There are two basic ways of setting a price for a product. Either a business can calculate the manufacturing costs, add a profit margin, then use that calculation to set a price. Alternatively, a business can look at competitor prices, set a price that is competitive with those rivals, then work out how to manufacture to meet that price.
I doubt though that many consumers pay much attention to either of these approaches. Instead, consumers largely evaluate a price through reference points. For a consumer, value is not necessarily based on manufacturing cost for example, but what they think the product is worth in relation to something else.
For me, this is a starting point for studying the field known as behavioural economics i.e. working out how consumers assess value. There are many theories that explain the influences on the assessment of a price, such as how a price is ‘framed’, whether the product is ‘scarce’, or even whether it ‘signals’ high quality. I’ll go into some of these in future blog posts.
For now though, consider some practical examples. Most of us could buy a reasonable, newish car (four wheels, power steering, speeds of 70mph etc) for around £10,000, possibly less. Is a £50,000 sports car good value then? Well if you simply want to travel from A to B, you could argue no. But if other dealers are selling the same sports car for £60,000, suddenly the price looks good. It’s still £50,000 for a vehicle that essentially goes from A to B, but the reference point has made a difference.
Another example that provokes a lot of discussion: the price of petrol. I know people who will often remark about a 5p rise in the price of petrol perhaps costing them another £3 each visit. Yet, when my local petrol station began selling coffee for about £3 per cup, many customers decided that paying an additional £3 for an additional coffee was no problem. This is probably some form of ‘mental accounting’ process: I suspect petrol is seen as an expensive and painful necessity; coffee is an enjoyable caffeine boost.
Lastly, scale also makes a difference. When haggling with a vendor to buy a house, most of us wouldn’t think for too long about paying an extra £5,000 over the asking price to secure the house of our dreams. But if I added £5,000 to your water bill (bearing in mind that we all need water to survive) you’d probably protest in the streets! £5k when set against a large figure is a smaller proportion and therefore less scary. But it’s still £5k!
There is much more to say on these points, but this is a blog post rather than a book. I’ll save some for future posts. If you’re interested in discussing this or any other points regarding marketing and psychology, let me know.
I am a senior lecturer in marketing and a behavioural science researcher within Bristol Business School at UWE Bristol. I teach digital marketing at undergraduate and postgraduate level, and lead the MSc Digital Marketing.