Because consumers are human beings, our actions aren’t necessarily rational. We have strong emotional reactions to price signals. The sheer ubiquity of discounts demonstrate they must work.
Lets review a couple of findings from behavioural (and traditional) economics that help explain why discounting – both real and fake – is such an effective marketing ploy.When will firms offer discounts on their products? If they are profit-maximising firms (the assumption we usually make in economics), then they will lower prices if it increases profits. When prices are lowered consumers will buy more. That is the straightforward Law of Demand. However, lower prices don't automatically raise profits, because while the firm will sell more items, it sells those extra items and all the rest of the items that they could have sold at the higher price at the new lower price. Profits might even go down.
So, firms will only lower prices if it is more profitable to do so. However, if firms are better off with lower prices, you would (rightly) wonder why they need to discount - why would they ever offer the higher price, if they already know the lower price is more profitable? They should just start with the lower price.
There can be good reason for discounting. For some retailers, starting with a high price and discounting later has nothing to do with behavioural economics. For instance, consumers who wait until later to buy may have a lower willingness-to-pay (or be more price sensitive) than consumers who buy early. In this situation, it makes sense for the retailer to sell 'new season' items at a high price, but heavily discount those same items at the end of the season (this is what economists refer to as 'temporal price discrimination'). However, this is not what most retailers are doing when they discount items.
Most retailers are trying to take advantage of behavioural economics, as Bayer explains:
The prospect of buying something leads us to compare two different changes: the positive change in perceived value from taking ownership of a good (the gain); and the negative change experienced from handing over money (the loss). We buy if we perceive the gain to outweigh the loss.
Suppose you are looking to buy a toaster. You see one for $99. Another is $110, with a 10% discount – making it $99. Which one would you choose?
Evaluating the first toaster’s value to you is reasonably straightforward. You will consider the item’s attributes against other toasters and how much you like toast versus some other benefit you might attain for $99.
Standard economics says your emotional response involves weighing the loss of $99 against the gain of owning the toaster.
For the second toaster you might do all the same calculations about features and value for money. But behavioural economics tells us the discount will provoke a more complex emotional reaction than the first toaster.
Research shows most of us will tend to “segregate” the price from the discount; we will feel separately the emotion from the loss of spending $99 and the gain of “saving” $11.Bayer is describing the idea of transaction utility (which I have blogged about before in this context). When we buy an item, we get utility (satisfaction or happiness) from receiving the item (which we call consumption utility), plus we get utility from the transaction itself (transaction utility). If we feel like we are getting a good deal, that makes us happier about our purchase. It doesn't make us any more satisfied with the item itself, but it increases our transaction utility. Higher total utility (consumption utility plus transaction utility) makes us more likely to buy the item.
Retailers can exploit this, and often do. By posting a high 'regular price' or 'recommended price' and showing a deep discount, they increase the consumer's perception of getting a good deal, and increase their transaction utility. This makes them more likely to make the purchase, because it increases their total utility.
Transaction utility can wear off pretty quickly though. You know that feeling of buyer's remorse, when you've bought something and you felt really good about it at the time, but soon after you think it wasn't worth it and maybe you want to change your mind? That's the transaction utility wearing off, and you're realising that the consumption utility alone is not enough to make the item worthwhile. But it's too late! Bayer's conclusion is relevant here:
The bottom line: beware the emotional appeal of the discount. Whether real or fake, the human tendency is to overrate them.Read more:
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