Tag Archives: Consumer Spending

Behavioural Economics – Good Better Best Pricing

I was interested in an article about approaches to pricing – ‘Good, Better, Best’ by Rafi Mohammed from the September – October 2018 Harvard Business Review. Know as G-B-B pricing it involves adding or subtracting product features to create variably priced bundles targeted to customers of varying economic means or those who value features differently. This model is very evident with many products and services – for instance the airline industry:

  • Good – the standard economy fare
  • Better – premium economy with extra leg-room
  • Best – business class with extravagant meals and a bed

However with all three tickets the basic service is the same – e.g. flying a passenger from Auckland to Doha. Below is another example with an oil change. Some G-B-B strategies are more general responses to consumer psychology.

Image result for good better best pricing

In giving consumers too much choice a lot will feel overwhelmed and confused – the paradox of choice which Barry Schwartz studied in his book of the same name. However a G-B-B plan helps consumers focus on particular aspects of each option and direct them to consider the incremental value and spending. With three choices consumers tend to decide whether to buy the product or not and they typically see the ‘Good’ as the default option which makes them amenable to an upgrade.

One of the key insights to behavioural pricing is that items that don’t sell can change what does. The William-Sonoma chain once offered a fancy bread maker for $279. They later added a somewhat bigger model, pricing it a $429. The $429 model was a flop as unless you require it for major catering purposes. However the $279 model nearly doubled. Clearly, they were people charmed by the idea of a quality breadmaker from William-Sonoma. The only thing that stopped them from buying was the price. It seemed high at $279. Once the store added the $429 model, the $279 machine was no longer seen as such an extravagance. It could be rationalised as a useful product that did nearly everything the the $429 model did, at a bargain price. Adding another price point, even though hardly anyone chose it, increased the price consumers were willing to pay for a breadmaker. William-Sonoma didn’t plan things this way but since then retailers have gotten wise to contrast effects of prices. Tversky and Simonson (1992) identified two rules of manipulative retail pricing.

1. Extremeness aversion – this means that when consumers are uncertain, they shy away form the most expensive item offered or the least expensive: the highest quality or the lowest quality; the biggest or the smallest. Most favour something in the middle therefore the way to sell $800 shoes is to display some $1,200 shoes next to them. The same product may appear attractive on a background of less attractive alternatives and unattractive on a background of more attractive alternatives.

2. Trade-off contrast – go into a leather a leather goods store and there will be dozens of handbags, none of them indisputably the best by anyone’s standards. One bag can be:

  • more practical,
  • more stylish,
  • more colourful
  • less expensive

The customer being loss averse is uncomfortable with the abundance of choice and fear that she will pick the wrong bag. The trade-off contrast rule says when item X is clearly better than an inferior choice Y, consumers tend to buy X – even when there are many other choices and it’s impossible to say whether X is the best choice of all. Just the fact that X is better than Y is a selling point, and it carries more weight than it reasonably should. Apparently the shopper tries to reduce anxiety by choosing an item that can be justified – she is able to talk herself into X because it’s so much better than Y.

G-B-B pricing structure

The G-B-B pricing structure for most companies will be to identify a product which is Better and subtract features to create Good and add features to create Best.

Better – features = Good
Better + features = Best

As mentioned earlier too much choice is risky. Research by Sheena Iyengar and Mark Lepper which offered samples of jam to shoppers in an upscale grocery store – results:

  • When offered 6 flavours, 30% of tasters made a purchase.
  • When offered 24 flavours 3% of tasters made a purchase.

Before a company can begin to identify the potential benefits of G-B-B it must address 3 questions:

1. Does the feature have mass appeal or low appeal?
2. How would adding or subtracting it affect the cost of producing the good or offering the service?
3. And is it a “fence” attribute—one that constitutes a barrier preventing existing customers from crossing over to something cheaper?

