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The library of essays of Proakatemia

Pricing – Decoy effect



Kirjoittanut: Thais Santos Araujo - tiimistä SYNTRE.

Esseen tyyppi: Yksilöessee / 2 esseepistettä.

KIRJALÄHTEET
KIRJA KIRJAILIJA
PREDICTABLY IRRATIONAL : THE HIDDEN FORCES THAT SHAPE OUR DECISIONS
Thinking Fast and Slow
Dan Ariely
Daniel Kahneman
Esseen arvioitu lukuaika on 4 minuuttia.

Decoy effect

 

As an entrepreneurship student in my second year, I have learned that pricing is a crucial aspect of any business strategy. Pricing decisions can significantly impact a company’s profitability, as well as customer perceptions and behavior. There most common and covered in the main books about pricing are cost-based pricing, value-based pricing, competition-based pricing, and dynamic pricing. I’ll use the products from the newest project of the team SYNTRE from Proakatemia, Pikku-Brasilia as examples to talk about pricing in this essay. Pikku-Brasilia is a street food trailer in Tampere city center selling healthy and delicious Brazilian açaí cups or bowls with fresh fruits and different toppings.

 

Cost-Based Pricing refers to setting the price by adding a markup to production costs. According to Oxford Dictionary, “Markup is an increase in the price of something based on the difference between the cost of producing it and the price it is sold at.”

 

Value-based pricing methodology is about setting the price based on the product’s perceived value to the customer. Pikku-Brasilia used this technique on the opening day of the business. Due to the product being from Brazil and being hard to be found in Finland, the product value is high, and the customers can pay a high price for the value.

 

Competition-based pricing is based on setting the price based on what competitors charge to keep the product competitive. This technique is hard to apply to Pikku-Brasilia products because there is no açaí-focused bar or café in town. We did find açaí bowl in a café of a second-hand shop as one option among many other products such as sandwiches, and in a Brazilian café which is not in the center and also has a different focus on lunch and catering. Pikku-Brasilia can consider ice cream trailers as your main competitors once they sell a summer frozen dessert.

 

Dynamic pricing is another method that adjusts prices based on market demand or other external factors. Not a very relevant way of working for PB (Pikku-Brasilia) at the moment, while nothing external would offensively affect the price of the product-

 

Besides these examples, there is a methodology that is part of price discrimination called the “decoy effect.” It took most of my attention and interest because it works through the customer’s psychology. In the book “Thinking, Fast and Slow” by Daniel Kahneman, the decoy effect is described as a cognitive bias that affects decision-making (Kahneman, 2011).

 

The decoy effect is a pricing strategy that involves adding a third option to influence customer behavior. The idea is to make one of the other options more appealing by comparison. For example, a cinema may offer small popcorn for $5, medium popcorn for $7, and large popcorn for $10. To make the medium popcorn more appealing, they add a jumbo popcorn for $12 that is too big for most people to finish.

 

Kahneman provides another example of the decoy effect in action using a subscription offer from The Economist magazine. The offer included two options: an online subscription for $59 and a print subscription for $125. When a third option was added – a print and online subscription for $125 – the majority of people chose the print and online subscription, even though it was the same price as the print-only subscription. Kahneman explains that the decoy effect works by changing people’s perceptions of the other options, making them seem more attractive or valuable by comparison (Kahneman, 2011).

 

The decoy effect has several positive aspects. First, it can increase revenue by encouraging customers to choose a higher-priced option. For example, it can help businesses differentiate their products and create a perception of value. By offering multiple options, businesses can appeal to a wider range of customers and create the perception that their products are high-quality and worth the price (Nagle and Hogan, 2018).

 

In Pikku-Brasilia, we started with two sizes of açaí cups, small and large. We realized that most clients would go for the small because they wouldn’t see big value added to the product bigger size invest more money on the second option. The project changed the strategy bringing a third option size: small, regular, and large. The customer behavior change is still being tested, but it looks promising.

 

One potential downside is that it can create confusion or dissatisfaction among customers if the pricing structure is not transparent or consistent with their expectations. For example, if customers feel like they are being tricked into choosing a certain option, they may be less likely to trust the business or make repeat purchases. Another potential downside is that the decoy effect may not work as intended if customers do not perceive the decoy option as credible or relevant to their needs.

 

In his book “Predictably Irrational,” Ariely (2008) argues that the decoy effect can lead customers to make choices that they may not have otherwise made if presented with only two options. This can be seen as a form of manipulation, as customers may be coerced into making a purchase that is not in their best interest.

 

Concisely, Kahneman warns that the decoy effect can be misleading and manipulative if the additional option is designed to be irrelevant or unattractive to consumers but is added solely to influence their decision-making process.

 

For example, a business might add a decoy option that is intentionally overpriced or of poor quality, in order to make the other options appear more appealing.

In such cases, consumers may feel that they are being deceived or manipulated into making a particular choice. They may also feel that the pricing structure is unfair or inconsistent with their expectations. This can lead to dissatisfaction with the business and a reluctance to make repeat purchases.

 

In PB, we are avoiding these downsides by being fair cost-wise with all the product sizes and providing a different value for each size, not only guiding the customer to one of the more appealing options by comparison. The idea is to use the methodology responsibly and fairly steering the customer choices in a way that benefits both the consumer and the business.

 

Despite these potential drawbacks, the decoy effect remains a popular pricing strategy that businesses can use to influence customer behavior. To implement the decoy effect effectively, businesses should carefully consider their product offerings and pricing levels and test different options to see what works best for their target market. By leveraging the decoy effect and other price discrimination techniques, businesses can optimize their pricing strategies and improve their bottom line.

 

References:

Ariely, D. “Predictably Irrational.” HarperCollins, 2010.

Kahneman, D. “Thinking, Fast and Slow.” Farrar, Straus and Giroux, 2011.

Markup. markup noun – Definition, pictures, pronunciation, and usage notes | Oxford Advanced Learner’s Dictionary at OxfordLearnersDictionaries.com. Available at: https://www.oxfordlearnersdictionaries.com/definition/english/markup  (Accessed: May 4, 2023).

 

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