William Poundstone, author of Priceless: The Myth of Fair Value, believed that people are clueless about prices and contrary to behavioural economic theory we do not look at A and B and calculate which one yields higher utility. We ‘make do with guesstimates and have a vague recollection of what things are “supposed to cost”’. People are weird and ‘predictably irrational’ (Ariely, 2008). Such as, shoppers moving in a counterclockwise direction spend on average £2 more at the supermarket or why we spend a fortune on an expensive meal then scrimp and collect vouchers for 50p off milk.
Dan Ariely, author of Predictably Irrational, believes that all choices are irrational and that people rarely make choices in absolute terms. Ariely (2008) proposes we look at things in relation to other offers and uses the example of Decoy Pricing to show how the addition of a decoy option pushes people towards the higher option.
Using Decoy Pricing, Dan Ariely, looked at subscription offers from The Economist.
There are three choices. Two of the choices (print and print & web) cost the same.
In a study with 100 people (MIT students) 16 chose option A and 84 option C. No one chose option B – so why have option B? In a second study, he removed option B and then gave the subscription information to another 100 students.
Now more chose option A than option B. Why?
In the first instance, comparing option B and C, it is easy to see which is the better deal (with option C you get print AND web) whereas, taking away option B left a harder choice and so people just went with the cheaper option. Therefore, the use of the decoy middle offer makes people buy the higher priced subscription.
Another reason why three is better than two is that people often go for the middle option – if the options are all different prices. This is true when looking at other companies, such as Netflix. Netflix has started offering three subscription choices. A basic, standard and premium option. Which one are people most likely to go for? The New York Times found that in restaurants whilst few people buy the most expensive main course the mere presence of the most expensive main course make people pick the second most expensive main – thus higher profit margins for the restaurant. Now apply this to Netflix. People don’t like to feel like a cheapskate however, they also don’t want to buy the most expensive option and so settle for the middle option as a compromise.
To conclude, three options are better than two for two reasons. If you want people to pick the premium product, placing a decoy product of the same price that offers the consumer less helps push the consumer towards picking the most expensive option. Furthermore, if you give people three choices; a basic, standard and premium, then people make a relative decision and often choose the middle option.
If you wish to read Predictably Irrational by Dan Ariely here is the PDF link to the book:http://radio.shabanali.com/predictable.pdf
- Poundstone, W. (2009). Priceless: The myth of fair value (and how to take advantage of it). New York: Hill and Wang.