Hi! Welcome. You being here means more than you know. Knowing it resonates with you keeps me going. I'm Lavena Xu-Johnson. I write about psychology for founders. Why? Because scaling a business means knowing ourselves first.
Hi founders,
It's almost the end of the year!
I've been going through your replies and write-ins, and realised many of you enjoyed the past pieces on cognitive biases and decision economics, like the cognitive bias that keeps our business from growing and how to take smarter risks. So, to continue in this lane, this essay is all about the psychology of how price changes customers’ perception of what they buy.
When we set a price, most of us start from our costs, profit margin and what competitors charge. When sales slow down, we start a discount campaign.
Consumer research reveals something we don't consider enough: the number on the label tells customers what to expect, and that expectation changes how much they enjoy the product or service, how much they use it, and whether they trust it.
Whether we sell software, skincare, coaching or coffee, our price is part of the product.
A heads-up: this essay references a few more studies than usual, so find a quiet space, and let's dive into the pricing psychology founders need to know about.
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The same wine at $5 and $45
In 2008, a team of neuroscientists and marketing researchers from Caltech and Stanford asked 20 volunteers to taste several Cabernet Sauvignons while lying in an fMRI scanner.
The volunteers sipped each wine through a small tube and rated the wines they tried. The wines were presented in random order, with price labels of $5, $45, $10, and $90.
What they didn't know was that the $5 and $45 wines were the same wine, and the $10 and $90 wines were also the same.
The volunteers rated the higher-priced wines as much more pleasant, and their brain scans showed the same results: activity rose in the pleasure and reward regions (medial orbitofrontal cortex).
Their brains registered more pleasure when the exact same bottle of wine was labelled as more expensive.
Marketing actions can modulate neural representations of experienced pleasantness. (Plassmann et al., 2008)
For a business, this means price keeps affecting customers after they have paid. It changes how good the product seems to them while they use it.
Three perceptions change from our pricing
1. Expected quality
Price tells customers what quality to expect: the wine volunteers had no other information about the wine, so the price directly affected their judgment.
Consumer research has found the same pattern for decades. A review of dozens of price-quality studies found that, on average, people judge higher-priced products as higher quality.
Marketing researchers have also argued that services rely on price even more, because customers can't inspect a service before they buy it: a coaching programme, a software contract, an agency retainer, or a skincare range that takes weeks to show results.
A price far below the market can make a new customer doubt the quality of the product and service.
2. Outcome or results
Discounts can lower the results customers get.
In one study, students were given an energy drink before solving a set of word puzzles. One group paid the full price for the drink. Another group paid a discounted price for the same drink. The students who got the discount solved fewer puzzles than those who paid full price.
In a separate study, volunteers received mild electric shocks and then took a painkiller, without knowing they were sugar pills. Those who were told the pill cost $2.50 a dose rated their pain lower than those told the same pill had been discounted to 10 cents.
When the result depends partly on the customer, as with a fitness programme, a course or a productivity tool, a heavy discount can lower what they expect to get out of it. Their effort, and the result they report back to us, may drop with it.
3. Customer retention
The price point and payment structure also changed how much customers used the product.
Marketing professors John Gourville and Dilip Soman studied attendance at a health club where members paid once or twice a year. Attendance was highest in the months right after a payment and dropped as the payment faded from memory.
They also found that members who paid monthly attended more steadily.
The more a customer uses our product, the more likely they are to renew. A heavily discounted first year may bring in customers who use the product less and leave sooner.
Key takeaways
1. Price for the expectation
When our product or service is priced at a premium range, customers' perception of its quality and return on investment goes up, and they may even become more engaged with our business.
User behaviour differs by business. To understand why our most loyal customers return, we can design a customer expectation survey and send it to them.
2. Add value instead of cutting the price
When we need to win a sale, we can add bonuses, gifts, or extra features to keep the price and expectations intact.
3. Invest in brand value
Price is one signal customers use to judge quality, and our brand is another.
In the wine study, the price label was the only thing the volunteers had to go on. Our customers usually have more: what they have heard about us, what they see on our website and how we treat them before they buy.
Consumer research has found that a known brand name also raises how people rate a product's quality, alongside its price.
When customers already trust our brand, a premium price confirms what they expect. Building that trust is what makes a higher price easier to accept:
Show the people and the process behind the product, for example through founder posts or behind-the-scenes content, so customers understand where the price comes from.
As always, hit reply if something in here hits home.
Until next week,
Lavena
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