For years, businesses have been aware of a practice among consumers that seems to drive how they respond to marketing. This practice is called Mental Accounting. Mental Accounting refers to a set of cognitive operations used by individuals and households to organize, evaluate and keep track of financial activities. It was first coined by Robert Thaler of the University of Chicago.
Here is an example. When a person considers that he has spent his $100 monthly budget allocation, he then proceeds to bring a homemade lunch for work, even if a nearby store offers a 70% discount on its food prices. Unless free, the customer will prefer to bring a pack lunch rather than take on any offer, since in his mind, he has already spent all that he can for the month.
This mentality follows what we call a reference price, or a price mentally allocated by a consumer to a certain product or service. It is a moving target based on multiple factors:
This refers to the price offered by their business of choice for a single item. This is the first factor that affects the reference price since this is what the customers sees firsthand – on a shelf, on an online store, or by word of mouth.
After seeing the original price, most consumers start to look at competitors that offer the same product. The price offered by competitors in turn affects the reference price, as the customer starts to mentally compute the other costs that will be incurred if he chooses the competitor over the original.
This refers to the last price the customer paid for the same product. Consumers compare the reference price against (1) the actual price at the time of purchase and (2) the value of the good/service at the time of consumption. These two comparisons lead the consumer to conclude if a purchase is a good deal (transactional utility) and worth the cost (usage utility).
These factors affect how a consumer perceives your company when choosing you or your product for their private consumption. So, take these in mind when setting your prices.
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