Three price rise tips from Behavioural Economics

The Australian financial year has clicked over to FY2011/12, and with it no doubt some tweaks to the profit and loss.  Your opportunity now is to use Behavioural Economics to rethink one of the most common activities associated with this time of year; introducing a price rise.

Whilst common place, introducing a price rise doesn’t necessarily mean it will be well received. Three behavioural principles of which you should be mindful;

1.       Relativity – we judge one thing relative to another, so in this case your pricing will be compared with inflation, competitor prices and value.  How do you stack up? The best course of action is undoubtedly to increase the value at the same time you increase your price, but let’s be honest, sometimes you just want a healthier profit line. Here you will need to do some homework. With what can you compare your pricing favourably?  Guide the relativity judgement by providing cues (eg last year’s rise, overpriced competitors, allied industries etc) otherwise your customers will do it by themselves.

2.       Adaptation – if it’s bad news, get it over quickly. The principle of adaptation has proven that we adapt more readily to news if we are not constantly reminded of it. “Quick like a band aid” springs to mind.  For a price rise, communicate it as you need (ie appropriate and legal disclosure) but don’t keep reminding your customers!  Even if you are increasing the price in increments (eg every quarter), communicate at the first rise, not every time. 

3.       Status Quo Bias – This is one to help you feel better about your decision!  We have a strong status quo bias, tending to stick with what we know.  Still scared that your price rise will result in customer attrition?   Sure, it may happen. But take heart from banks. Remember when one of the big banks raised interest rates above the RBA’s cash rate increase?  Outrage followed by mass exit? Well, no.  Same goes every time the health insurers raise their fees. Of course, exit fees and other penalties for changing provider may have helped, but what is really at play is inertia. Oftentimes we just can’t be bothered taking our business elsewhere.

Have a business issue on which you would like a Behavioural Economics perspective?  Let me know by emailing peoplepatterns@gmail.com.  Until next week, happy pricing.

This article originally appeared in Smartcompany for whom I am contributing articles on how Behavioural Economics can be applied to common business issues.

Buying a vote for 20 cents

What can you buy for $0.20 vs $10?  A vote at the local bushwalking club.

Two scenarios are outlined below, both with the objective of securing a $10 increase in the annual club membership, from $40 to $50.  The story illustrates how the positioning of a price increase can impact much more than whether it goes through or not.

Scenario 1

"Welcome to our monthly meeting, I am Jane Smith, your club president. As you know, you are one of over 500 members, 200 of whom are here tonight to discuss and vote on the plan to adjust annual membership fees by $10.  As you also know, what brings us together is our love of the outdoors and bushwalking, so I am really looking forward to sharing our plans on how we can do even better than last year.  Our plans mean that we can support up to five different walk locations every single week rather than the current three, we can continue to provide our monthly newsletter via your choice of post and email, but most importantly, we are all protected through accredited safety training and our insurance policy. It also means we can at last buy 2 satellite phones to use on our most remote walks. And to make this the best year yet, all it will take is one of these (holds up a 20 cent coin) per week. But let's go through the detail so you know why it's 20 cents and not say 10 or 50 cents, and then I can open the floor to questions."

Scenario 2

"Welcome everybody.  Now tonight as you know we need to vote on the proposed increase in membership fees.  These were outlined in the newsletter. We've got the figures in a spreadsheet up on the screen behind me (gestures to excel file that is a bit too small to read from the back of the room). It's $10 for individuals, from $40 to $50.  Does anyone want to say anything before we vote?"  (Member takes the microphone and asks what the financial health of the club was and whether a sizable sum should be used to offset the fee increase rather than sit untouched. President hands over to Treasurer and it quickly resolves into a discussion on the detail of how much a newsletter costs to print, including paper, printing and post. 30 minutes later the President calls for a vote. I meanwhile had plenty of time to work out that $10 on $40 is 25% increase which was much steeper in relative terms than the $10 on top of the $60 family membership).

What are the key differences between how the fee increase - the price rise - was positioned? 

The first scenario used the principles of behavioural economics and change management to motivate the affirmative vote. Let's step through the principles;

• Shrink the change - $0.20 a week seems a lot less burdensome than having to pay $10. The mere mention of $10 conjured in my mind all the things I could spend it on, so by visually holding up a 20 cent piece the president was bumping an abstract image from my mind with a tangible representation. I couldn't even remember the last time I had used a 20 cent coin, so of course 20 cents a week wouldn't be a problem.
• Adaptation - don't assume your customers are consciously aware of the benefits they already receive, so the president in scenario 1 was right to remind me of our common love of bushwalking and all the services the club provided.  The Adaptation principle tells us that people get used to good things and can forget the value they extract along the way. The joy of a pay rise quickly fades as it becomes the usual.  And Adaptation also helps us get over the pain of a price change. Remember the last interest rate rise?  I certainly remember the media hype but I can't remember what it has meant to my mortgage because I have adapted. So Adaptation also tells us that the club was right in both scenarios to charge the amount as a once-off rather than by instalment.  We get used to prices rises as long as we are not reminded of them (aka the 'quick like a band-aid' rule).
• Executive Mind - a fee increase engages the executive mind which looks for logic and value - it's provoking the Rider when the Elephant has been happily trotting along*. Don't engage this type of processing with a price rise unless you couple it with the value argument, otherwise the Rider will yank the reins and march that elephant right out of your shop. However, the big trick here is to not just base it on logic.  Like me, I'm sure you have seen many logical arguments fail because they did not appeal to the Elephant as well as the Rider.  In scenario 1 the president not only illustrated the scale of change (Rider) but why we needed to contemplate this.  Safety, shared love of bushwalking, the number of members which illustrates the thriving nature of the club all got our Elephants stampeding for the affirmative vote.  In scenario 2, instead of reminding us of why we were members in the first place, it was inferred we were an insurance risk and communication burden that had to be covered.   The unhappy Elephant was thinking 'Yes, I logically get why you need to put up fees but I really resent it. Why am I part of this club again?'
• Clarity - Detail is great as long as its accurate and meaningful, but clarity is much more important.  In scenario 1, the president was clear in the amount of increase ($10) and what this meant (equivalent of $0.20 per week). She also cleverly introduced it as an anchor (20 cents rather than 10c or 50c) so we inferred that it was not too little or too much. In scenario 2, the $10 was clear but not in terms of why - what was the context around the amount, and what was it paying for? 

I mentioned in the introduction that the positioning of a price rise can impact much more than whether it is implemented.  If you haven't already guessed, Scenario 2 was the situation I and my fellow club members endured.  Did the fee increase go through? Yes.  We voted for the $10 increase and the committee can say that it was a successful outcome.  I think many of us voted just to get it over with and we had justified to ourselves that $10 wasn't worth another 30 minutes of awkward discussion.  Instead of the fee change being viewed as a positive sign of growth for the club, we have come away with a nagging sense of incredulity, and that's a shame for a club with such hard working volunteer committee members. 

So when you are contemplating a price rise in your line of business, remember it's the customer churn resulting from your decision, the lost advocacy for your product, the Elephants that may have voted one way in the room but now walked out of it that you need to worry about.  We all know that prices rise - that's the easy part - it's how you get people to vote for it that is your job.

* For an explanation of Riders and Elephants, please refer to previous posts such as http://bri-williams.blogspot.com/2011/01/normalising-ethical-shopping-with.html