Gain–Loss Framing

A final consideration in price communication involves how the price is presented to customers, who tend to evaluate prices in terms of gains or losses from an expected price point. How they frame those judgments affects the attractiveness of the purchase. To illustrate this effect, grounded in prospect theory, ask yourself which of the following two gasoline stations you'd be more willing to patronize, assuming that you deem both brands to be equally good and you would always pay with a credit card.

• Station A sells gasoline for $2.20 per gallon, but gives a $0.20 per gallon discount if the buyer pays with cash.

• Station B sells gasoline for $2.00 per gallon, but charges a $0.20 per gallon surcharge if the buyer pays with a credit card.

Of course, the economic cost of buying gasoline from either station is identical. Yet, most people find the offer from station A more attractive than the one from station B. The reason is that people place more psychological importance on avoiding “losses” than on capturing equal size “gains.” Also, both the gains and losses of an individual transaction are subject, independently, to diminishing returns, as one would expect from the Weber-Fechner effect we discussed earlier: A given change has less psychological impact the larger the base to which it is added or subtracted.

In our gas station example, cash buyers prefer A, where they receive the psychological benefit of earning a discount, a “gain” to them. Paying the same $2.00 net price per gallon at station B, which offers no explicit discount, does not provide a psychological benefit. Credit card buyers also prefer station A, mainly because station B's credit card surcharge creates a “loss,” a negative psychological benefit to be avoided. Paying the same $2.20 net price per gallon at station A, which requires no explicit surcharge, does not provide a psychological benefit, positive or negative.

Buyers otherwise indifferent to paying by cash or credit will not be indifferent to stations A or B despite the sellers' economic value equivalence; such buyers would always pay cash to get the lowest price but would likely choose A to get the psychological satisfaction unavailable at B. Prospect theory has many implications for price communication:

• To make prices less objectionable, make them opportunity costs (gains forgone) rather than out-of-pocket costs. Banks often waive fees for checking accounts in return for maintaining a minimum balance. Even when the interest forgone on the funds in the account exceeds the charge for checking, most people choose the minimum balance option. People find it less painful to pay for things such as insurance or mutual funds with payroll deductions instead of buying them outright.

• When a product is priced differently to different customers and at different times, set the list price at the highest level and give most people discounts. This type of pricing is so common that we take it for granted. Colleges, for example, charge only a small portion of customers the list price and give everyone else discounts. To those who pay at or near the full price, the failure to receive more of a discount (a gain forgone) is much less objectionable than if they were asked to pay a premium because they are not star students, athletes, or good negotiators.

Unbundle gains and bundle losses. Many companies sell offerings consisting of many individual products and services. For example, a printing company not only prints brochures but also helps design the job, matches colors, schedules the job to meet the buyer's time requirements, and so on. To maximize the perceived value, the seller should identify each of these as a separate product or service and promote the value of each one explicitly (“Look at all you get in our Deluxe Package!”), unbundling the gains. However, rather than asking the buyer to make individual expenditure decisions, the seller should identify the customer's needs and offer a package price to meet them (“One price brings it all to you”), bundling the loss. If the buyer objects to the price, the seller can take away a service, which will then make that service appear as a stand-alone “loss” that will be hard to give up.

Strategists who think only in terms of objective economic values might find these principles far-fetched. One might argue that buyers in these cases could easily think of the same choices as entirely different combinations of “gains” and “losses.” That is precisely the point that prospect theorists make: Buyers can frame the same transactions in many different ways, each implying somewhat different behavior. Researchers have shown that changing how people think about their gains and losses in otherwise identical transactions consistently alters their behavior.

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