You’ve heard of the placebo effect. If not, it essentially works like this. You take a pill thinking it’s medicine, but it’s actually a sugar pill, and yet because you believe it is medicine, it works like medicine.
Before we get into what this has to do with pricing, I’d like to take a moment to stress just how powerful the placebo effect is. This excellent video does a superb job of explaining the power of the placebo effect.
Cool, huh? And as a somewhat shocking aside, when I was at Smith I learned that in clinical tests of new medications, the placebo often out-performs the medicine being tested. I doubt the pharmaceutical industrial complex wants you to know that!
What does that have to do with your pricing?
Well, here’s where it gets interesting. Researchers have found that the placebo effect as applied to pricing can change not just the perception of value of a product or service, but the actual efficacy of a product or service.
An elegant experiment by Baba Shiv of Stanford gave an energy drink to groups of participants. The difference between groups was that one paid full price for the product, while a second group were given a discount. After participants in each group drank up, they were given a series of word puzzles to solve. The result? People in the discounted group solved on average 30% fewer puzzles than those in the full price group. This phenomena held true in experiment after experiment. Shiv’s conclusion is that consumers expect lower quality for cheaper goods, and this belief translates – like a placebo effect – into actual experience of the product’s efficacy.
Or consider another experiment by Plassman, Doherty, Shiv and Rangel that looked at what happens in the brain when the placebo effect of pricing occurs. Subjects were given a taste of 5 different wines and then asked to rate them. Subjects were shown pricing of the wines which ranged from cheap to expensive. What subjects didn’t know was that they were only tasting three different wines, so two of the wines were tasted twice — once at a high price point, and once at a low price point. Subjects, as expected, rated the “higher priced” wines as more likable. Additionally, the brain scans of subjects showed that when tasting the “expensive” wines brain activity increased in an area known as the medial orbitofrontal cortex (mOFC).
The orbitofrontal cortex has been shown to be involved in determining the “value” of experiences, as well as correlations with ratings of taste and pleasantness of smell.
No brain effects were shown for areas of primary taste, but the increased activity in the mOFC along with self-reported ratings suggest that the subjects’ experience — indeed, the efficacy – of the wine was significantly affected by the price.
Source: Plassman, Hilke, John O’Doherty, Baba Shiv and Antonio Rangel. “Marketing Actions Can Modulate Neural Representations of Experienced Utility”. <http://w4.stern.nyu.edu/emplibrary/jobmarket_paper_plassmann_final.pdf>
What these two studies, as well as others, illustrate is that expectations can impact outcomes. When we expect expensive to be better, it is better.
Takeaway for the business owner – Charge what your service or product is worth! Just don’t be shady about it by trying to charge more than your product or service is worth. It’ll only come back and bite you.
Takeaway for the consumer – Never underestimate the power of mind over matter. Your brain creates most of your reality in ways you’re not always consciously aware of. Conversely, don’t overestimate the power of your reasoning or logic. By keeping a realistic view of your own mind’s capabilities, you’ll be able to make smarter decisions.
Takeaway for the manager – I’m making a bit of a leap here, but maybe it follows that if what you charge changes perception and experience of value, then what you pay might change level of abilities and skills. True or not, pay people what they’re worth, not the lowest you can get away with, because it’s the right thing to do.
Update 3/16/11 2:55 P.M. I knew I was making a leap with the above, which is why I made the caveat, “true or not, pay people what they’re worth”. Still, I saw this link on Twitter today (shared by Eating Lightbulbs) that highlighted a study that showed teacher pay and incentives had no significant impact on student performance. This would suggest that the placebo effect we see with pricing doesn’t reverse to pay. All of this reminded me of Daniel Pink’s Ted talk, “Drive: The Surprising Truth About What Motivates Us”. Worth a re-watch.
Takeaway for the Social Entrepreneur, Triple-Bottom-Line Business, and Non-Profits – All of the above, but especially think about being careful that your price isn’t perceived to include a donation (unless it does). What do I mean by this? When I see a product being sold by a TBL that’s selling goods made by poor people in another country, the primary message is “by buying this product you’ll be helping such and such peoples”. Noble, yes, and there are plenty of people who will buy for the emotional benefit of helping others. But why stop there? The product you’re selling is not a charity. The purchase should be an exchange of value. In theory the product should have value in and of itself, no? If you’re not careful, you could be lowering the expectations of quality by highlighting too much how the product will benefit others. Why? We don’t expect much in return for donating, except to feel good. Be sure product descriptions and pricing reflect the value of the product first and foremost. Even better if you can include how this product made by these people gives it a unique value. For example, if the people in question make the best handcrafted widget because those skills have been passed down, and the quality of craftsmanship, care, expertise is higher than you can get elsewhere…HIGHLIGHT IT! Everyone benefits.