Category Archives: economics

Why marketers play with price


When advertising agencies brainstorm client solutions, pricing rarely comes up, because “price” is perceived as both dangerous and boring. Dangerous because get it wrong, and sales will plummet. Boring because, hey, who cares about pennies when we could be discussing brand positioning?

So when a friend recently asked us whether an airline-related client should adjust price, we dug into the research — and realized, yes, this lever is critical. Here are two frameworks for price strategy: One based on logic, the second tied to emotion.

Economic logic: The price elasticity of demand

The “price elasticity of demand” is a classic model that rekindles visions of boring Econ 101 classes, but it is fascinating when put in human terms. Think of this fancy phrase as how elastic, or stretchable, demand will be if you change the price. If you lower your price, will demand “stretch” up much higher, with many more people clamoring for your service? Or is demand inelastic or “unstretchable,” with shifts in price barely moving sales?

This elasticity concept is important for marketing, because it tells you whether you can justify a high price. Consider our friend’s question:

“I’m working for a travel-related service, and they charge about $80 for a unique [service offering X]. The client wants to know, should they lower the price by a few dollars to spur more sales?”

At first, the puzzle seems unanswerable. But the theory of price elasticity of demand has an answer: Demand will respond most to price changes if the product and service has (a) readily available substitutes or (b) if it is a big chunk of the buyer’s income. Demand fluctuates least if your offering is (a) unique and (b) a small part of the buyer’s income.

Consider milk and houses. Milk is an example of a product with many brand substitutes — if one brand charges $2.10 a gallon and the other brand in the store cooler costs only $1.90, consumers will readily shift from Acme Farm Milk to purchase the cheaper Beta Farm Milk. Same product perceptions; lots of substitutes; thus a price shift makes a change in demand for a given brand. 

Houses are an example of something that’s a big chunk of your income. If you are moving to a new city and find one home priced at $500,000 and another similar house for $490,000, you’ll go for the lower price — even though the difference is only 2%. Same product perceptions; high share of your income; thus a price change also makes a quick shift in demand.

But let’s think now of this unique travel service. It’s only $80 and the service is unique. Should the marketer drop the price to say, $75? Nope. A small change in price would do zilch to stimulate demand. There are no substitutes, and it’s a small part of a frequent traveler’s annual budget. To back up our recommendation, we researched how airlines charge for other up-selling services and found that, indeed, travelers pay $38.1 billion annually in surcharge fees to U.S. carriers for things as odd as more legroom, booking by phone, changing flights, or bringing extra bags. Apparently, in the crush to get on a plane, people will pay something for almost anything that makes the trip easier.

Behavioral emotion: Playing with price framing

That’s the logical way to look at price changes. But, as our election debates show this year, consumers are often illogical and emotional, too. In 1980, Richard Thaler wrote the landmark paper on behavioral economics outlining how consumers often use a “mental accounting model” to decide if prices are good or bad. Thaler’s central argument was that shifting a price point is not the only way to stimulate demand; instead “framing” the perception of price could be more effective.

Consider, which offer is more appealing?

1. A dress that costs $60.

2. A dress that costs $70 marked down from $140 (50% off sale).

Thaler noted, in several studies, that choices such as No. 2 above are often preferred by consumers, when in reality, the second dress is just more expensive. His explanation: People are inherently bad at judging value, so use “reference points” see if they are getting a benefit or loss. Because in option 2, the dress is positioned as being far below the “real” price of $140, it feels like a better deal. This illogical-but-compelling mental accounting is why most retail stores offer goods “on sale,” or why candy at movie theaters that costs $5.00 comes in oddly shaped boxes. We feel great when we get something that looks larger than usual, or is bundled with other things, or is “marked down” in price, when the reality is each of these experiences is a bit of manipulation from a marketer creating an artificial reference point.

So there you have it: With logic, moving a price point makes sense if there are few substitutes or the total cost is a low overall risk to the buyer. With emotion, you can keep prices as is, and even increase them, by positioning the cost against a “reference point” that makes the buyer feel better about her or his mental accounting.

We all want to win. Prices are numbers that, if used carefully, can make every buyer feel a winner. Sorry if this sounds manipulative, but we have to run — there’s a great sale at the hardware store we want to hit on the way home.



