How we consumers become happy to pay more
Steve Imke, SCORE Mentor
A recent RV trip took my wife and me through the Pacific Northwest and into Canada to explore the Canadian Rockies. The trip was chock-full of marketing lessons for small business, based on my behavior as a consumer.
When we left Colorado, fuel prices on the Front Range were below $3.50 per gallon. When we crossed into Canada, fuel was priced at $1.33 per liter, or $5.34 per gallon. After the initial shock at the pump we began comparing prices at various fuel stops and were soon delighted when we were paying $1.09 per liter ($4.13 per gallon) south of Calgary, Alberta. We were so happy with our fuel savings that we sprang for an up-scale RV park that boasted "Free WiFi."
A few nights later, I sat outside in a no-frills campground in the hinterlands of Montana and looked up at the moonless night sky so full of stars I could plainly see the Milky Way. I reflected on our trip, looking for takeaways for this month's business article. As I considered my reactions to gas prices and free WiFi, I began to think about how Behavioral Economics framed my reality and caused me to react irrationally, economically speaking. It occurred to me that savvy marketers could clearly use behavioral economics to their financial advantage.
While economics assumes that an individual provided with all the facts will respond rationally and make good business decisions, behavioral economics recognizes that our brains, in some areas, are hardwired in ways that make us respond - often quite predictably - irrationally, and contrary to logical economic rules. With a better understanding of just a few hardwired behavioral economic concepts, small business owners could achieve much higher profit margins.
For example, when Blu-ray and HD DVD were competing head to head, it became clear that Blu-ray was going to emerge as the standard. Savvy retailers, knowing that buyers respond in irrational ways to the word "free," advertised the HD DVD players, which at the time sold for around $400 apiece, with "Five Free DVDs" with the purchase of a new DVD HD player. Economics, and a rationally thinking person would say, what good is a $400 DVD HD player if I can't purchase DVDs to play in it? However, the irrational attraction to FREE caused consumers to clear the retailers' existing inventory of the soon-to-become-obsolete HD DVD players.
Amazon recognized the power of FREE to tap into the irrational part of the consumer's brain when they began offering "Free Shipping" on orders over $25 dollars. Now, to take advantage of the free shipping offer, you were forced to buy two or more items, when you likely only wanted one item when you initially visited the site. The word "Free" appeared in more then 3/4 of a trillion (not million or billion) Google searches in the past month alone. Consider, "Free oil changes for life" if you buy a new car, "Free checking" if you open a new account, or the "Free WiFi if you stay here," that lured me in to the up-scale RV park.
These are just a few examples of how smart marketers have used "Free" to drive consumers into decisions that pure economic reasoning would cause them to ignore, if they were in their right minds. Knowing that buyers react irrationally to something for free, what pricing model involving the use of something for free can you use to improve sales in your business?
Another interesting consumer behavior is the way the brain likes to compare similar options when making a decision, and how the pricing window can be enlarged, using an extra "anchor." As a rule, faced with deciding between two similar options and one dissimilar option, behavioral economics says that most people will discard the dissimilar option and choose one of the similar options. Adding to this tendency, we can introduce a number that moves the consumer's price reference beyond the prices of the similar items using a high priced distracter know as an "Anchor". Adding this anchor to the consumer's choices leads him to contemplate all the prices and move his acceptable price window closer to the anchors price.
For example, consider the task of buying a new mattress. You see two pillow topper mattresses, one for $519 and the other for $540, and one with memory foam for $685. You have no idea what it will be like to sleep on them for a full night, so you must use other means to make your decision. Enter the role of behavioral economics. The hardwired section of your brain that needs to compare options kicks in and you discount the memory foam option, since you can't readily compare it to another memory foam product. However, its higher price sets a higher price anchor point. Your need to compare makes you focus your attention on the two pillow toppers. With little difference in the feel of the mattresses, you struggle with your decision and finally choose the $540 mattress.
Your choice of the $540 mattress is highly predictable, based upon behavioral economics principles. First off, if presented with several prices, buyers tend to choose the median-priced option. The high-priced memory foam mattress simply served as a distracter and an anchor to drive up the price window. Next, your need to compare similar items forced you to focus on the two pillow toppers, and you ultimately chose the higher-priced option, in spite of any definitive difference in feel. Your choice was based on our hardwired propensity to drive toward products priced in the middle of the pack.
Next time you are out for dinner at a nice restaurant, look over the menu and see if you can find that high-priced distracter. Recognize how it makes the overall higher-priced menu items look pretty cheap, by comparison. Knowing that buyers can be anchored by a high-price distracter, and have an irrational need to choose between two similar products or services, how can you design your company's offering to take advantage of these behaviors and drive sales to specific products or services you want to move for higher margins.
Alas, anchored by the shock of my initial Canadian fill-up at $1.33 per liter made me rejoice at the $1.09 per liter, which was predictable irrational behavior. The subsequent lure of Free WiFi caused me to spend over $50 per night, well above the range of $12-$32 per night spent for the rest of the trip, which is also predictable irrational behavior. In the final accounting, behavioral economics is a powerful tool and, in capable hands, can yield immense marketing advantages, resulting in greater sales and higher profit margins.