Many retailers focus on the Best option as they see this as the greatest opportunity to generate revenue but fence attributes is an area that is the most challenging task to G-B-B because of the risks of existing customers moving to lower priced options and thereby reducing sales. Fence attributes prevent this, by making the downgrade a difficult, unpleasant, or painful choice. For instance, when the New York Times launched its digital subscriptions, in 2011, it moved to a G-B-B model in which the physical paper (which many subscribers were loath to discontinue, and which is costly to print and deliver) served as a fence attribute. That fence is effective enough to support a hefty price differential: An all-access digital subscription currently costs $324 a year, whereas adding print delivery brings the price to $481 and up, depending on location.

G-B-B and The Economist subscription

I recently received a letter from The Economist (see image below) concerning the renewal of my subscription. Could the same pricing system of the New York Times be applied here? Does the print package acts as the fence attribute and is it effective enough to support the price differential? The combination of high appeal and high cost means that if the feature is part of the Better but not the Good offering, relatively few people accustomed to Better (that is, existing customers) will consider Good—but those willing to do without the feature can enjoy a significant discount. 1 year Subscription is:

Good – Digital Package – NZ$460
Better – Print Package – NZ$530
Best – Print + Digital Package – NZ$640

Conclusion
Most companies could implement some form of G-B-B. Every company already offers the equivalent of a Better offering, and even if some firms can’t implement both Good and Best, many could gain new customers, additional revenue, or both by adding either a Good or a Best to their lineup.

Sources:

‘Good, Better, Best’ by Rafi Mohammed. September – October 2018 Harvard Business Review.

Priceless (2010) – William Poundstone

Consumer interface removing the supply chain

HT to past student Shelalé Mazari for the image below. Tom Goodwin wrote a very interesting article on the battle for the consumer interface.

Uber, the world’s largest taxi company, owns no vehicles. Facebook, the world’s most popular media owner, creates no content. Alibaba, the most valuable retailer, has no inventory. And Airbnb, the world’s largest accommodation provider, owns no real estate. Something interesting is happening.

He states that since the Industrial Revolution there are complex supply chains including manufacturers – importers – wholesalers – franchises – retailers. However the rapid rise in technology has allowed a number of these parts of the chain to be removed.

Uber, Facebook, Alibaba and Airnb are companies with, what Goodwin refers to as, thin layers that sit on top of vast supply systems (where the costs are) and interface with a huge number of people (where the money is). The New York Times needs to write, fact check, buy paper, print and distribute newspapers to get their ad money.
Uber etc

Similar spending patterns amongst income groups

Many thanks to Year 12 student Andrew Reeves for this article from the MailOnline which shows the similarities between what the higher, middle and lower income groups prioritise with regards to their spending.

It classed the rich as those who earn $150,000 and more per year, the middle classes are those who bring in an annual income of between $50,000 and $69,000, while the poor scrape by on between $15,000 to $19,000.

Housing, by far, makes up the largest chunk of citizens’ expenditure. Regardless of income levels, affluent, middle class and poor residents spend a similar percentage on the home – between 26.7 and and 29.2 per cent.

Income groups spending

NZ Weekly Household Expenditure 2010 – 2013

From the December edition of the Parliamentary Monthly Economic Review.

Statistics New Zealand’s latest Household Economic Survey showed that households spent on average $1,111.40 per week in the year ended June 2013, up 9.1 percent (or $92.70 per week) from when the last full household economic survey was undertaken in the year ended June 2010.

The largest increase in expenditure by group in dollar terms was for the transport expenditure group. In this group, households spend $158.30 per week on average, up from $131 per week in the year ended June 2010. The increase was largely due to a rise in the cost of petrol, from $41 per week in 2010 to $49 per week in 2013.

For households that make mortgage repayments, the average weekly mortgage repayment was $356.20 in the year ended June 2013, while for households that pay rent, the average total rent payment was $275.30 per week. Property rates were $43.70 per week, up from $36.80 per week in 2010.

Average Weekly Household Spending 2013