Definition of Psychological Pricing
Psychological pricing is the practice of setting prices slightly lower than rounded numbers, in the belief that customers do not round up these prices, and so will treat them as lower prices than they really are. This practice is based on the belief that customers tend to process a price from the left-most digit to the right, and so will tend to ignore the last few digits of a price. This effect appears to be accentuated when the fractional portion of a price is printed in smaller font than the rest of a price.
An example of psychological pricing is setting the price of an automobile at $19,999, rather than $20,000. This type of pricing is extremely common for consumer goods.
Example of Premium Pricing
ABC International has created an all-electric car for the urban commuter. Upon investigation of competing price points, ABC finds that there is a cluster of similar vehicles priced at $19,999. Also, many car buyers use on-line price shopping services to evaluate vehicles, and those services present choices to car buyers in $10,000 pricing bands. Thus, ABC decides to price the vehicle at $19,999, not only to match the competition, but also to position itself within the $10,001 - $20,000 pricing band.
Advantages of Psychological Pricing
The following are advantages of using the psychological pricing method:
- Price bands. If a customer is accessing information about product prices that are segregated into bands, the use of fractional pricing can shift the price of a product into a lower price band, where customers may be more likely to make a purchase. For example, if a customer only wants to consider automobiles that cost less than $20,000, pricing a vehicle at $19,999 will drop it into the lower price band and potentially increase its sales.
- Non-rational pricing. If customers are swayed by the incremental price reductions advocated under psychological pricing (which is a debatable premise) then sales should increase.
- Control. It is much more difficult for an employee to create a fraudulent sales transaction and remove cash when product prices are set at fractional levels, since it is more difficult to calculate the amount of cash to steal.
- Discount pricing. If a company is having a sale on selected goods, it can alter the ending digits of product prices to identify them as being on sale. Thus, any product ending with a ".98" price will receive a 20% discount at the checkout counter.
Disadvantages of Psychological Pricing
The following are disadvantages of using the psychological pricing method:
- Calculation. It can be difficult for cashiers to calculate the total amount owed when fractional prices are used, as well as to make change for such purchases. This is less of a problem when credit card and other types of electronic payments are used.
- Rational pricing. If customers are more rational than psychological pricing gives them credit for, then they will ignore fractional pricing and instead base their purchases on the value of the underlying products.
Evaluation of Psychological Pricing
The overwhelming use of psychological pricing makes it clear that, whether or not the underlying concept is flawed, businesses are setting prices in this manner in order to compete with each other. Thus, to use the earlier example, setting a price a fraction higher than the prices charged by competitors might indeed lead to an incremental drop in unit sales volume, so a company probably has to use psychological pricing in order to remain competitive.