Maggie walked me downstairs to the factory shop. By this time the Chocolate Teapot Company was becoming well known, and every day a stream of tourists and fanatical customers visited for a tour. After seeing how the heatproofing technology is applied by the hand-built machines on the upper floor, and viewing the research labs in which new flavours of tea and chocolate are tested together, they ended up in the shop.
But there were two entrances to the shop, and Maggie showed me the difference between them. We watched some customers go in through the north entrance. The first thing they encountered was a display of smaller one-shot teapots for everyday use. Prices ranged from £1.30, for a single-layer milk chocolate pot, to £2.55, for a two-layered version with bitter cocoa overlaid on a rich vanilla white chocolate base. As we observed for a few minutes, we saw that, if they selected anything from this shelf, the majority of clients picked a cheaper pot.
We walked over to the south entrance, where another stream of customers was entering. These customers first saw a luxurious display of the high-end World Chocolate range, with specially selected cacao bean blends from a variety of locally owned African producers. Prices here were up to £6 for a single pot, or £25 for a gift box with a range of several different chocolate styles and flavours.
Most customers seemed intrigued by these products, but only a few of them picked one up off the shelf. However, when these customers subsequently stumbled upon the everyday display, their attitude seemed different. Having been exposed previously to the expensive range, they were much more interested in the £2.55 teapots than the cheaper £1.30 version.
On average, Maggie told me, those who entered by the south door were spending about 60% more than those who came in through the north entrance. In fact, the merchandising team planned to come in the next day and rearrange the store layout to replicate the more profitable presentation across both entrances.
Maggie introduced me to her head of merchandising, Julie Robinson, who explained her theory of how this process worked.
“When they enter this shop, most customers have no idea of the correct price for a chocolate teapot. Maybe 2p would be appropriate, given that that’s about the price of a teabag. Or maybe £3.45, which is the price of a large cup of hot chocolate at Starbucks. There’s a huge range of potential values. We’d argue that the daily experience of enjoying your favourite drink is worth several pounds to most people, and for an occasional indulgence you might easily spend £20 or more. But we don’t have enough staff to walk round the store with each customer trying to persuade them of that. So we use pricing as a cue to value instead.
“First impressions are really important. When a customer is wondering about the worth of a teapot and the first price tag they see is £1.30, it sticks in their mind. Anything they subsequently see that’s above that level looks like an expensive, luxury version. But when the first one they see costs £6, their subconscious assumption is that £6 is what people pay for this kind of thing. £2.55 looks reasonable, and £1.30 is downright cheap. Too cheap, in fact, for some people – and so they tend to opt for a more expensive version.
“Whatever people think of as the default price, all others will be compared with it. Anything too cheap looks suspicious, while we have learned to indulge in more expensive products only occasionally. So the default price – which is called the anchor – sets the benchmark for what they’re willing to pay.”
Maggie interrupted. “I don’t entirely agree. There’s something else happening. Sure, there’s something to the ‘first impressions’ idea, but I think we also change our minds when we see new prices. So a person who sees the £1.30 pot first, and then the £6 pot, is still willing to pay more than someone who has only seen the cheaper product.
“On some level – maybe not fully conscious – the customers are remembering all the prices they’ve seen for this type of product. Then when they look at a specific item, they compare it to the whole range. So this product type – one-shot teapots – has a £1.30–£6 range. And the £1.30 product is right at the bottom of a fairly wide range. Customers therefore draw the conclusion that it’s not very good. And if they can trade up to a £1.50 or £2.50 product, they will feel much more comfortable that they’re getting something of quality.”
Research shows that Julie’s idea that first impressions count and Maggie’s theory that the range of prices matters are both valid. Academic experiments have found both effects to be true, and as the teapot merchandisers found, it’s quite straightforward to use both of them at the same time.
The technical name of the ‘first impressions’ effect is anchoring, and it has been seen in dozens of economic lab experiments and countless commercial settings.
In an experiment with MIT undergraduates, Dan Ariely and colleagues auctioned off some tricky-to-value items – wireless keyboards, boxes of luxury chocolates and obscure French wines. The trick was this: before the auction, they asked each person to write down the last two digits of their social security number and ask themselves ‘Would I pay this number of dollars for the item?’ So someone with the social security number 440-84-8398 was looking at an initial price tag of $98, and their fellow student with the number 232-20-3911 started instead with $11.
These price tags were not part of the auction – it was a straightforward process where the highest bidder bought the product – but they had a huge effect on the bids that the students placed. Those with high digits ended up bidding about 50% more than those with low digits.
