Anchor Pricing Strategies

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by: Roger Dooley

Here’s a scenario… You decide to venture into a cell phone store despite your reluctance to deal with a bewildering number of phones, options, plans, along with a confusing price structure. As usual, you find you’ll have to wait a bit for a salesperson. The greeter hands you a card with a big “97″ printed on it, and says, “It should only be a few minutes. We’ll call your number, 97, when a salesperson can help you.” You notice that a large digital display on the wall is showing “94.” You see it click to 95, then 96, and finally 97. The receptionist says, “Number 97, please,” and a salesperson appears to assist you.

You thought nothing of the numeric ordering of customers, but it’s possible that the store had an ulterior motive: they could have been attempting to manipulate the price you would pay. Sound bizarre? Read on…

When a consumer is presented with an offer, a key element in the decision to accept or reject it is whether it appears to be a “fair deal” or not. We know that buying pain – the activation of our brain’s pain center when paying for a purchase – increases when the price seems too high. But how does that value equation work? The answer is anchoring – typically, we store an anchor price for different products that we then use to judge relative value. That sounds simple enough… but it’s actually not. Some anchor prices are stickier than others, and at times totally unrelated factors can affect these anchor points. The better marketers can understand how anchoring works, the more creative and effective pricing strategies they will be able to develop.

Gasoline: Drifting Anchor

First, let’s look at a non-sticky anchor price scenario that most of us are coping with today: fluctuating gasoline prices. In the U.S., we’ve seen prices surge past the $4 level in the last few months. The first time I saw that “4″ digit at the front of the price, I’m sure my brain registered pain. I had barely become used to $3 gas. But, after a short time, my anchor was reset. $4 prices were no longer exceptional, and if I had been seeing mostly $4.29 prices, a $4.09 price would register as a good deal. If I saw a station offering gas for $3.99 – a price that only a few months earlier would have seemed outrageously high – I’d be hard pressed not to pull into the station to take advantage of the “bargain.” Of course, gasoline is a unique product – we expect its price to vary, and we have constant feedback on current pricing as we pass gas station signs. For this product, we are constantly re-anchoring.

Real Estate Prices

Other items have stickier anchor points. In Predictably Irrational, Dan Ariely describes research by Uri Simonsohn at Penn and George Loewenstein at CMU that showed it took about a year after relocation for home buyers to adapt to the pricing in a new market with higher or lower real estate prices. People who moved and bought a new home immediately tended to spend the same amount on housing as they had before, even if it meant buying a home that was much larger or smaller than the one they left. (I’d suppose that some practical factors could affect the decision to spend the same amount. If one sold a large four-bedroom house in Michigan one would hardly expect to duplicate the home in San Francisco. U.S. tax laws may discourage “trading down,” too.)

Less Familiar Products

But what about items for which we have fuzzier anchors? We get daily feedback on gas prices, and if we own a home we probably keep an eye on sales of comparable properties to gauge our own level of equity. Items that are unfamiliar or rarely purchased may form an anchor point when we start thinking about the purchase. If we decide to buy a big-screen plasma television, we may spot one we like in a Best Buy circular for $2,000. We may not buy that item, but according to Ariely that now becomes an anchor price against which other deals are measured.

Irrational Anchors

Here’s where anchor prices get weird – and “weird” isn’t a word we throw out lightly here at Neuromarketing. Up to this point, there was a perfectly logical framework underpinning the brain’s anchoring process. But research conducted by Ariely showed that getting subjects to think of a random number – in this case, the last two digits of their social security number – impacted the price they were willing to pay for various items. A higher random number led to higher prices.

Below is just one data set from Ariely’s experiment – prices that subjects would pay for a cordless keyboard:

SS Number    Price 
  00-19 $16.09
  20-39 $26.82
  40-59 $29.27
  60-79 $34.55
  80-99 $55.64

For an unfamiliar product like a cordless keyboard, the random number that the subjects were thinking of ended up impacting the price they said they’d pay. The correlation between SS range and price for this data set was an amazing (to me, at least) .52! (One cautionary note before you start hanging posters with big numbers all over your store: as with many of Ariely’s clever experiments, this one used subjects who were answering a questionnaire, not actually buying the product.)