An end to the Hot Waitress Index

Our favorite economist Jodi Beggs points out many “indicators” of recession are sexist, the result of male-skewing humor from the men who dominate the dismal economic science. We’ve had the skirt-length indicator, lipstick measures, and our favorite, the Hot Waitress Index — you know, the idea that pretty women lose jobs in real estate or sales when bubbles collapse and so are forced to serve food at the local bar. The prettier your waitress, the worse the economy.

Sexist stereotyping? You bet. So the Puma sports brand is playfully fighting back with the PUMA Index, a stock ticker for cell phones showing models — male or female — who take off their clothes when the Dow goes down. Sure, you can pick a girl, but the default image on the app is a buff guy cranking weights, ready to drop his jeans. Economists, hope for a rally.

Image: Scott Eklund

Newspaper pricing fantasies

The Associated Press and Rupert Murdoch have been making rumblings about charging for internet use of their content (technically, AP is cracking down on users repurposing its reports, while Murdoch will build pay walls around some of the content on his news sites). Economist Jodi Beggs explains why this won’t work. Demand curves slope from upper left to lower right, silly. You can’t raise prices without reducing demand, especially when 100 million competing sites give away news and entertainment for free.

Stouffer’s correlation is not causation

Hey, we love Stouffer’s, but Jodi Beggs is on to something when she notes the pre-packaged dinner company stretched logic in a recent TV spot. Jodi writes:

This is the statement that first caught my attention: “Studies show that kids who have regular family dinners tend to get better grades.” While I am confident that this is a true statement, it’s not as meaningful as it appears. The advertisement is trying to imply that having regular family dinners CAUSES the good grades, so obviously the viewer should buy whatever Stouffer’s product is enabling the good grades…you don’t want your kids to grow up stupid, do you? In reality, it is just as likely that the families that have regular family dinners are more supportive in other ways as well that enable the students to get good grades. Or perhaps the students that have regular family dinners are the ones that aren’t overscheduled with other activities and thus have more time to study and get good grades.

We’re all for good grades and easy food. Perhaps the Stouffer’s claim is just advertising writ large; we all consume goods trying to increase happiness, or coolness, or perhaps even intellect, when the traits we seek were lying inside waiting all the time.

Hat tip to Jodi’s blog Economists Do It With Models, worth watching.

Pricing strategy: How to fight deflation in the new year

Are you feeling cheap?

For the first time in 70 years the price of most goods is falling significantly, creating a thorny tangle of “deflation” for marketers. You see, your customers don’t like to buy stuff today when they believe the same stuff may cost less tomorrow. How should advertisers react? By reframing the price.

Here’s an example: Say you’re in the business of selling tickets to dancing elephant events, and the price of admission is $120. The typical elephant fan in the past comes to three such events a year — so the total cost is $360. In a down economy, consumers may retrench. So reframing the price might include moving it to a subscription model — sign up for a season pass for a monthly fee of $30! — or using artificial discounts.

Ways to reframe your price:

Optimize margins — by strategically deciding whether to sell fewer products at higher margins, or more products at lower prices. If the market won’t bear high prices, you may need to move down a step and shoot for scale.
Create a reference price — an artificially high price that you then “discount” beneath. Retailers such as Talbots use “40% off” deals to show a perceived value that really does not exist.
Obscure the reference price — make it difficult for a buyer to discern the real cost by bundling in other items or services. Toyota does this brilliantly when you buy a minivan that includes numerous packages, until you just can’t figure out the real sticker.
Segment your customer base and charge variable prices — increasing prices for some customers seems damned unfair until you realize most of the world does this. Supermarket coupons are a perfect example, where your Aunt Millie buys a can of soup for 50 cents while you pay the full buck. You’re both getting the same soup, but at different prices. Campbell’s makes more money off you because you are less price sensitive than your coupon-clipping aunt.
Explore subscription or extended payment models — You can help customers manage their bills by reducing spikes in payments. Utilities do this with monthly payment plans; can you?
Bash the competition — If you ever thought someone else was charging too much, this is the economy in which to shout about it. See McDonald’s slamming Starbucks. We bet customers will respond.

If pricing strategy is not on your task list for January, jot it on the whiteboard and get going. Read Richard Thaler, the economist who wrote the book on the psychology of price framing. Your customers are waiting for a better deal.

Hat tip: New Shelton.

The lonely guy who called the economic meltdown

Next time you hear a solitary voice disagreeing with a huge group of consensus, tell the others to shut up … and listen.