I have repeated a version of this experiment at many conferences and talks – and even when people are aware that I’m talking about pricing psychology, and many of them can guess exactly what I’m trying to prove, it still works. This effect is so strong that even when we consciously try to adjust for it, we usually can’t.
Case study
Business consultancy
Consultancy businesses can use anchoring very effectively, for two reasons. First, consulting is a very non-commoditised business: it is difficult to compare one consultant with another, so clients are unlikely to have a clear pricing assumption already in their head. Second, you are often preparing a bespoke quote for each client, so you can create a range of solutions at very different price points with complete credibility. (The ‘credibility’ question is one which worries a number of businesses, so if you are concerned about this see Chapter 5).
So when you are asked for a quote by a client, offer at least three options:
• A high-end, everything-including-the-kitchen-sink quotation, which covers everything they could possibly want. I’ll call this the A package, though you would probably want to choose a more expressive name such as ‘in-depth support service’ when you describe this option to your client. This might be priced, for example, at £60,000 for a project (the exact numbers will vary according to the situation, of course). You don’t expect most clients to go for this size of project, but some might – especially bigger companies for whom the value of getting it right will far outweigh the cost of your service. However, what it does is establish that the value of what you offer can be at this level or above.
• A middle-of-the-road option at, say, £19,000 – the B package. This is the level you think most clients should go for. The service should be clearly distinguished from the high-end option, so that clients who are considering the A package have good reasons to stay with it instead of trading down to the B package. But it should still include most of the key benefits of your service so that you don’t risk losing the client to a competitor on the basis of a feature comparison. It’s important that this option is not a hollowed-out version of your service – instead, the A package should have lots of luxury extras.
• A cheap version at, say, £12,000 – the C package. It’s OK for this one to be clearly inferior to the B package – it is meant to give people the option of spending less money but to feel that there is a good reason for them to move up to the standard B package.
Note the ratios in price: approximately
12:20:60 or 3:5:15. The numbers do not need to match these proportions exactly – a 1:2:4 ratio is also common – but these are good guidelines. The point is that the primary anchor, the A package, is significantly higher than your standard price; and that you still offer people at least two options even if the A package is too expensive for them. The C package is lower than the B package, but not too much lower. The overall effect of this structure is to set the expectation that some people are willing to pay the A price (so the product must be a high-value product) but that the real decision is between B and C, so B and C must be relatively close in price. If C is too low (say £3,000), it is more difficult for the customer to form a view on a core price band. So you should use B and C prices as an upper and lower boundary on what you want to portray as a sensible price.
(This approach also has the advantage of achieving successful price discrimination. See Chapter 3, ‘Reading the customer’s mind’ to find out more about this.)
Downsides of anchoring
Standing outside the south entrance to the teapot store, I noticed a few customers approaching the shop and then wandering away without going in. When I pointed this out to Maggie, she nodded.
“People do seem to get the impression that this is an expensive store when they glance at the prices. The £6 and £25 packs are so prominent at this doorway that a few customers are put off going into the shop at all. We’re not quite sure how much this matters. Those customers were probably never going to spend a lot. But we are trying something new soon – next time you’re here come back and we’ll take a look at how it’s going.”
You can find out the answer in Chapter 17, “Managing the pricing environment”.
Anchoring has a powerful effect on the sales of the product you’re focusing on, but it can have an effect on consumers’ assumptions about your overall price levels. If you have high-priced anchor products it will be difficult to convincingly present an image as a discount or good-value supplier. In any case it is difficult to make those positions profitable unless you have very high volume and strong operational efficiencies, but some companies can do it. Most smaller businesses are better off with a high-value, high-margin positioning, and for these, anchoring is very powerful.
How to apply it
There are a lot of different ways to apply anchoring in most businesses. Here’s a process you can follow to work out how best to use it.
1. Collect data. You want to know as much as possible about the range of prices that you and your competitors charge for a given product. Maggie had the advantage of a unique product for which no benchmark existed, but for most businesses, there are competitors or at least some kind of comparable product out there already (see Chapter 1 for more about this). Even if there are no direct competitors, find the range of things you’d like to be compared to – in this example, teabags and Starbucks mochas. Then compile a list of as many examples as possible, writing down the product name, who sells it, the size or quantity, and how much they charge.
2. Order these by price level, so that you can see the range of prices charged for similar products.
3. Now consider the path a customer takes before choosing to buy your product. Do they see a range of items in your shop? Or on your website? Or do they find different options by searching the Web? Is your product sitting in a shop alongside other similar products?
