The Myth of Fair Value
(and How to Take Advantage of It)
By William Poundstone
Hill and Wang, Copyright 2010
[Buy on Amazon]
[We receive commissions for purchases made through these links (more info)].
This book is about: The complex and powerful psychology of pricing, the myths related to how we perceive and calculate fair value, and how to take advantage of it (in your pricing and negotiations).
You should read this book if: You want to learn more about the psychology of pricing, and real examples of how these techniques are used by businesses and negotiators. You offer a menu of products or services. You want to leverage anchoring techniques in your pricing and negotiations.
Selected Highlights (paraphrased from the book):
- The numbers (in assessing value, pricing, and negotiations) we use are not so solid, immutable, and logically grounded as they appear. In the new psychology of price, values are slippery and contingent.
- Coherent Arbitrariness: consumers really don’t know what anything should cost; they are mainly sensitive to relative differences, not absolute prices. [We are good at comparing prices, but not at determining what something should be worth independently.]
- What consumers say and what they do (or how they behave) are not the same thing. [i.e. people say they want comfort and luxury from airlines, but continue to choose their carrier based solely on price.]
- Memories of prices are short, and memories of packaging shorter. [Hence why manufacturers can shrink packaging, but keep the price the same, and consumers don’t notice.]
- When lotteries want to increase ticket sales, they raise the jackpot, not the chances of winning.
- We pay “too much” for coverage (insurance) because we worry more about the dollar value of catastrophes than the remoteness of the odds.
- Willingness to pay must be exploited to the full.
- You may not be able to reduce your costs, but you usually have the freedom to set prices.
- Shoppers spend an average of $2 more when moving through a store counterclockwise. [Notice many grocery stores are setup this way?]
- The visual cues should be about the food, not the prices. Photos of food are the most powerful motivators, but it’s perceived as inappropriate for high-end restaurants. [You may have noticed many restaurants have changed their menus to include more pictures.]
Effective Pricing Tactics:
Anchoring: Anchoring takes advantage of the common tendency to rely too heavily on the first piece of information (the anchor) offered when making decisions.
- Whenever we guesstimate an unknown quantity (or amount) that cannot be readily calculated, we can be influenced by other numbers just mentioned or considered.
- An effective anchor must be in short-term memory at the moment a decision is made.
- Anchoring can include a high-priced item offered mainly to manipulate consumers into thinking everything else is affordable.
- The more you ask for (when you set the anchor), the more you get.
- Your idea of what an item should cost is influenced by advertised prices even when they are totally unbelievable.
- An original price included along with the new discounted price is most effective. [i.e. originally $125, now $99]
- Place high-profit items next to high-priced anchors. [On menus, displays, etc.]
- Anchoring also works well in negotiations, where stating your inflated number first is an advantage. On the flip side, the best tactic to the other person setting the anchor is to threaten to walk away from the negotiation, rather than suggested adjustments to their anchor price (you must reset the anchor).
- Decoy: Using a higher or lower priced item or service to influence consumer choice.
- Extremeness Aversion: When consumers are uncertain, they shy away from the most expensive item offered or the least expensive; the highest quality or the lowest quality; the biggest or the smallest. Most favor something in the middle. The way to sell $800 shoes is to display some $1,200 shoes next to them. Offer at least three price choices if possible; most customers will choose the price in the middle. Expensive items on a menu influence customers to spend more. The goal is to draw attention to the most profitable items.
- Bracketing: Offering two expensive items in two sizes, with no price on the smaller (and more profitable) size.
- Bundling: Selling several items for a supposed bargain price. [i.e. combo meals]
- Unbundling: As with bundling, purpose is to make it harder to compare prices. [i.e. airline fees for bags, etc.]
- Opportunity Price Increases: blame someone else for the increase. [i.e. higher gas prices requires an “energy surcharge”]
- Don’t list prices in a column. Minimize price sensitivity by removing any leader dots, dollar signs, decimal points and cents if possible.
- Consumers prefer flat-rate pricing, even when it costs more.
- Rebates can be effective. Breakage – rebates that never get sent in (~40% never used). Slippage – rebate checks that never get cashed. Rebates can be effective; people are more inclined to buy a $200 item with a $25 rebate than a similar item at $175.
- Differential Pricing – charging different prices to different customers based on willingness to pay. [i.e. business traveler pays more for a refundable ticket with no advance purchase]
- Charm Prices are effective: Price a little below a round number. [i.e. ending in 9, 99, 98, 95]
- “Regularly $48, now $40” is more effective than “$39”. [It’s the anchoring effect at work!]
- Don’t raise the price, decrease the discount (or shrink the packaging/portion).