What Exactly Is Psychological Pricing?

This is an excerpt from my new book Priced to Influence, Sell & Satisfy: Lessons from Behavioral Economics for Pricing Success.

When managers started applying pricing theory to business decisions, well before the popularity of social psychology and behavioral economics-influenced thinking, they used a unidimensional (and some might argue, ethically questionable) consumer model on which to base their pricing strategies. Essentially, they saw consumers as powerless, ill-informed and myopic creatures, ripe for manipulation and money extraction. The goal of pricing during this era was to hoodwink customers and to earn the highest possible profit from each and every transaction, customer satisfaction and welfare be damned.

Our model of the consumer could not be more different. We see our customers as empowered human beings whose decisions and behaviors are made volitionally even when they are habitual or made with little effort. They are governed by their thoughts, motivations, self-identity constructions, routines, and emotions. Their value assessments and decision processes are dynamic, context-dependent, and changeable. Our customers are both susceptible to social influence, and they desire to influence others. They put the requisite amount of thinking and due diligence into their purchase decisions, but they are constrained in different ways. With everything else going on in their lives, they have limited time, cognitive resources, and money to buy and consume our products.

The way consumers respond to price is equally complex. On the one hand, price is a physical stimulus, subject to psychophysical laws. Consumers are hardwired to follow precisely-specified rules in how they compare prices, tell them apart, and identify that a price has changed. On the other hand, prices also produce visceral emotional responses. Shoppers feel pain when they have to pay money to buy something and happiness when they score a deal or buy something particularly meaningful. In one study, consumers whose brains were scanned while they saw very high prices showed increased activation in the insula region that is associated with pain.

In conjunction with this complex and rich consumer model, the way we view pricing strategy is that as managers, we want to sell products and services at prices that will deliver value to consumers. Instead of tricking or manipulating them, we want to listen to them and accommodate their voices in our pricing decisions, and share the value generated by our offerings with them equitably. Our fundamental goal is to initiate and maintain mutually beneficial, long-lasting relationships with customers where the value created by our offerings is maximized and shared. With these consumer and pricing strategy models as our guiding framework, we can now define psychological pricing as follows:

Psychological pricing is a set of strategic and tactical managerial pricing actions designed to influence consumers’ perceptions, decisions, and behaviors through thinking and feeling processes. Its goal is to deliver a high degree of value to target consumers, while concurrently generating healthy revenue and profit for the business.

My new book Priced to Influence, Sell & Satisfy introduces the latest science of designing effective pricing strategies using behavioral economics principles. You will learn how customers search for, evaluate, share, and use prices in their buying decisions, how they participate in setting prices, and what managers can do to understand and influence these processes. The power of psychological pricing actions lies in their leverage. Many of them require relatively small investments and produce disproportionately large returns to the business.