Behavioral Pricing

What is behavioral pricing?

Behavioral pricing is not a standalone solution, unlike other methods. It is a strategic tool best utilized in combination with other methods, such as value-based pricing. For instance, a price calculated through value-based pricing can be adjusted to the nearest price threshold using behavioral insights.

Explanation

The starting point of behavioral pricing is the recognition rooted in behavioral economics that customers are not rational but instead use a range of simplifying heuristics to make purchasing decisions.

For example, a pricing manager might add a third product to a product range to serve as a decoy to make the other products appear cheaper.

Let's take a well-known wine example case. First, a wine vendor only offered the two bottles priced at €10 and €20. In this case, most customers go for the €10 bottle because they are risk-averse and do not want to spend more than needed. If then the vendor adds a €50 bottle, the €20 bottle looks much more reasonable to most people, and they switch from the €10 to the €20 bottle.

This behavior is considered irrational because the preference between the €10 and €20 bottles should not be affected by adding the €50 bottle. However, considering common and empirically stable behavioral patterns when setting up an offer can be very profitable.

Many behavioral effects have been identified and can be used for pricing, such as default nudges, the power of free, price anchors, price thresholds, the endowment effect, or reference prices.

What are the disadvantages of behavioral pricing?

The key problem with behavioral pricing as it is applied today is that it is not a consistent method but rather a selection of anecdotes and specific cases.

For example, the above wine decoy example cannot be transferred to every industry. If customers have a good understanding of their requirements, a decoy cannot greatly influence them.

In addition, behavioral pricing does not offer specific pricing advice. For example, should the decoy wine be priced at €40, €50, or €60? In sum, many behavioral pricing tools are available, but there is no consistent guidance on how to use them best.