We previously discussed why dynamic pricing can be a powerful strategy for retailers to optimize revenue and profit. With the rise of pricing intelligence and repricing tools, they can now quickly and accurately reprice inventory based on repricing rules that take into account key profitability points. Let’s take a closer look at why dynamic pricing works in terms of psychological pricing – in particular, how the contrast effect plays into it.
1. Reference pricing and the contrast effect.
Picture this scenario:
Consumer 1 – She visited a boutique to purchase a dress. The dress was marked down by $10 for a promotion. The regular price was $40, but she only had to pay $30, or 75% of that.
Consumer 2 – She visited a different boutique to purchase the same item as Consumer 1. The price of the dress is $25, which is the regular price. There is no markdown, but she paid less for the same item than Consumer 1.
Who got the better deal?
A behavioral economist would suggest that Consumer 1 did. Why would a person who pays more be happier with his or her purchase than someone else who pays less? This can be explained in 2 ways. Both have to do with buyer psychological pricing. Consumer 1 has the original price as a reference point to compare the discounted price to. They see how much they’re saving, whereas Consumer 2 doesn’t (and isn’t). Fixed pricing isn’t as appealing, even if the price is lower. Consumers are more satisfied and feel like they got a better deal when they receive a discount versus a fixed price. The other psychological reason is that consumers are usually happier when they pay for more (or know that the original price was high) as it assures them of the quality. This can be true most of the time; most expensively priced products tend to last longer than cheaper ones.
2. Demand is inversely correlated with relative price.
What about competitors’ prices? We know that consumers comparison shop now more than ever, and it’s getting easier and easier for them to do so. Again, the contrast effect applies here. How does your price compare to your competitors? Consumers are looking for this, and it affects the demand for your product. A relative price is the ratio of your price in relation to another price. Absolute or nominal price doesn’t really matter.
As players in the retail industry are increasingly employing dynamic pricing strategies and investing in dynamic pricing engines and repricing solutions, price changes happen more frequently. As a retailer, if you fail to adapt and respond to these changes, it affects your relative price, and consequently your demand. Relative price is an opportunity cost and is used in the purchase decision making process. Of course you can add value in other ways besides price (customer service, shipping or return policies, etc.) but strictly looking at pricing, if you can’t keep up with pricing trends for your products, you’re potentially giving your competitors an advantage. Many data components can play into dynamic pricing algorithms, but competitor benchmarking is definitely an important one.
Dynamic pricing continues to be a growing practice in the retail industry and it’s here to stay. Wiser is one tool that can help with both the data collection and implementation of this kind of pricing strategy.