The way people pay for goods and services is changing. This is having an impact on how consumers perceive the value of their purchases. Companies need to grasp this in order to craft sustainable business strategies.
I always have been heavily into consumer psychology around money and their perceptions of value, so here I will describe several core concepts for understanding promotions and how people make spending decisions.
Research suggests that, when using non-cash means such as credit cards and mobile apps, people tend to spend more freely. At the same time, increasingly complicated rewards programs and deep discounts are affecting the value that consumers assign to certain products.
It’s all about Perception
We first need to grasp two fundamental principles from behavioral economics: reference points and prospect theory/loss aversion. Both of these concepts are helpful starting points for devising marketing strategies, as well as for framing your offer, bearing in mind how consumers’ perceptions of value may be affected.
Freebies and price promotions don’t always work the way you want them to, they should only be used as a short-term tactic. Companies that rely on these tactics to boost sales can find themselves locked in a downward spiral. What’s more, by using discounts as incentives, you may be unwittingly training your customers to shop based solely on price. Since price is your main lever to make money, we should use this approach in moderation. In scenarios where discounts are uncommon, cut-price offers can lead to an altered perception of quality. Rightly or wrongly, higher prices signal higher quality. Offering a discount for products that are rarely discounted can also suggest to customers that there is inadequate demand for the product at its original price and could likewise lead to a negative quality perception.
Prospect Theory/Loss Aversion
Please imagine you are shopping for a plane ticket and your reference point is $2,000 MXN. If you find a ticket for $1,500 MXN, you’ll be very happy. But what if the opposite occurs? What if the only ticket you can find costs $2,500 MXN? The pain of spending $500 MXN more than your reference point will be felt more acutely than the pleasure you experienced at having found the ticket for $500 MXN less. This is an example of prospect theory, also known as loss aversion. The basic idea is that margins of utility diminish in the domain of gains with respect to a reference point, while in the loss domain, disutility is steeper. In other words, a customer’s pain of paying more than expected will have a stronger impact on future spending decisions than the satisfaction felt after having paid less than expected.
The Effects of Promotions on Consumers
It is important to understand these psychological behavior patterns and their effects on consumers. We can categorize promotions by their three functions or effects: economic, informational and affective:
1. The economic effects of promotions can be monetary or non-monetary. Obviously, consumers benefit economically from most promotions, as indicated by the amount of the rebate (discount) or the face value of the coupon.
2. Promotions also serve to inform consumers about a product, thus having a positive effect on purchasing behavior. For instance, the mere presence of an endcap display at a supermarket can not only remind consumers about the product, but also lead consumers to believe the product is offered at a discount. However, the tactic of offering the product on promotion may end up failing, and consumers may be less willing to purchase it later.
3. Consumers’ feelings and emotions are influenced when they see, purchase or miss a promotion. These affective influences can be either general or specific, positive or negative. For instance, consumers may feel annoyed when purchasing with a discount, if discount levels are low or if they are inconvenienced. Furthermore, research indicates that consumers often try to figure out why manufacturers or retailers offer a deal, so they can decide if the price is actually fair or not.
I think we all should be aware of the different trade-offs involved with price promotions and their long-term effects. These can lead to lower price reference points for a brand as compared to one that is not promoted. Additionally, they can have long-term implications if the promotional price becomes the consumer’s new reference.
The Ultimate Goal
As virtual payment systems go mainstream, greater attention should be paid to consumers’ changing perceptions of money, of product value and of the trust they place in businesses. Constantly fluctuating prices -often driven by pricing optimization software- can have a significant effect on price reference points.
In the end, I believe trust is still a priceless asset. Thus, companies must keep a razor-sharp focus on fostering trust among customers, this will ensure long-term success.
Pricing and the Psychology of Consumption
The first rule of pricing is: you do not talk about pricing
What’s in Your Wallet? Psychophysical Biases in the Estimation of Money
Prospect Theory and Loss Aversion: How Users Make Decisions