December 19/26, 2016: Volume 31, Issue 14
By Lisbeth Calandrino
Simply put, behavioral economics provides a framework to understand the real-world, decision-making process. We’d like to believe we are all rational human beings and, therefore, make logical decisions. In reality, nothing could be farther from the truth.
So how can behavioral economics help you improve your profit margin? A better understanding of how and why consumers spend their money can help you persuade them to spend it on your products or service.
Everyone loves the word “free” (even though everyone knows nothing is really free). Have you noticed how consumers react to the prospect of “free carpet installation” or how quickly they walk out the door when they learn it’s not offered? It’s a fact that dopamine levels in our brain are actually measurably enhanced by the word free. When dopamine levels are raised, we feel good and tend to act irrationally. This could be why consumers flock to take advantage of free items no matter how ridiculous the actual purchase terms seem to be.
For many people, instant gratification is more important than their own future. Feeling good now is more important than paying attention to their budget or actual cost vs. value. People overspend when they are feeling depressed, i.e., “This will make me feel better.”
Following are some key points about behavioral economics to remember:
- Not all money is equal. This explains why 70% of lottery winners go broke in seven years. Since they didn’t work to earn the money and never actually felt the money in their hands, they are willing to spend frivolously. This may also explain why people are apt to spend their income tax rebate checks on unneeded items. It’s not really “free” money; it’s actually their own hard-earned dollars.
- Financing takes the sting out of the price. In fact, consumers are willing to pay more money for items when they can delay the pain. Financing may actually increase costs in the long run, but consumers tend to not worry about the future when they can have the pleasure of using the merchandise now.
- We gain more pleasure from a loss than a gain. Consumers give more weight to a cell phone carrier’s plan that states “unused minutes will be lost” vs. a plan with “unlimited minutes” available.
- Each of us has a price we will pay. Why did JC Penney lose market share when it changed to whole dollar pricing? The brain encodes numbers so quickly it rarely includes the second number. The number 2.99 is actually registered as “2” and 3.00 is encoded as 3. While it is true the actual difference is only one cent, the brain translates it as a difference of one dollar.
- Higher prices usually signify higher quality. If you are selling better merchandise, show the products first and then the price. Tiffany’s displays items with large photos and uses very small fonts for pricing.
- Remove the comma and the price becomes less expensive. Phonetic length of your price actually affects buyer perception of cost. For example, $1,499: one-thousand four hundred and ninety-nine (10 syllables) vs. 1499: fourteen ninety-nine (5 syllables).
- We prefer bundling to individual pricing even if it costs more. Car dealers offer packages to new car buyers. Adding $300 for leather seats is considered frivolous when compared to dealer packages—even when those packages include less-desirable options.