Behavioral Pricing

Definition:

Unlike the other methods, behavioral pricing does not offer a full recommendation, but rather it is used in combination with other methods such as value-based pricing. For example, a price computed via value-based pricing is 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 rather use a range of simplifying heuristics to make purchasing decisions. For example, a pricing manager might decide to 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 €50 bottle is added, 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 bottle should not be affected by the addition of the €50 bottle. However, it can be very profitable to consider such common and empirically stable behavioral patterns in setting up an offer.

There are many behavioral effects that have been identified and can be used for pricing, such as default nudges, power of free, price anchor, price threshold, endowment effect or reference price.

What to watch out for

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 into every industry. If customers have a good understanding of their requirements, they cannot be much influenced by a decoy.

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 best use them.