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Applying behavioral insights to understand the psychology of pricing | Deloitte University Press

Pricing products and services is a tricky business: Strategies based on utilitarian logic can fail in the face of the irrational ways humans often perceive value. Executing a winning pricing strategy starts—and ends—with understanding how customers and the front line answer the question, “Is this really worth that?”

Dust off your microeconomics textbook and read about “econs”: fully rational, always calculating individuals who make decisions with actuarial precision. Econs view companies’ negotiation tactics and sales promotions as useless clutter, obstacles to avoid as they try to maximize their utility.

In this vein, a few years ago, J. C. Penney decided to remove the noise and offer customers straightforward prices that reflected “everyday low prices.”1 The retailer’s goal was to make things simple, cut through the distractions, and offer prices that would pave a path to profitability while balancing consumer market demands. But what seemed like an attractive policy on PowerPoint yielded disturbing results: Store traffic decreased by 10 percent and sales plummeted by more than 20 percent.2

Though hindsight would suggest that this was a bad idea from the start, at the time it seemed as rational as the economics textbooks would advise. In fact, after the announcement to offer “fair and square” pricing, J. C. Penney’s stock immediately rose.3 But behavioral economics teaches us that straightforward policies do not always yield straightforward results. Unlike econs, humans instinctively consider a number of other factors when measuring the merits of a purchase. They are often accustomed to anchoring on reference points—that is, relying heavily on an opening number, such as a car manufacturer’s suggested retail price (MSRP). They are also highly sensitive to how much their neighbors paid for the same product. And timing matters. Consumers can be fickle, and the behavioral sciences suggest that is completely natural, even if not necessarily rational.

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Applying behavioral insights to understand the psychology of pricing | Deloitte University Press.

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