The Rational Price

By November 12, 2017Marketing, Psychology
The Hutch Report

Price is all around us and our contemporary society has managed to come up with a myriad of ways to refer to price over the years.  You pay rent for your apartment, a tuition for your education or a fee for your dentist. Airlines, railways, taxis and bus companies all charge you a fare. Local utilitiy companies talk about the rate they charge you and your bank will charge you interest for the money you borrow. The price for taking your car on to the ferry or the price you have to pay to use a highway or a bridge is called a toll. The company that insures your car will charge you a premium. Clubs or societies to which you belong may make a special assessment to pay unusual expenses. Your lawyer will ask you for a retainer to cover his/her services. The price of an management executive is considered a salary, unless you are a salesman, then it may be a commission. A worker will recieve a wage. Finally, income taxes are what we pay for the right to earn money, hence the name tax on income, (although an economist would probably disagree).

Everything that we pay a price for has some kind of utility, or something that will be useful to us. The importance, worth, or usefulness of that something is also considered value (the terms utility and value and used differently among economist so to simplify things I will just refer to value). The price of something is a mechanism that allows us as consumers to make a decision.

Price is probably the most influencing factor for buying because consumers are rational. What makes them rational is the fact that they have limited income as well as a limited budget. An irrational consumer that spends beyond his or her means are quickly pushed into insolvency. Although there are an increasing amount, it can be agreed that the majority still act in a rational manner.

Making a decision on price, however, is not always the easiest thing to do for consumers. Price is not only the amount that customers pay for utilizing a product or having a service. There are a number of psychological factors that impact how they feel.

Companies can sustain themselves in the market if and only if they can make a profit, which totally depends on price. When a company is going to determine the price of a product or service they need to first understand their cost of the product/service offered. No company that prices a product for $5 but cost $10 to produce can survive for long. They need also to think about the rationality of pricing; that might include the product’s quality, availability of the alternatives in the market, types of products and the category of entry into the market. A company’s pricing determination can be incredibly complex and not in the scope of this article.

We want to look at what a consumer is confronted with when making a purchasing decision and how they can improve their ability to make the best decisions with the information available to them. Dan Ariely described how what may seem a simple purchasing decision, is not always so simple for the consumer to make.

“Consider the following situation as an example: You are thirsty, tired, and annoyed and just want a cup of coffee. You see two coffee shops across the street from each another. One is a specialty coffee shop that sells handcrafted, designer coffee and the other is Dunkin’ Donuts which sells standard, decent coffee. The price difference between the two options is $1.75 for your cup-a-joe. Now, how do you decide if the benefit of the handcrafted coffee drink is worth the additional $1.75? What you should do (if you wanted to be rational about it) is consider all of the things that you could buy with that $1.75, now as well as in the future, and decide to buy the expensive coffee only if the difference between the two coffees is more valuable than all of those other possibilities. But of course this computation would take hours, it is incredibly complex, and who even knows all the possible options to consider?”

So what does one do to make the decision? Dan Ariely states that in place of making decisions “correctly” we adopt simple rules or what academics call “heuristics” (heuristics are simple, efficient rules, learned or hard-coded by evolutionary processes, that have been proposed to explain how people make decisions, come to judgments, and solve problems typically when facing complex problems or incomplete information.) Simply put, we will decide what we have always decided. If you have purchased designer coffee in the past and have been content to pay the additional price then you may well do it again, whereby it becomes a habit. However, if your financial situation changes then your purchasing habits will most likely change. It may become a better option to go for the Dunkin` Donut’s coffee and pay a bit less.

By examining these habits, and quitting them when it makes sense to do so, we might actually discover ways in which we could reduce our spending on a long-term basis. Or more to the point, we may discover where we are paying more for less value received or paying less for more value received.

In addition to analysing your current purchasing habits in this way you may want to do some deeper research and discover your true motives for purchasing a service or product in order to establish some better buying habits from this point on.

We make our purchase decisions from a rational point of view or an emotional point of view. However, Professor Baba Shiv of the Graduate School of Stanford Business points out that 90 to 95% of our decisions are made by our emotional brain, even if we think we are being rational the emotional side will always win out. (Clotaire Rapaille goes deeper into this analysis in his brilliant book, “The Culture Code.”)

Below are a few examples of rational purchasing decsions vs. emotional purchasing decisions. You also have to keep in mind that your decisions may be based on a combination of both. However, when you are analyzing the emotional side, it is much more difficult to quantify the value. Companies understand this so they often market to your emotional side. This is why they pay athletes and celebrities millions of dollars to represent their brands. If I purchase a Nike product then it means emotionally I may be in the same class as Roger Federer, but how can I possibly value that emotion? I may have paid $40 too much!!

The price you pay for any product/service all comes down to the individual’s choice. Take a bit of extra time during your next purchase, regardless of the price, and try and discover your true motivation for making the purchase, and if emotional, what value does that mean to you. You may discover something new!