4. Find where in that path you can add a new product at a high price. If you are a retailer or if you sell products from your own website, you have a lot of control over this. You can place a high-priced option in front of the customer before they see your ‘standard’ product. If you have a product in someone else’s shop, you have less direct control. But you can still try to persuade the retailer to display a higher-priced, luxury version of your product alongside the standard one (show them this chapter if you like – it is in their interest too!) or even try to place your product in retailers where the default prices are already higher (Waitrose instead of Sainsbury’s).
5. Choose your anchor price to be substantially higher than your standard price. The anchor effect still works for a £5 product with a £6 anchor, but it isn’t very strong. If two prices are close together, customers are likely to compare them directly instead of changing their subconscious evaluation of the true value of the product. But if you can put a £20 anchor alongside that £5 standard product, then the true value is much more likely to be shifted.
6. If possible, try to measure consumer behaviour with and without the anchor. There are at least three variables that can change: the number of consumers who buy anything at all; the proportion who buy this type of product; and the relative share of the £5 product versus other versions (for instance, if you have a £5 and a £3 version, which sells more?). Measurement is really important as there are lots of effects which may be going on at the same time, and you want to know which ones are stronger.
Collect data for anchoring
Product
Sold by
Quantity or size
Price
Hot chocolate
Starbucks
20oz (venti)
£3.45
Teabag
Tetley
1
2.5p
Teabags
Tetley
80
£1.99
Toolkit
You can copy this page and reuse it if you offer multiple products; or you can download more copies from www.psyprice.com. ProductSold byQuantity or sizePrice
Product
Sold by
Quantity or size
Price
Now design your product anchoring spectrum. Set the price of your core product to be close to whichever products from the above list you are competitively positioned against.
Product 1
Your core product
Cost price
Quantity or size
Price (a)
Your premium product
Cost price
Quantity or size
Price
(a) + 100%
Your super-premium product
Cost price
Quantity or size
Price
(a) + 200%
Product 2
Your core product
Cost price
Quantity or size
Price (a)
Your premium product
Cost price
Quantity or size
Price
(a) + 100%
Your super-premium product
Cost price
Quantity or size
Price (a)
(a) + 200%
Product 3
Your core product
Cost price
Quantity or size
Price (a)
Your premium product
Cost price
Quantity or size
Price
(a) + 100%
Your super-premium product
Cost price
Quantity or size
Price (a)
(a) + 200%
Product 4
Your core product
Cost price
Quantity or size
Price (a)
Your premium product
Cost price
Quantity or size
Price
(a) + 100%
Your super-premium product
Cost price
Quantity or size
Price (a)
(a) + 200%
Chapter summary
• Anchoring is one of the most powerful psychological effects relating to prices.
• If you show someone a high price fi rst, their expectations about the value of a product will be shifted upwards. When they then see the lower price which they will actually be charged, this will increase the attractiveness of your product or service.
• People will compare the price of your product to the range of prices for comparable options. So if your pri
ce is £2,000 and the comparative range is £1,000–£10,000, you will look like good value. If the comparative range is £300–£2,000, you will look expensive.
Chapter 8
Competition
In January I went into the local Cosanostra Coffee for a chocolate teapot and spotted something I hadn’t seen before: heavily promoted discounts on their regular menu of cappuccinos and Americanos. A whole range of key products – the medium size option on most drinks – were priced for the first time at 30p less than CTC’s main price point of £2.89.
Was I tempted to switch? Not really. Thirty pence is quite a small temptation to switch product categories. But it did make me notice the offer. I decided to stay and watch for a while.
Over the next hour a stream of customers – maybe 50 or so – came into the shop. I’d watched this happen before, and there was a pattern: about half of the customers visibly notice the chocolate teapot shelf and eye it with curiosity. Of these, about one in five end up buying one to try.
This time, about the same number of people looked at the teapot display, but only a single person bought one. One sale instead of five – a serious impact on the number of people trying out the new product.
Later that week I mentioned this to Maggie.
“We spotted that. It’s a bit of a problem for us. Our exclusive deal with that chain expired so they’ve lost some of their sales to their competitors. One of their people, name of Valerie Salmon, has just been promoted to head of coffee products and I think she wants to make her mark. She persuaded the head of retail that they need to make up the profit somewhere else. Their espresso drinks are more profitable so they are promoting those instead. Existing customers are mostly staying with us, but new customers think the teapots look expensive compared to their regular coffee, and they aren’t so keen to try it out. Sales from the café channel have stopped growing for the first time since we launched – they’re exactly the same as last month.”
The Psychology of Price Page 7