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Psychological pricing

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Psychological pricing or price ending is a marketing practice based on the theory that certain prices have a psychological impact. The retail prices are often expressed as "odd prices": a little less than a round number, e.g. $19.99 or £6.95 (but not necessarily mathematically odd, it could also be $2.98 or $3.90Template:Ref). The theory is this drives demand greater than would be expected if consumers were perfectly rational. Psychological pricing is one cause of price points.

Contents

[edit] Overview

According to a 1997 study published in the Marketing Bulletin, approximately 60% of prices in advertising material ended in the digit 9, 30% ended in the digit 5, 7% ended in the digit 0 and the remaining seven digits combined accounted for only slightly over 3% of prices evaluated.[1] In the UK, before the withdrawal of the half penny coin in 1984, prices often ended in 99½. This is still seen today in petrol (gasoline) pricing ending in Template:Fracs of the local currency's smallest denomination; for example in the US the price of a gallon of gasoline almost always ends in US$0.009 (e.g. US$3.289).

In a traditional cash transaction, fractional pricing imposes tangible costs on the vendor (printing fractional prices), the cashier (producing awkward change) and the customer (stowing the change). These factors have become less relevant with the increased use of checks, credit and debit cards and other forms of currency-free exchange; also, the addition of sales tax makes the pre-tax price less relevant to the amount of change (although in Europe the sales tax is generally included in the shelf price).

The psychological pricing theory is based on one or more of the following hypotheses:

  • Consumers ignore the least significant digits rather than do the proper rounding. Even though the cents are seen and not totally ignored, they may subconsciously be partially ignored. Some suggest that this effect may be enhanced when the cents are printed smaller (for example, $1999).
  • Fractional prices suggest to consumers that goods are marked at the lowest possible price.
  • Now that consumers are used to psychological prices, other prices look odd.
  • When items are listed in a way that is segregated into price bands (such as an online real estate search), price ending is used to keep an item in a lower band, to be seen by more potential purchasers.
  • Judgments of numerical differences are anchored on left-most digits, a behavioral phenomenon referred to as the left-digit anchoring effect. This hypothesis suggests that people perceive the difference between 1.99 and 3.00 to be closer to 2.00 than to 1.01 because their judgments are anchored on the left-most digit.

The theory of psychological pricing is controversial. Some studies show that buyers, even young children, have a very sophisticated understanding of true cost and relative value and that, to the limits of the accuracy of the test, they behave rationally. Other researchers claim that this ignores the non-rational nature of the phenomenon and that acceptance of the theory requires belief in a subconscious level of thought processes, a belief that economic models tend to deny or ignore. Research using results from modern scanner data is mixed.

Now that many customers are used to odd pricing, high-end retailers and restaurants such as Nordstrom psychologically-price in even numbers in an attempt to reinforce their brand image of quality and sophistication.

[edit] Research

Kaushik Basu used game theory in 1997 to argue that rational consumers value their own time and effort at calculation. Such consumers process the price from left to right and will to tend to mentally replace the last two digits of the price with an estimate of the mean "cent component" of all goods in the marketplace. In a sufficiently large marketplace, this implies that any individual seller can charge the largest possible "cent component" (99¢) without significantly affecting the average of cent components and without changing customer behavior. [2]

Kenneth Wisniewski and Robert Blattberg at the University of Chicago's Center for Research in Marketing showed that when the price of margarine was lowered from 89 cents to 71 cents, sales volume increased a mere 65%, but when it was lowered from 89 to 69 cents, sales volume increased by 222%.

In another study, the perceived value of all the numbers between 1 and 100 were studied, and 77 was shown to have the lowest perceived value relative to its actual value.

Schindler & Kibarian (1996) tested odd pricing using three versions of a direct mail catalog for women's clothing. The catalogs were identical except for the prices, which ended with 00, 99, or 88. The version with prices ending in 99 generated 8% more sales volume and had more purchasers than the 00-ending version. The 88-ending catalog produced a similar sales volume and number of purchasers to the 00-ending version.

The euro introduction in 2002, with its various exchange rates, distorted existing nominal price patterns while at the same time retaining real prices. A European wide study (el Sehity, Hoelzl and Kirchler, 2005) investigated consumer price digits before and after the euro introduction for price adjustments. The research reports clear trend towards psychological pricing after the nominal shock of the euro introduction. Further, Benford’s Law as a benchmark for the investigation of price digits was successfully introduced into the context of pricing. The importance of this benchmark for detecting irregularities in prices was demonstrated and with it a clear trend towards psychological pricing after the nominal shock of the euro introduction.[3]

[edit] Historical comments

Exactly how psychological pricing came into common use is not clear, though it is known that the practice arose during the late 19th century. One source[4] speculates that it originated in a newspaper pricing competition. Melville E. Stone founded the Chicago Daily News in 1875, intending to price it at one cent to compete with the nickel papers of the day. The story claims that pennies were not common currency at the time, and so Stone colluded with advertisers to set whole dollar prices a cent lower — thus guaranteeing that customers would receive ample pennies in change.

Others have suggested that fractional pricing was first adopted as a control on employee theft. For cash transactions with a round price, there is a chance that a dishonest cashier will pocket the bill rather than record the sale. For cash transactions with an odd price, the cashier must make change for the customer. This generally means opening the cash register which creates a record of the sale in the register and reduces the risk of the cashier stealing from the store owner.

A third theory is that the practice arose during that period as an attempt by merchants to appear to be significantly underselling the competition while in fact lowering prices by only a small margin.

In the former Czechoslovakia, people called this pricing "baťovská cena" — "Baťa's price", referring to Tomáš Baťa, Czech manufacturer of footwear. He began to widely use this practice in 1920.[5]

Price ending has also been used by retailers to highlight sale or clearance items for administrative purposes. A retailer might end all regular prices in 95 and all sale price in 50. This makes it easy for a buyer to identify which items are discounted when looking at a report.

It may be observed that the major retailer Wal-Mart prefers price endings like 99.98 instead of 99.99.

A recent trend in some monetary systems is to eliminate the smallest denomination coin (typically 1/100 of the local currency). The total cost of purchased items is then rounded up/down to the nearest 5/100's of the local currency. This may have an effect on future "odd-number" pricing to maximize the rounding advantage for vendors by favoring 98 and 99 endings (rounded up) over 96 and 97 ending (rounded down) especially at small retail outlets where single item purchases are more common. Australia is a good example of this practice where 5 cents has been the smallest denomination coin since 1992, but pricing at .98/.99 on items under several hundred dollars is still almost universally applied (e.g.: $1.99 – $299.99) while goods on sale often price at .94 and its variations. This has led to another phenomenon noted by economists in the January 2009 issue of Choice magazine. A Price point (such as $4.99) remains stable for a long period of time with companies instead slowly reducing the quantity of product in the package until consumers begin to notice. At this time the price will increase marginally (to $5.05) and then within an exceptionally short time will increase to the next price point (of $5.99).

[edit] See also

[edit] References

  1. The Widespread Use Of Odd Pricing In The Retail Sector, Marketing Bulletin, 1997, 8, Research Note 1, J Holdershaw, P Gendall and R Garland
  2. Why Are So Many Goods Priced to End Nine? And Why This Practice Hurts Producers. Economic Letters, p41-44
  3. El Sehity, T., Hoelzl, E. & Kirchler, E. (2005). Price developments after a nominal shock: Benford’s Law and psychological pricing after the euro introduction. International Journal of Research in Marketing, 22 (4), pp. 471-480.
  4. The Straight Dope: Why do prices end in .99?
  5. Social responsibility of the Bata Company, in Czech language

[edit] External links