By Dan Skodol, Vice President of Revenue Analytics, The Rainmaker Group
“All our knowledge has its origin in our perceptions.” ~ Leonardo da Vinci
Is a pair of $50,000 Sennheiser Orpheus headphones really fifty times better than a pair that costs $1,000? Expensive items and experiences are often branded as high quality, exclusive, or bespoke. But are they really better than their less-expensive counterparts? And what truly motivates people to pay more for something?
In the hectic daily life of a hotel revenue strategist, coming up with optimal pricing presents the greatest challenge – a challenge that’s typically handled through reliance on a sophisticated RMS, complex algorithms, and in-depth analysis. But there’s a creative component that comes into play as well. And this involves looking at some of the fascinating psychological research on consumer behavior and pricing. Here we balance proven theories on pricing psychology with practical takeaways that you can utilize in your revenue strategy.
The Phenomenon of Preference Reversal
Human brains are wired to think in ways that seem irrational at times. There’s an intriguing phenomenon known as “preference reversal” which was first observed in the late 60s and early 70s by Sarah Lichtenstein and Paul Slovic in the gambling context. They noted that if people were asked to choose between a game they perceived as a safe bet (good chance of winning a small gain) over a long shot (small chance of winning a larger gain), they tended to prefer the safe bet. However, when asked to place a specific dollar value on the right to play each game, respondents switched, placing a higher value on the riskier bet.
Takeaways: This all comes down to preference toward risk. Preference reversal phenomenon presents an arbitrage opportunity for hotels – where the presence of risk subtly influences a customer’s ability to put an estimate on value. As a result, you may be able to extract additional value from customers based on the decisions they make. This can come into play when upselling guests to premium room types – by tailoring your sales approach to affect what a customer considers “risky.” There’s the “risk” of paying more for a room versus the “risk” of missing out on valuable features like a view or enhanced service. These types of risk often influence a customer’s willingness to make a purchase
Prospect theory holds that there can be shifts in preferences toward risk. We tend to be more risk averse when we stand to gain something, and we tend to be more risk seeking when we’re faced with the possibility of losing something. Central to this concept are reference transactions – in other words, an expectation of what we think we should get, and some perception of what we think we should pay for it. Using the reference transaction as a starting point, anything that puts us worse off is a “loss,” and anything that makes us better off is a “gain.”
Dan Ariely, professor of psychology and behavior economics at Duke University, did research which he presented in a TED Talk showing the effect of “useless” price points in transforming “bargain hunters” into “value seekers.” To illustrate his point, Ariely described a pricing situation he encountered at The Economist:
OPTION #1: A web-only subscription for $59 OPTION #2: A print-only subscription for $125 OPTION #3: A web + print subscription for $125
Ariely examined what would happen if you removed OPTION #2, a seemingly “useless” price since shoppers were better off getting the web + print for the same price. He found that while OPTION #2 appeared useless, it was actually useful in that it emphasized the great value of OPTION #3, with an overwhelming 84 percent of subscribers choosing it. However, when he removed OPTION #2, the purchase of OPTION #3 plummeted to 32 percent. The price differential was too extreme, and people convinced themselves they didn’t need the upgrade.
Takeaways: Apply techniques such as strike-through pricing that makes customers feel they’re entering the “gains” domain. Unbundle gains, like detailing the benefits of upgrades. And bundle losses. For instance, combine a room upgrade with a “free” resort fee to make it more appealing, or package a high-priced room with a complimentary breakfast to transform bargain hunters into value seekers.
It’s All Relative
Price anchoring is a technique of showing a very expensive price before revealing a cheaper price. The human brain tends to make judgments based on contrasts. (Which is why legendary Serendipity 3 restaurant’s $1,000 Golden Opulence Sundae makes their $9.95 fruit cup look like a steal!) Not only does the contrast have a powerful effect, but the high price by itself influences what a shopper expects to pay for any product from that seller.
A practical example for hoteliers may be featuring a $10,000 penthouse suite on your website. Research shows that by doing so, you’re more likely to sell your $500 standard room, as opposed to if you’d simply presented your standard rate alone. Clearly, the presentation of an offer makes a difference in our decision-making and perceptions.
Our perception of price also impacts our perception of the quality of something. A study by California Institute of Technology and Stanford University scholars,4 showed that people not only rated the same wine more highly when they were told it was expensive, but magnetic resonance imagery (MRI) scans of their brains showed that they even enjoyed the experience of drinking it more.
Another study by marketing professors at Stanford and Rice universities5 used an auction site on eBay to evaluate the impact of implicit versus explicit price comparisons. They found that when a $1.99 CD was flanked either by identical versions priced at $6.99 or $0.99, the selling price of the original $1.99 CD captured much higher prices when flanked by the $6.99 CDs. In this case, shoppers made comparisons on their own. However, when auction participants were explicitly told to compare the $1.99 price to its neighbors, the buying price dropped. The simple fact that they were asked to make a comparison made shoppers more cautious and risk averse. They were suspicious they were being tricked in some way.
Takeaways: Go big with anchoring! The more you ask for, the more you get. And while you may not intend to sell your high-priced penthouse suite often, its price can serve as an anchor for customers in placing a value on your standard rooms. Also, be aware that comparative selling is powerful, but overt comparisons with competitors can backfire.
Time & Experiences Over Money
Canadian race car driver and businessman Josh Cartu admits that he collects Ferraris not only because he loves them but because of the accompanying perks he receives, like access to special events and the exclusive community he gets to be part of. Feelings can be powerful motivators, and you can get people to spend more by tapping into them.
“The Time vs. Money Effect” study by Stanford Graduate School of Business researchers, showed that mentioning time and increasing focus on “the experience,” led to a favorable shift in product attitudes and decisions – and to more purchases.
As part of their study, the authors set up a lemonade stand operated by two six-year-olds. They used three different signs, displayed one at a time:
SIGN 1: Spend a little time and enjoy C&D's lemonade SIGN 2: Spend a little money, and enjoy C&D's lemonade SIGN 3: Enjoy C&D's lemonade
Customers could pay between $1 and $3 per cup, the amount was up to them. The results showed that the sign stressing time attracted twice as many passersby – who were willing to pay almost twice as much as when the sign emphasizing money was displayed.
Takeaways: Our relationship with time and experiences are more personally meaningful than our relationship with money. Be aware of what experiences bring meaning to the lives of your potential customers to assist your pricing and marketing efforts.
When it comes to pricing psychology, perception can be more important than reality. And frames of reference will differ across individuals. So, your guests’ perceptions may be very different from our own perceptions of your pricing and products – and will even vary from guest to guest. Hotels must clearly communicate the value they offer. It’s crucial for hotel revenue managers to understand how and why their guests book, so you can adjust rates accordingly. By considering the psychological pricing factors that influence travelers’ behaviors, you will enjoy healthier revenues and more robust profit margins.