Andy Jukes notes the delicious but bittersweet victory of Peter Schiff, who appeared on various financial networks over the past few years warning that the economy would implode due to the toxic mortgage speculation rotting at its core. Andy writes, here’s this poor guy … correctly predicting the current financial meltdown and all the other “experts” are not just contradicting him, they are smirking, laughing, mocking him!

Schiff’s foes were victims of groupthink, the tendency of people with similar training, education, and ideologies to rush merrily toward a cliff. If you look around a table and everyone is smiling and nodding in unison, perhaps in the same striped suits (corporate) or black T-shirts (agency) or polo shirts with horsy logos (startup) … pinch yourself and ask, what could this group of like-minded folks all be missing?

American politics, tied to the land

Give me some land, lots of land, and you’ll understand U.S. politics.

The slightly fuzzy graphic you see above shows the average votes of U.S. states in the past four elections from 1992 to 2004. Dark red are states that tipped Republican in all four presidential races; dark blue to Democrats in all four; and the rest are variations in the middle. Notice the trend?

Politics is a function of land — the more open space you have, the more conservative you tend to be. The map of voting results looks almost like one of population density; blue states are coastal or northeastern with high concentrations of urban development, and the red could be the wide open skies of Montana and Texas. Politics aside, this makes sense. Liberals tend to advocate a more active role of government, which is needed in urban areas where crowding, transportation, education, police, and health services may be more pressing. Conservatives believe in a lesser role of government, relying more on rugged individualism — which works best where scant crowding does not require cooperation and the resources of the land are abundant. Neither point is right or wrong; but the conservative-independence approach works best where you can carve your own path, while liberal-heavy-government helps manage urban density.

We like this thesis (which holds up if you dig down to county levels within states, too) because it helps explain why America often feels like a nation divided. All economic systems must deal with the creation and distribution of wealth; the father of economics, Adam Smith, after all, was the guy who invented the progressive tax. Politics is the debate over how much should be shared. Americans still haven’t figured it out; the top marginal tax rate was 91% under President Eisenhower, 70% under Nixon, 50% under Reagan, 39.6% under Clinton and 35% under Bush; while today’s structure seems like a historically fair deal, any discussion on changing it brings out heated attacks from both political parties.

As the history of our tax system shows, logic has little to do with either parties’ view; gut instinct seems to take over on whether to share more or less. Marketers might think about the collective consciousness of their target audience tied to the land they live on, and how it drives their motives for independent or cooperative response. If you are launching a campaign remotely tied to such motives in the U.S., very different messaging might work in different markets.

Well, at least we know why we sometimes disagree with the talking head on TV. She was probably born in the wrong state.

Why everything won’t be ‘Free’ tomorrow

If you want to know why everything won’t be free within a few years, just think about your airport luggage.

Wired editor Chris Anderson is about to publish “Free,” a look at how the proliferation of free media online is expanding into other business dynamics. The über-designer David Armano explains the entire book in one graphic, above: Either you give something away by subsidizing it with sales of something else (either cross-sales of other products, or third-party advertising for free media), or you give something away while charging a small portion of your customers for premium service.

It’s a simple get-this-but-pay-for-that trade-off. And it seems to make sense; consumers have put up with advertising-supported free radio and TV for years, so why wouldn’t free expand?

Trouble is, when you push “free” models that work online to real-world goods or services, people rebel — because in the real world you see what other people get, and transparent cross-subsidies tick you off. The perfect example is the U.S. airline industry. When fuel prices skyrocketed, airlines had a big problem — they could either raise ticket prices or pass the extra charges along in other fees. Raising travel prices in a day when any consumer can shop for the best deals on is suicide; if you jump $25 on your ticket price to Vegas, consumers flow easily to a competing carrier.

So airlines did what Chris Anderson recommends — move to Free Model 1, where the price of one good is subsidized by sales of others. Airlines held ticket prices steady but tacked on a range of surcharges, for baggage check-in, food on planes, etc., to cover their higher operating costs.

And people screamed.

The problems were many. First, surcharges forced lower-income consumers to bear a disproportionate share of the fuel increases; families going on vacation with four kids and 10 bags where walloped with high baggage fees, while affluent business travelers waltzed aboard with a single carry-on bag. Second, the perception of unfairness abounded as everyone in the real world could compare what others were paying; if you bring bags, you get charged, and your fellow passenger may not. And third, each surcharge created yet another negative touchpoint in the travel experience — a bump here, an unexpected fee there, a series of unfortunate events.

