Pricing has a major influence on a consumer’s decision making process and if you know how to take advantage of this, you can increase both sales volume and revenue. This is because there are a few key factors that a pricing strategy can impact to make that decision making process work for you as a retailer, or as a brand with a direct to consumer channel. Before we dive in and look at the effects of pricing itself we need to identify the two decision making styles people have as well as the five different steps consumers follow when making a purchase decision. We can then map pricing rules to key moments in this decision making process.
System 1 and System 2:
A consumer has two thinking styles they can use to come to a choice. Kahneman (2011) wrote about these two systems in his book Thinking Fast and Slow and describes them as System 1 thinking and System 2 thinking. System 1 thinking refers to our intuitive system, it is fast, automatic, effortless, implicit and emotional. System 2 thinking refers to reasoning, it is slower, conscious, effortful, explicit, and logical. People are more likely to rely on their System 1 thinking when products are cheaper and less impactful to their lives or when the decision makers are busier, more rushed, and when they have more on their minds. Our System 1 thinking is quite efficient, it would be impractical to logically reason through every choice we make while we are making menial purchase decisions. System 2 logic is often active in consideration of our more important, more impactful, and more expensive decisions.
Which of these two systems is used depends on the type of product and the situation the consumer is in. A consumer will make a quick and fast choice if they need a pair of socks for example. In these instances a quick decision is made without a big time investment and this is often a retailer’s long tail of products. If, however, a consumer needs to purchase a house, car or new TV they will most likely go with System 2 thinking.
The consumer decision making process:
Having discussed the thinking styles, let's discuss all the steps a consumer goes through when making a decision. Most obviously within the second system the decision making process can be split in five steps. These five steps range from not knowing what to buy, to the retrospective evaluation that follows the eventual purchase decision. These five steps were originally proposed by John Dewey in 1910 and still function as an important theory within consumer behavioral models. The five steps are as follows:
1) gathering information
5) evaluation of decision outcome.
In step one, our model consumer gathers the information needed to make an evaluation. In this step they initially have to define the problem for themselves. Imagine our consumer’s TV breaks down a week before the World Cup. The defined problem is that they do not have a working TV anymore and will not be able to watch the highly anticipated international tournament as expected. Then the consumer identifies the decision criteria and weighs these criteria, for example the size of the TV, the audio quality, the amount of money they want to spend, and the usability of the TV after the World Cup to name a few. Before they start to evaluate the options they will first evaluate the alternatives. You could watch the football on your work laptop, in a pub, or at a friend's place. Accordingly, the consequences of the alternatives are assessed. If you go to the pub for example, you still won't have a working TV, irrespective of the World Cup.
Once all of these criteria have been assessed, step two kicks in. In step two, the evaluation process begins. The consumer judges all available options collected during step one to then calculate the optimal outcome for themselves. They will look at the TV, listen to the TV, compare prices, etc. with the end goal of finding the TV with the highest utility for themselves.
Step three is simply the decision making itself. Our example consumer will choose the option that has the highest outcome or utility to them. From a retailer’s perspective this means that not only a product itself is selected, but also the store at which the desired product is purchased. This is a key distinction because you want the purchase to happen at your store or webshop, not at the store or webshop of a competitor, irrespective of which TV is chosen.
Step four is the actual execution of the decision, also known as the implementation. In this step, the consumer will actually execute the decision made in step three. Our model consumer will go to your webshop and leave the webshop once they have paid for the TV and have the delivery date confirmed in their mailbox. If of course yours is the right price.
Last but not least, in step five, the retrospective purchase evaluation takes place. Our model consumer will evaluate their decision to see if they bought the right TV or if they made any mistakes during steps one and two. They will decide if they need to correct these mistakes, or in some cases, if any of the criteria or available options have changed since they made their decision. This is an important step, especially when looking at the ratio between the customer lifetime value and the customer acquisition cost. It also influences repeat purchases, the price perception your customers have and defines your relationship with the customer.
Where does pricing come in?
Now that we have discussed both systems and the consumer decision making process we can look at the effects of pricing.
Margin increase for long tail products:
For the long tail of products, System 1 is active and as such consumers will quickly skip through the five steps, if they use them at all. For these products, you can increase your selling price to a sustainable level to increase your margin. Consumers will most likely not put the same weight on the product price and they will not re-evaluate the purchase afterwards. The impact of these purchases is not high enough to warrant that kind of financial nor time investment. This allows you to increase profitability without increasing product returns or creating a bad pricing image in your consumers’ eyes. Examples of pricing rules in this area are margin uplift based on stock, product views, and/or selling price until an equilibrium or the RRP is reached.
Creating visibility for high runner products:
For larger, more impactful purchases, for which System 2 is relevant, consumers will run through the five steps. Therefore, you want to ensure price is not a negative influence on the consumer's decision making process. A great example of products for which System 2 thinking is used are high runner products. For a quick overview of a high runner strategy please check out this article on “What is a high runner strategy?”.
For these high runner products, pricing is one of the key influencing factors in the purchase decision. An important distinction to make is the difference between the product choice and the vendor choice. At all steps price influences which product a consumer will choose and how they will feel about that purchase afterwards. While only at steps three and five will pricing influence at which store or webshop the product will be bought and how they will feel about your shop afterwards. Therefore dynamic pricing should primarily focus on the impact pricing has on vendor choice where you want to use pricing to make a consumer choose for you over one of your competitors. All else being equal, the consumer will most likely go for the cheapest option. Meaning that it is essential to be competitive for these high runner products. However, service, delivery terms, etc. will also be of influence and can set you apart. These additional services also have an impact on your pricing image from the consumer’s perspective. Examples of pricing rules are setting your price equal to key competitors if available and setting them equal to market average or slightly above tier two or tier three competitors so your combination of product and additional services offers the highest utility to the consumer.
Maintaining the feeling of value for your consumers in the evaluation:
In step five it is essential that during the retrospective evaluation period, the consumer will not find a significantly better option that provides them with more utility. Examples are price drops a couple days after the purchase or the release of a newer, better product for the same price. The result is that a consumer might reconsider their choice, send back the product, and make a new purchase decision. Therefore you want to minimize significant price drops and offer compensation for large price decreases in your store to customers still in the evaluation period. This will reduce returns, unhappy customers, and will have a positive effect on repeat purchases with you as a vendor. Rules that one can implement here focus on promotion pricing where you could drop the price of products near the end of the product lifecycle to give consumers the feeling they still get value out of last generation's product. Next to all mentioned rules, safety rules are always a good idea so you never price above RRP or below your minimum margin price, making the system work for you without risk.
How to capitalize on the consumer decision making process in your pricing strategy?
Omnia allows you to easily set your own rules to both generate uplift on these long tail products as well as be competitive on high runner products compared to your key competitors, or the entire market if desired. Implementing any of the strategies mentioned in this article is very straightforward with a pricing tool such as Omnia. Dynamic Pricing with Omnia is able to capitalize on the combination of timely competitor data, giving an outlook on the market that can be used as input for any pricing rule, and your own internal data such as page views, stock coverage, conversion rates, high runners and more. This can be done either through feeds or Google Analytics for example.
Interested in how Omnia Retail can help you increase profitability with any of the mentioned strategies or business rules? Contact your dedicated solution consultant if you are a customer or request a custom demo for your assortment!