In a perfect world, what you spend for something should be based on your opportunity costs. Let’s say you walk into a dollar store on a hot day and you have just one dollar you can spend. Every item in the store has the same absolute value of one dollar. What has more value to you- a pair of cheap sunglasses or a gallon of natural spring water? Of course, that all depends upon your personal situation.
Each person’s opportunity cost will vary depending on the person and the conditions. If you are working outside on a hot day, the water would appear to be more important to you and, therefore, have a greater opportunity cost to you. You could live without the sunglasses, but you would be thirsty working outside in the heat. However, if you were just starting a long drive in an air-conditioned car on a sunny day, you are far less likely to get thirsty in the shaded cabin of your automobile with the A/C running, so in this instance, the sunglasses might have greater personal value to you.
The above example is how we might respond in a perfect world, but that is not the world that we live in. In the real world, there are many ways that a product’s absolute value can be distorted by retailers and thereby short-circuit your rational decision-making process based on absolute value and opportunity cost.
First off, as a consumer, it is often hard to determine an opportunity cost since we rarely face a choice just between two options at the same moment in time. Let’s say that you have $100 in your budget that you can spend as you wish on discretionary items between paydays. Over that 7-day time span, you will be spending your $100 on several items over the course of the week.
Your opportunity cost is a lot less visible on the day after payday when you have $100 in your pocket than it will be on the day before payday when you might have only $5 left. It is far easier to spend money on the day after payday, when you know that you still have most of your $100, than on the day before when you only have a few bucks left. Said another way, it is harder to weigh the opportunity cost between an item the day after payday than with an opportunity cost on the day before payday.
Perhaps it was not a good idea to go out to dinner on the day after payday when today, the day before payday, you are out of gas, and all you have is $5 left.
Timing
From a marketing perspective, it is much easier to separate a customer from his money right after payday than the day before. Therefore, the timing of your specials should be timed to when the customer has money.
When I was in the Coast Guard, paydays occurred on the 1st and 15th of the month. I recall that right after payday, twice a month, we would go out for pizza. However, by the end of the pay period, I was often searching the couch cushions and the dryer looking for loose change to buy diapers for our son.
Credit
In another sleight of hand based on the concept of time’s role in leveraging irrational buying behaviors is the idea of credit/payment plans. Without the full burden of the opportunity cost today, a savvy business person will introduce the ability of the consumer to defer the payment to a later time by offering the customer credit or a payment plan. Why wait until you have saved enough money when you can buy today and make payments later. Without the hard stop offered by running out of money before the next cash injection (Payday), retailers that offer credit distort the true opportunity cost.
Relative Value
Another way to distort opportunity cost is to introduce relative value. In our previous example of the sunglasses and the water, it was easier to determine the product’s absolute values. However, in the real world, it is much harder to establish an item’s absolute value. As consumers, we often look for clues to a product’s value. When you buy a house, you don’t look at the cost of the land and add the cost of materials required to build it and the labor to put it all together. Instead, we look at what other similar homes in the area recently sold for or comps.
Business often markup their list price to distort the actual price. The buyer psychology is quite different for a $60 shirt and one that lists for $100 that is discounted by 40%. The actual price for the shirt is the same, $60, but in the 2nd example, the buyer feels like they got a deal. In the real world, the actual price is $60; however, by distorting the actual price by introducing a relative price of $100, a customer is convinced that they are getting a better deal.
The value of altering the customer perception of the actual price by introducing a distorted relative price was proved by the great re-branding experiment done by J.C. Penney in 2012. J.C. Penny felt that consumers did not want to be deceived by the distorted relative prices and felt that if it introduced what it called “Square Pricing,” believing that their customers would be happier. J.C. Penny dropped their list prices to the actual price and they did away with sales and coupons. In-store revenue plummeted, as did J.C. Penny stock. Customers no longer felt like they were getting the same deal with old-fashioned everyday low prices.
The lesson from the J.C. Penny epic pricing failure is that customers look for value clues and want to feel good about their purchase after the sale, knowing they got a deal. Customers are irrational when it comes to money. Customers feel better when they feel like they took advantage of savings, even if they know it was just an illusion.
When it comes to pricing, how can you distort the opportunity cost so the customer will feel happy with their purchase and spend more money?
