One of the things that most interests me about pricing is the psychological aspect of it. Economists like to make pricing out as something that attracts “rational actors” who aren’t influenced by silly things like pricing something at $14.99 instead of $15.00 because that makes the item seem less expensive. Of course, retailers use price endings for other purposes too, often for reasons having nothing to do with the customer. One retailer we know of used a 7 cent ending to indicate a product was on final markdown, and retailing giant Walmart is fond of the 8 cent ending. But whether for accounting purposes or loss prevention purposes (pricing to ensure the ring of the cash drawer opening as way to make sure the money exchanged made it into the till), as all retailers know, there is a lot of psychology to pricing – for exactly the reason that $14.99 is somehow a more effective price than $15.00.
What’s funny is, retailers historically have rarely applied that insight to their own operations. From RSR’s latest pricing report, we found that retailers typically leave consumer pricing decisions to the buyer or merchandiser who also negotiates the product cost. After all, a buyer is a rational actor, right? They come to market armed with spreadsheets and analytics and years of buying experience. So they won’t be susceptible to the psychology of pricing decisions, right?
Wrong! And so over the years we’ve seen a shift. Retailers are moving away from leaving pricing decisions with buyers and putting them either into a separate pricing department, or embedding pricing specialists into their merchandising teams (Figure).
Perhaps even more interesting, retailers who leave pricing in buyers’ hands report more challenges in persuading merchandising teams to accept tools like price optimization and price intelligence. And Retail Winners – the sales over-performers – are moving to embedded pricing specialists at a much faster rate than their peers.
Why? Because buyers – who negotiate product costs with suppliers – can easily fall prey to a psychology of pricing concept called anchor pricing. Anchor pricing is when the first price that a person encounters becomes their base expectation for how much the product should cost. For a buyer, the anchoring comes not on the consumer pricing side, but on the product cost side.
It works like this. A buyer is tasked with meeting a margin objective across a category (or sub-category) of goods. While not every item is going to hit that exact margin objective, the buyer knows that she needs to stay kind of close to that objective across all of the items in the assortment to have things average out well in the end and meet her margin plan. Whatever price she negotiates from the supplier becomes her anchor price as she looks to set the price the retailer will offer to the consumer.
The thinking goes like this: I paid $15 for this item, and my margin objective is to hit an average initial mark-up of 40%. Therefore, I should price this item at $15 x 140% = $21 (or $20.99 for those of you playing along at home).
But what if the market can bear $24? What if there just aren’t a lot of items out there like this one? Or what if everyone else out there is selling it for $19? A smart buyer will do the competitive analysis that prevents this kind of misstep, but that’s not really her job – a buyer’s job is to present the best assortment to the customer that nets the best margin to the retailer.
Retailers increasingly recognize that the cost of the item actually has little bearing on the price. And that pricing is as much a discipline – with all of the art and science that goes into it – as merchandising itself.