August 10, 2012
Innumeracy: How Your Pricing Strategy can take Advantage of Mathematical Ignorance

These days it seems that practically every retail and online store has bright red “SALE” signs and posters boasting odd discount percentages clogging their storefront window. 70% off here, 35% off there, and a whole lot of numbers everywhere. These discount incentives appear to be practically begging those passing by to come in and look around. Yet, beyond the psychological pricing and pricing strategy implications of these practices, we need to take a step back and truly take a look at how these incentives affect the customer. You may be thinking, “Well, they’re sales, so they should be bringing in more customers,” but as a recent article from The Economist so blankly states in its title, “Something Doesn’t Add Up,” because research shows that consumers don’t comprehend the mathematics of a discount. To better understand what’s going on here, let’s subtract out the confusion, add in some clarity, and multiply the knowledge dropped.

Pricing Strategy

photo credit: ansik

Innumeracy: We don't understand discount percentages

Typical sales, both online and offline, follow a century’s worth of discounting and premium pricing strategies to hook in consumers. The idea being that with a high anchor price being smashed by an impressive discount price would create a sense of urgency and high perceived value to push a consumer to purchase. Yet, in a study completed by Akshay Rao of the University of Minnesota’s Carlson School of Management, the research team found that consumers are waning on discounts in favor of receiving something extra. Essentially, consumers would rather “buy one month and get the next free” than “receive 50% off [their] first month.”

Keen observers of pricing trends may believe this phenomenon is due to price fatigue or the rise in consumer intelligence to pricing tricks. After all, we’ve seen “buy now, this sale won’t last long” for years and know that it really doesn’t go away. Yet, we actually prefer getting more to a discount, because of our ignorance with math. Rao puts it simply, “most people are useless at fractions.”

The team exposed this incompetence through a series of studies that asked consumers which deal they would prefer: a 50% increase in quantity or a 33% discount in price. The secret: they’re both the same offering. Despite their mathematical equivalence, they found consumers overwhelmingly assume the quantity increase is a better value. What’s even more interesting is that the results stayed true even when the discounted product was blatantly a better deal.

Businesses have been using this phenomenon for years

A.K. Dewdney, author of 200% of Nothing describes this phenomenon as innumeracy, where individuals have the “inability or unwillingness to understand basic mathematical ideas involving numbers or logic as they apply to everyday life.” On a large scale Dewdney even posits that innumeracy could be a bigger threat to consumers than illiteracy, because of just how much sellers can take advantage of a consumer’s weakness.

For instance, one way businesses utilize our mathematics hiccups is through double discounting, where an item will be marked down by a percentage and then an additional percentage. I’m sure we’ve all seen the signs for “all clothing 25% off, now an additional 20% off!” Our minds instinctively think we’re getting the equivalent of 45% off the product when in actuality we’re getting 25% off the original cost and then 20% the sale cost. For a $100 item, the 45% off discount would be $55 and the double discounted item would be $60, giving the retailer more cash for what you thought was the same price.

Other methods include coupon design, where the enticing deal is in big bold letters (“10 OFF!”) and the details will be in microscript (“purchased of $100 or more”), the trick of 9’s, a psychological pricing technique we’ve chatted about where consumers think they’re getting a great deal, and percentage pumping, where defunct mathematicians manipulate formulas and percentages to make a product seem better than reality. For example, a light bulb box saying its saves “200% on energy” is mathematically incorrect, but could be “proven” through bogus formulas.

Enough with the nerdiness, how can this help my business?

We’re now at my favorite part: why should you care and how can you use innumeracy in your business?

1. Be Transparent and Upfront: Shady coupon design and percentage pumping do work, but they aren’t a long term strategy, especially with B2B style sales. When you’re trying to build a relationship, it’s not great to start out on a decptive note, even if it does get the customer into the door initially. Retailers will continue to use those types of practices if they’re focused on the short term gain (pushing a lot of product to a large volume of people), but more and more customer-centric companies are wising up to being direct with discounts.

2. Build Your Value before slashing your prices: Instead of cutting your prices in bad times for a marginal increase in revenue, give more away for the same cost with a much different effect. When times get tough or we want to maximize revenue, the common practice is to slash prices, but as we’ve seen here, consumers react better when you boost your value, even if your’e essentially giving away the same offer. Plus, by boosting your value, you can maintain your brand and not be looked at as the desperate discount desperado of your industry. You’ll delight customers, build trust, and forge an everlasting relationship that will pay significant dividends.

For more on pricing strategy, download our Pricing Strategy ebook or check out what we have to say about our price optimization software

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