In theory, someone always has to pay and “free” models that move the cost around can work on many levels. But in reality, consumers going through a customer service experience do not like surprises, and they hate any perception of unfairness. A utility could reduce your electric bill by 30% and then charge you $350 every time a serviceman comes to check your electric meter. In this new model you’d pay the same amount every year, but the fact you pay so much for a home visit would probably be infuriating.

The online media world is moving to the free. Just don’t expect the offline world to meet it there anytime soon, because in the real world, the costs transfers are much more visible.

Obama the Destroyer: Why fear works in advertising

Fresh on the heels of Wrangler ads using death to scare you to attention, John McCain today rolls out a new TV spot scaring the be-taxes out of Americans. Seems Obama is a recipe for disaster, cooking up new ways to snatch the bread off your kitchen table.

The logic is debatable. Obama would raise the highest income tax bracket in the U.S. from 35% to 39.6%, putting a 4.6% ding on affluent individuals. Conservatives suggest this would inadvertently slam 34 million small business owners, who often pay the highest tax rate on business income filtered through S corporations or farm proprietorships, and thus depress the economy. Liberals respond noting the last Democrat in office didn’t really kill the economy.

No matter. What counts here is that fear is effective, scaring people silly sells, and if you can plant a seed in someone’s mind that Product A is tied to Horror B, that doubt creates a natural aversion. People buy things, or vote for politicians, often on emotional whims. As we near the final mile of U.S. elections, expect more claims of catastrophe — global warming? war mongering? nuclear winter? — to be thrown by both sides.

Does your team suffer from the Nash Equilibrium?

Ever argue over a contract? Feel caught in a Mexican stand-off? Have a harsh debate with your spouse? You’re probably caught in the Nash Equilibrium.

John Nash was a mathematician who went mad, as immortalized in the film A Beautiful Mind, and he created the game-theory concept. The idea is obvious, once you think of it — there are occasions when individuals who compete, if they stick to their own strategies, end up with a lesser outcome than if they had cooperated.

A classic example is men competing over women in a bar (bear with the ownership construct, female readers, we don’t mean to offend and you must admit, men compete). Say three men walk into a nightclub and see four women; three of the four women are moderately cute, and one is a stunning model.

If each man follows his “individual best strategy,” he will likely try to win a date with the model, ignoring the other three women. This of course will mean (a) only one man can possibly get the model, and (b) if the girls are friends, the guys’ ogreish behavior may alienate all of the women. Ending: No one gets a date.

Now, rewind. If the three men change their strategies, they could each flirt with one of the three cute women, and ignore the beautiful model. The probable outcome in this scenario is each man will find a woman as a date, six people walk home happy holding hands (and the model struts off in a huff).

Trouble is, Nash wrote, the latter scenario — with a more optimal outcome — is not an equilibrium. All parties pursuing their selfish interests are more likely to use selfish strategies, so the “equilibrium,” or balance of opposing forces, will probably be chaos. Men get selfish. Individuals fight at odds with each other. People grab for resources. Everyone neglects the big picture, and the greater good is lost.

Hey, we just explained much of human history.

Which brings us to marketing. Many campaigns today require cooperation among multiple parties, and success usually hinges on the parties all working together. Unfortunately, multi-dimensional cooperation is often hampered by disputing interests — as suppliers and advisors and producers and creative shops and a host of other groups negotiate back and forth with each other. This turmoil is exacerbated by the economy of the 2000s, in which small business groups band and disband efficiently to achieve goals (vs. the old models of giant corporations like GE and IBM controlling all levers). As the global economy has become more networked and fluid to form groups to meet short-term project demand, the competing interests often make goals hard to achieve — if each party follows its individual strategy without evaluating the best possible group outcome.

There is one recent positive example of competing parties overcoming the Nash Equilibrium. The United States and Soviet Union somehow managed to avoid nuking the Earth in the Cold War of the 1940s-1980s. Both nations had a strong individual incentive to strike the other first, in hopes they would knock out missiles, achieve victory, and then rule the planet … but sanity prevailed.

Such sanity is rare. Optimal success, not just individual success, requires a level of cooperation that individuals usually cannot muster. In the absence of the big picture, small teams will follow their own incentives … into the failure of the Nash Equilibrium.