Pricing, Ego, and Emotion

Neuromarketing and Pricing. Why do people sometimes set prices that are too high, and then stubbornly stick with them despite evidence from the marketplace that the price is indeed wrong? Neuroeconomics research tells us that financial decisions are often evaluated in a way that lets our emotions overrule rational financial analysis, and setting prices turns out to be one more area in which this is true. Kirstin Downey of the Washington Post wrote For Sale, By the Owner’s Ego to show how home sellers have difficulty selling their house when there’s a disconnect between market pricing and the owner’s perception of value.

Little of this research has been applied directly to real estate, but neuroeconomists say the principles would logically apply to housing, too. For example, much work has been done on the concept of “loss aversion,” which shows that people tend to deny reality when something they own, such as stock, declines in value. They will keep holding that stock, confident the price will rise again if they wait long enough. They do the same with their homes, maintaining the asking price even at a level that makes no sense, economists said. Similarly, home sellers become attached to the prices their neighbors received at the top of the market rather than current prices, and they become reluctant to sell unless they get that higher price.

“It’s classic loss aversion,” said Christopher J. Mayer, director of the Paul Milstein Center for Real Estate at Columbia Business School in New York. “You could do it, but you don’t want to. You don’t want to realize the loss. It leads to housing markets that don’t function very well. You’ve got a lot of houses on the market and they aren’t selling.” Mayer said that people allow their wishful thinking to overcome realistic perceptions because they don’t want to view themselves as having made a mistake…

David Laibson, who teaches psychology and economics at Harvard University, said a common error people make is believing that homes can’t drop in value below what they paid for them, and, in particular, that they can’t fall below their mortgage amounts. “There seems to be a psychological resistance to taking losses on the sale of a house,” Laibson said. “People think they’ll make money on it. . . . That logic worked for a long time, and now anyone who bet on that logic is being burned.”

Emotional Pricing in Business. Pricing is a key element of the marketing mix for any product or service, and businesses aren’t always as coldly rational as one would expect. Often it IS quite rational, of course. One firm I worked with made machinery parts that were subject to high wear and were viewed as consumables by their customer. Any new product that offered a longer life was priced in direct proportion to that advantage. A product that lasted twice as long was priced twice as high as the base product. Customers didn’t cut their part expense, but they experienced less frequent downtime and saved money on labor. This was a rational and effective pricing strategy that served that firm well.

Another firm I worked with also sold industrial products, in this case a commodity metal product used as a raw material by manufacturing firms. That’s about as unglamorous a market as one can imagine, and the pricing was typical for that sort of commodity: suppliers charged the same delivered price for the product, and competed mainly on service and availability. One executive, though, was armed with data showing that the firm’s products were of marginally higher quality than some of the competitor’s products. In addition, the firm was an industry leader, with more sophisticated technical support and a much higher research and development budget than any competitor. Customers should be willing to pay a tiny premium, he reasoned, considering the additional benefits they received by dealing with the firm. Overruling line executives who cautioned that customers would not pay more, the exec pushed through a small increase. Customers did, in fact, bolt to the competition, and the price boost was quickly rolled back.

This pricing decision was easily as emotional as that made by a homeowner who won’t drop his selling price to market levels. In this case, the executive placed a higher value on aspects of the company that he felt strongly about (better manufacturing technology, higher R&D spending, etc.) than the market did. That’s not much different than a homeowner who cites a list of features (custom woodwork, imported tile floors, etc.) to justify a higher value while buyers are largely oblivious to them.

Business pricing decisions are usually rational, simply because they are often hammered out by groups of managers who use market data to come up with price points. Still, it’s all too easy for business leaders to “fall in love” with their product and assign a higher value to it than justified. It’s also possible for a manager to adopt a risk averse attitude and assign too LOW of a value to an innovative product. Setting a high price point could greatly increase profits, but might also result in low sales – a lower price point might be less profitable, but would produce satisfactory revenues and reduce the risk of failure. And neuroeconomics research tells us that avoiding risk, sometimes to the point of forgoing probable benefits, is highly typical behavior.

There’s no easy way to keep emotions out of pricing, but recognizing that potential for less than rational decision making is a good start.