Dust off your microeconomics textbook and read about “econs”: fully rational, always calculating individuals who make decisions with actuarial precision. Econs view companies’ negotiation tactics and sales promotions as useless clutter, obstacles to avoid as they try to maximize their utility.
Unlike econs, humans instinctively consider a number of other factors when measuring the merits of a purchase. They are often accustomed to anchoring on reference points—that is, relying heavily on an opening number, such as a car manufacturer’s suggested retail price (MSRP).
They are also highly sensitive to how much their neighbors paid for the same product. And timing matters. Consumers can be fickle, and behavioral science suggests that this is completely natural, if not necessarily rational.
Organizations can set up guardrails that account for behavioral biases and faulty execution in sales. Finance leaders can also use some tactics to develop more behaviorally savvy pricing strategies and help their sales organizations carry them through to execution
These phenomena aren’t confined to only the purchaser experience. Salespeople also succumb to behavioral biases, which can affect their ability to maintain price points. Two common pitfalls:
- Underestimating how much anchoring can drive customers’ reactions. This suggests the need to pay close attention to both the opening offer and any external perceptions of value upon which customers may anchor.
- Undercutting themselves—and the organization’s pricing strategy—even before setting a price. For salespeople, losses can loom larger than gains. They often fear turning away an opportunity to close a deal. “We can’t charge that!” is a common worry when salespeople lack confidence in the company’s pricing strategy.
There is hope, however. By confronting these mistakes head-on, organizations can set up guardrails that account for behavioral biases and faulty execution. In this issue of CFO Insights, we’ll consider some tactics finance leaders can use to develop more behaviorally savvy pricing strategies and help their sales organizations carry them through to execution.
Behavioral nuances of pricing
For sports fans, there’s nothing better than a big comeback, and nothing worse than the immense heartbreak that comes from letting it all slip away. The pricing lesson: People can be profoundly affected by where something starts and how it finishes.
When someone buys a new car they may happily talk about how big a discount they received from the list price. If an airline adds a $30 surcharge for checking an extra bag, however, a grumbling customer may feel taken advantage of.
Here are some of the cognitive biases that hinder well-intentioned pricing:
Reference points matter more. Daniel Kahneman and Amos Tversky, in their Nobel Prize-winning work, demonstrated that the reference points people pick have drastic effects on their perceptions of value. Since then, further research has shown that the tie to reference points goes even deeper—that people will often anchor on the chosen reference point even when other relevant market information is readily available to inform their decision-making.
An experiment conducted on real-estate values, in which trained negotiators were assigned the role of either the seller or the purchaser, illustrates this point. Participants were given a brochure with relevant property and market information to inform their negotiations. Four groups were randomly provided with brochures that had one of four options: a high asking price, a low asking price, a market asking price, or no asking price at all.
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