The best way to frame a discount

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Imagine you are in the final stages of closing a deal that involves selling a package of two distinct services. The value proposition for the services has been accepted; the prospect is excited for the project to begin; and the only discussion item remaining centers strictly around price. Both services will need to be purchased for the project to begin. You are offering Service (A) for $40,000 and Service (B) for $5,000; a total asking price of $45,000 for the project. The buyer has stated that he won’t accept your $45,000 asking price, but you think he could pay up to $42,500 for both services. What’s the best way to present your new offer to the buyer? Do you apply the discount to Service (A), Service (B) or discount both equally to reach the $42,500 level?

We’ve talked before about the psychological bias among people to avoid loss (loss aversion) and how this bias affects the behavior of both buyers and sellers alike. Researchers Daniel Kahneman and Amos Tversky were prominent in their research on the subject (“Prospect Theory: An Analysis of Decision Under Risk” – 1979) and not surprisingly, they have also gathered enormous data on behavior as it relates to the framing of discounts. In a paper published in 1981 (“The framing of decisions and the rationality of choice“), the authors posed a similar situation to their test subjects.

Situation1: You are about to purchase a jacket for $125 and a calculator for $15 for a total cost of $140. You are informed that the calculator is selling at a $5 discount at a store located 20 minutes away. Do you drive the 20 minutes to receive the discount on the calculator?

Situation 2: This time, the jacket sells for $15 and the calculator for $125 for a total cost (again) of $140. You are informed that the calculator is selling at a $5 discount at a store located 20 minutes away. Do you drive the 20 minutes to receive the discount on the calculator?

While both situations have the same economic return ($5 discount on the calculator to travel 20 minutes), they differ in that the calculator sells for $15 in Version 1 and sells for $125 in Version 2. On a purely economic basis, the results (those who said that they would drive the 20 minutes for the $5 discount) should have been the same. But the actual results told a different story. According to the study, significantly more people said that they would travel the 20 minutes to save the $5 when the calculator cost $15 but not when it cost $125.

Why are people willing to drive across town to save money on a small purchase and not on a much larger one? The reason, according to Kahneman and Tversky, has to do with how people frame their choices. On a percent basis, five dollars is a significant savings (33%) on a $15 purchase, but not nearly as significant (4%) on one costing $125. In both versions the absolute discount was identical on an economic basis but clearly not on a psychological basis.

So let’s get back to the pricing question laid out in the opening paragraph. What do you think is the best way to discount your services to the buyer? Do you discount Service (A) by $2,500 (6.25% discount); discount Service (B) by $2,500 (50% discount) or discount them both equally? If you believe in the concept of psychological framing, the clear choice would be to keep Service A priced at $40,000 and to discount Service (B) by the entire $2,500 amount.

Here’s the takeaway. Psychological influences on pricing can be just as powerful as economic ones. Effectively pricing your services and products involves taking both into account. Those who fail to do so, run the risk of either losing business (perhaps to competitors who are more adapt at leveraging the psychological aspects of pricing) or leaving money on the table – money that will never be recovered. Both of which are deadly sins in today’s economic climate.

Republished with author's permission from original post.

Patrick Lefler
Patrick Lefler is the founder of The Spruance Group -- a management consultancy that helps growing companies grow faster by providing unique value at the product level: specifically product marketing, pricing, and innovation. He is a former Marine Corps officer; a graduate of both Annapolis and The Wharton School, and has over twenty years of industry expertise.

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