile gain. They also are more aware of pricing when prices are not paid as part of a bundle, but separately.

You've seen the infomercials that eagerly tell you to purchase their product for only five easy payments of $49.99, right? We know that it's really just $249.95, paid in full or in parts. But marketers rely on this trick because they know customers are likely to veer away from the higher number if it is displayed. By doing this, marketers are reducing the "loss" which customers perceive.

2. Reference Price Effect When a customer can directly compare the price of a product with a competitor, price sensitivity increases.

Knowing that stools at Wal-Mart and Target are cheaper than at a small shop, a customer may be wary of the price difference. This effect is difficult to work with because each customer has their own priorities and values when it comes to products.

This is why you shouldn't bother making an argument that your product is better. Rather, you should talk about why your product is different.

3. Fairness Effect Customers are more price sensitive when they consider a product's price to be past the point of "fair" or "reasonable" depending on the context of the purchase.

Similar to the Reference Price Effect, this concept of fairness and what the customer feels they should be paying is relatively unpredictable. Customers may have an average price they are willing to pay for a product, but there are always outliers above or below the average.

4. Shared Cost Effect

If you and three friends have a barbeque, the price of all the food appears lower because the amount you pay is only a fourth of the total price. The smaller the amount of the product price customers pay for themselves, the less price sensitive they tend to be.

Difficult Comparison Effect

If a customers feels that the effort required to find information about the best price, competing products or best solution is excessive, they'll less likely to be sensitive to the price. Similarly, if they have to compare an unknown product to a familiar one, and it take a long time for them to discern the difference, they'll probably select the familiar one regardless of price.

Customers may also be less inclined to find alternatives on the fly if they are short on time or are given a sense of urgency. This is exactly why limited-time offers work so well.

6. Switching Costs Effect The higher the inconvenience a customer must make to switch providers, the more price sensitive the customer becomes to look for alternatives. Switching costs take many forms - investment of time, resources, complexity of purchase, number of people a buyer needs to convince (like their husband), etc.

7. Price-Quality Effect Customers worry less about the price if higher prices denote higher quality. Creating a perception of exclusivity, rareness or quality will persuade the buyer to be ok spending more. The product itself doesn't need to be of the highest quality. If the branding denotes a high-quality ethos, customers will spend.

Do you truly believe that a shirt with a Nike Swoosh is worth on average $15 more than one without? It's the perception of Nike being a quality brand that convinces customers to pay the higher price.

8. Expenditure Effect

Customers are more price sensitive when the purchase accounts for a significant percentage of a customer's available income or budget.

When customers are on a tight budget, they will think harder about whether or not the product is worth the purchase, compared to a spendthrift or a person with enough money to spend wildly. Knowing your ideal customer will help you decide pricing; delving deep and considering his or her spending means and income is the sort of detail that will help direct your business.

9. End-Benefit Effect Customers look at the overall big picture of their purchase: the end benefit. There are two parts to this:

  • Derived Demand - The more sensitive customers are to the end benefit price, the more sensitive they tend to be to the prices of the products that make up or contribute to that benefit.
  • Price Proportion Cost - This refers to the percent of the total cost of the end benefit determined by a particular component that contributes to the end product. The smaller the components share of the total cost of the end product, the less sensitive customers will be to the end benefit's cost.

This applies to high-priced products that have multiple components contributing to that cost (ie. Computers, entertainment centers, exercise packages/programs, etc.). A customer considers what warrants that high price and decides if that is worth it for them in the end. As you've probably read, some of these effects overlap. One effect can lead to another. Hopefully you have a better idea of the purchasing mentality of customers and can use it to your advantage. These will not help you predict the perfect prices that will make some buy every single time, but you can understand why someone may not purchase one thing. And also, it should be encouragement to look into your competitors so you can outwit their prices.

For more information on price sensitivity and consumer psychology, read Holden and Nagle's book, The Strategy and Tactics of Pricing. Or leave a comment below!