Psychological pricing definition

What is Psychological Pricing?

Psychological pricing is the practice of setting prices slightly lower than a whole number. This practice is based on the belief that customers do not round up these prices, and so will treat them as lower prices than they really are. 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 $29,999, rather than $30,000. This type of pricing is extremely common for consumer goods. A variation on the concept is to set prices higher, in the belief that customers will attach more importance to a product if the price is set at a premium level.

Example of Psychological 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.

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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. This tends to result in prices being parked at the extreme upper end of a price band.

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. It may be possible to measure this effect with A-B testing, where prices are left alone in one sales area, and adjusted downward with psychological pricing concepts in another sales area, to see if there are any differences.

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. Conversely, it is easier to steal funds when prices are set at rounded dollar amounts.

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. This makes it easier for checkout clerks to apply discounts on an item-by-item basis.

Disadvantages of Psychological Pricing

The following are disadvantages of using the psychological pricing method:

Price 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 cards 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. This is especially likely to be the case when products are heavily branded, so that customers are willing to pay substantially more money for them.

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.

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