How does a company decide how it should price a product? How do we decide how much we’re willing to pay for that product? What affects those decisions? We answer these questions and more on this episode of Ratehub’s Real Money Talk Podcast. Tyler and MoneySense General Manager Jon Vassallo sit down with Eric Dolansky, a professor of Marketing at Brock University. The trio discusses consumer psychology of money, the impact of COVID on behaviour and pricing, and why the UP Express is an excellent example of failing to price a product correctly.
While doing his Ph.D. at the Ivey School of Business at Western University, Eric knew he needed a focus. His aim was to break the traditional understanding that a product’s price is simply where supply meets demand. This interest launched him into a career of analyzing consumer behaviour, price fairness, and who is to blame for price skyrockets and plummets.
How does pricing work?
How does a company set the price of their product? Eric has a simple answer to this question:
“Most companies, most of the time, do not set their prices based on how much they think someone is willing to pay. Most companies, most of the time, set their prices based on what it costs them to deliver that service or acquire that product.”
There are times when companies do some research to figure out what you might be willing to pay, but the majority of the time, they decide their markup and set the price.
How they present that final price to you as a consumer can significantly impact the decision you make. An interesting example is what would happen if you flipped the ordering of wine bottles on a restaurant’s menu. Wine is usually listed from cheapest to most expensive, but people tend to buy more expensive wine if you flip its order.
Why? Eric says two things are going on. The first is an anchoring effect: the first price you see sets your expectations for the rest. If it’s a high number, the moderate prices will feel a lot cheaper. The second is the framing effect. We have a range of prices we’re willing to pay in our head, and the set of prices we see on the menu can affect that frame. Overall, this flipped list makes diners more likely to pick a more expensive wine.
“If people see an ascending series of prices, they would not only expect the next prices to be even higher, they would be more accepting of them.”
COVID’s effect on pricing and psychology of spending behaviour
How has COVID affected prices and behaviour? There have been many examples like the considerable increases in demand for household products like toilet paper and sanitary wipes. Famously, the upscale Toronto grocery store Pusateri’s charged $30 for Lysol wipes. Not only did the store get called out by the Premier, but Eric also believes they made a poor economic decision.
“From a theoretical standpoint, that makes perfect sense. Those Lysol wipes are far more valuable during this situation then they were before it. On the other hand, that’s a very short term way of looking at things.”
Eric believes that COVID won’t have a significant impact on behaviour once we fully return to normal. But what he finds surprising is how easily we accepted the significant restrictions we faced at the start of the pandemic.
“If you had said a few months ago, ‘you know what, we may be in a situation where the government is going to have to tell everyone to stay home they’re going to shut down all the business, and it’s going to be like what they did in Wuhan, China.’ I think a lot of people would say that would never work.”
How should you think about prices and behaviour?
Although there are many insights Eric shares about pricing, he says that most of those decisions are for business and shouldn’t really impact how we buy our goods. His big advice for consumers is – be honest with yourself about the decisions you make.
“The mistake we make as consumers is that when we plan for our purchases and when we look back on our purchases, oftentimes we like to think of ourselves as rational actors. As I am making a rational, sensible decision exchanging this much money for this specific benefit. I’m buying this sweater because it keeps me warm. There’s nothing wrong with saying I’m buying this sweater because I happen to like the colour or something about the design or the logo on it or whatever else.”
Hear the full conversation with Eric, Jon, and Tyler on your trusted Canadian personal finance podcast, Real Money Talk.