$19.95, Mental Anchoring, and Rationality Failure in Everything

An interesting tidbit of research til I have a bit of time to write up some more substantive thoughts, via Scientific American (with a hat tip to Economist’s View). The article title is a bit of a misnomer, it’s really about the effect of seeing a price like “$19.95” vs. “$20”.

Why Things Cost $19.95: Scientific American:

Janiszewski and Uy ran a series of tests to explore [their ideas about anchoring and prices, read the rest of the article for more details]. The experiments used hypothetical scenarios, in which participants were required to make a variety of “educated guesses.” For example, they had subjects think about a scenario in which they were buying a high-definition plasma TV and asked them to guesstimate the wholesale cost. The participants were told the retail price, plus the fact that the retailer had a reputation for pricing TVs competitively.

There were three scenarios involving different retail prices: one group of buyers was given a price of $5,000, another was given a price of $4,988, and the third was told $5,012. When all the buyers were asked to estimate the wholesale price, those with the $5,000 price tag in their head guessed much lower than those contemplating the more precise retail prices. That is, they moved farther away from the mental anchor. What is more, those who started with the round number as their mental anchor were much more likely to guess a wholesale price that was also in round numbers. The scientists ran this experiment again and again with different scenarios and always got the same result.

Why would this happen? As Janiszewski and Uy explain in the February issue of Psychological Science, people appear to create mental measuring sticks that run in increments away from any opening bid, and the size of the increments depends on the opening bid. That is, if we see a $20 toaster, we might wonder whether it is worth $19 or $18 or $21; we are thinking in round numbers. But if the starting point is $19.95, the mental measuring stick would look different. We might still think it is wrongly priced, but in our minds we are thinking about nickels and dimes instead of dollars, so a fair comeback might be $19.75 or $19.50.

I am reminded of Wal-Mart’s strategy of “Opening Price Points”. Wal-Mart will have one product in a category (say, DVD players) that is exceptionally cheap, cheaper than anything offered by their competitors. But then, next to that product, they will have similar, and increasingly expensive products that look nicer, have better features, etc. Customers assume that because the first product is such a great deal, and so cheap, that the other products must also be cheaper than the equivalent at competing stores, even when this turns out not to be true.

It makes me wonder how much psychology research large corporations fund and, if not very much, why?

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