Presetting an Anchor

Other experiments by Ariely showed that anchors could be “preset” for unfamiliar items, in that case a payment for listening to an annoying sound. A questionnaire that included, “Would you be willing to listen to this sound again for $.10″ elicited lower bids than those subjects asked the same question with a price of $.90.

Starbucks and Avoiding Anchor-Shock

Ariely includes some interesting speculation about the amazing growth of Starbucks (notwithstanding its current woes). One would expect that coffee is a well-anchored product. Coffee drinkers are frequent consumers, and pricing at outlets like Dunkin Donuts, McDonalds, and convenience stores have been mostly similar. In its early years, how did Starbucks manage to thrive despite having prices that must have seemed at odds with the expectations of most consumers?

First, Starbucks did its best to disassociate itself from existing price anchors by redefining the product. The stores offered a different ambiance, they were permeated by an intense coffee aroma, the food items offered in glass display cases were high-end pastry items, and so on. Even the products themselves were distinct from other coffee vendors: the sizes weren’t small, medium, and large, but rather tall, grande, and venti. You weren’t buying a cup of coffee, you were buying a Caffè Misto or a Frappucino. All of this served to weaken the tie to anchor pricing formed at other shops.

Second, according to Ariely, repeated visits to Starbucks served to establish a NEW anchor price for high-end coffee products. Each purchase of $4 coffee strengthened that new anchor point.

Lessons for Marketers

It’s no big news to marketers that customers may have specific price expectations for a product or product category. If one can bring a product into that category with a price lower than expected, it should be an attractive offer. If one’s product is premium priced, then it will be important to separate it as much as possible from lower-priced products.

The more interesting challenge is how to deal with new products for which consumers have no clearly established anchor price. Ariely’s research shows that anchor pricing for such products is quite fungible, and marketers would do well to avoid inadvertently establishing a low anchor price. If a higher anchor price can be established, then offers involving lower prices will be attractive to consumers. Apple’s iPhone marketing has done a good job of using anchor pricing to keep demand strong. When they first released the iPhone, it was at a price of $499 to $599, establishing the initial anchor for what the unique product should cost. To the chagrin of early adopters, they dropped the price by $200 after only a few months – creating an apparent bargain and stimulating more sales. When they introduced the iPhone 3G, pricing was as low as $199, and they sold a million phones in three days.

There are many reasons why marketers start with a high price initially. One big one is to work the demand curve, i.e., get a high price from the portion of the market willing to pay that much before dropping the price to reach a larger number of customers. A key benefit of this strategy for new products, though, is that a high anchor price is established in the minds of customers, making each subsequent reduction a bigger bargain.

Can marketers take advantage of irrational anchor pricing? Would asking customers to think of a number between 90 and 99 while standing in line at a fast food restaurant make them willing to pay more for a burger? Should stores hang posters of big numbers by the checkouts? While Ariely’s work suggests that this kind of irrational anchoring effect could exist, I wouldn’t recommend building a marketing strategy around such techniques.

Infomercials and Anchor Pricing

One group of marketers that seems to implicitly understand anchor pricing are the creators of successful infomercials. Just about every one seeks to establish a high anchor price for their usually unique or unfamiliar product by saying things like, “Department stores charge $200 for this kind of product…” before making an offer at a lower price. They typically proceed to add bonus products into the offer as well, so that the “new” anchor price of their actual offer (”Only $59.99 plus shipping!”) looks better and better. By the end of the pitch, the offer price is not only far lower than the initial anchor but the offer itself has expanded to include far more product. (I saw one yesterday that, at the last minute, dropped the price by $5 “for callers in the next twenty minutes” – yet another exploitation of a favorable comparison to a previously established anchor.)

Marketers of all types could do worse than studying the techniques of successful direct marketers. The latter live or die by the success of their commercials, catalogs, or websites, and if you see an offer repeated time after time you can be certain that it is working.

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