Thursday, 18 August 2011

In which I ask a lot of questions about pricing, and answer none of them

It was a tweet from Rags Srinivasan, via Leigh Caldwell, that got me wondering. "If a designer shoe goes up from $800 to $860, who notices?"

Certainly not me; I operate at the grubbier end of the shoe market. Caldwell, however, commented, "When behavioural economics can answer this, we've won." Caldwell's blog Knowing and Making and Twitter feed are both essential reading; they're the sort of effort that make one wish they had studied economics at university (or even at school). I know next to nothing about either pricing or behavioural economics (Caldwell's specialities) but I have read snippets by Ward Edwards and others on the marginal utility of money and perceived price, and it set me on a daydream.

The starting point is that the actual price of a product, and the price that the consumer thinks it costs are different entities. The relationship between actual price of a good, and its perceived price by a consumer is not necessarily linear. It might also depend on the product, sector, economic circumstances or, of course, the individual consumer and his whims. If you ask people "which do you think is more expensive, good A or good B?" for a range of products, then you can roughly calibrate a "perceived price" scale - which, after all, is going to drive the purchase decision far more than the actual price of the product.

This got me wondering: if the perceived price depends on the individual consumer, for a given product, under given test conditions (economic circumstances, etc), if you were to plot a histogram of those perceived prices, what would the dispersion of the curve be? And how does perceived price change depending on the consumer's income, and indeed over time?

And how would those dispersion curves be affected from product to product? This would be particularly interesting when comparing two products in the same sector. The acid-test question would be, if two competing products happened to be the same price, which would be perceived as more expensive?

These aren't just "nice-to-know" theoretical questions. If your company's product is the same price as a competitor, but people think it's more expensive, then this will very likely have an effect on the purchase decision, all other factors being equal. Although whether it's a good thing to be perceived as more expensive is not necessarily clear cut, either; it might be offputting (consumers might opt for the commodity they think is cheaper) but on the other hand if "more expensive" equates to "more desirable" then it may be an advantage ( - although then, presumably, that brand's prices are set too low.

It is logical that the relationship between actual and perceived price would vary across product categories, frequency with which they are bought, price as a percentage of disposable income, and whether the product is an "essential" commodity or a luxury.

So perceived prices - and indeed perceptions in the rate of change of price - will surely be different between bus fares, beer, washing powder, a packet of crisps - or designer shoes. Perceived value for money may depend on external factors as well. The mix of online and offline word of mouth, advertising, and economic trends could all contribute.

It is one thing to ask "who notices?" but the other question, of course, is "at what point does it become a problem?" At what point does a consumer go elsewhere to a competitor, or change their habits? What are their motivations for buying the product in the first place, and where does value for money (perceived, of course) fit into the decision-making process?

This leads on to a further question: how often do people compare changing prices across categories? Aside from the odd nostalgic "I remember when a pint cost less than a loaf of bread", I suspect it's not very often - after all do we really compare the utility and value for money of a litre of petrol compared to a litre of Coke? How often do we consider the price of a month's travelcard, and evaluate it versus a month's electricity? Consciously, I'd argue, rarely - but subconsciously? And even if we do, how often do we make conscious decisions to spend money on one luxury over another, or to sacrifice a luxury for a commodity, or even vice versa? Surveys ask blandly "Do you think you have cut back your spending in the last 3 months?" but without probing the thought processes that go into belt-tightening or splurging, those sorts of questions strike me as next to meaningless. Knowing that people have less disposable income is one thing, working out behavioural patterns and irrational decisions, and how to make sure that as the manager of a gym your customers sacrifice a meal in a restaurant each month, or even shiver in darkness, rather than give up their membership - that's the sort of question we need to be asking. Are those purchasing decisions rational in a recession, and how can we find them out?

Putting people on the spot in surveys, asking "is product X good value for money?" always seems contrived, and I have instinctive doubts about the validity of answers when compared to an unprompted population. Worse still are questions along the lines of "how much would you be willing to pay for product X?" I have filled in surveys of this type before, and consistently give a figure lower than what I'd "really" be willing to pay, in a subtle effort to drive down the price of my favourite products, and I suspect this will be true of many people. I certainly can't imagine anyone saying "I think this product should cost more than it already does" - although perhaps someone can enlighten me to the contrary!

A lot of questions, then. One final one - where can I read more about the psychology of pricing, and hopefully find the answers to some of them?

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