Our pricing strategy discussion for this issue concerns gifts vs. price discounts to encourage purchases. Which work best?

Discount vs. Premium

I just uncovered a very interesting piece of research from Sinha & Smith that ran in the journal of Psychology & Marketing in March 2000.They were looking at consumer responses to what marketing academics call “transaction value.” Transaction value is whatever is driving the consumer’s perception of value at the moment of purchase. A discount will increase the consumer’s perception of value, as will added bonuses.

So… which is better? There is a clear winner!

Like gains / HATE losses

The psychological basis for what consumers are thinking as they see your offering(s) is “prospect theory.” One of the most interesting pricing strategy aspects of this theory is that people are more sensitive to losses than to gains. That means while they love extra gains (bonuses, better quality, a price discount, etc.), they don’t love them as much as they HATE extra losses.

An easy way to see this in action is to look at a business that charges extra for the customer to use his/her credit card. Even if it is only 2%, customers absolutely hate this. Now picture this same customer coming to the cash register and being told that as a special today, they get 2% discounted from their purchases. Will they be jumping up and down in elation? Calling everyone they know to rave at their happiness?

No. They are likely to smile and say, “That’s great!” and mean it. But it won’t make their day.

What’s the answer for this business? Using this theory, they should Increase all prices by 2% and give everyone who pays cash a 2% cash discount. This way the person using a credit card pays the “normal” price, so there’s no reason to blow a fuse. And everyone else gets a nice little discount.

So what does this mean for pricing strategy?

So what does this mean when it comes to cash discounts vs. bonuses or premiums?

Consumers close to making a purchase do a mental accounting of what their gains and losses would be from the purchase. The price is in the loss column and the product/service is a gain.

But… consumers treat bonus gifts or price discounts differently in this accounting. Price discounts are usually framed in your customers’ minds as a reduced loss. They lump your price discount into the overall cost of the product/service. Yes, it reduces the perceived loss, but once it’s lumped into the price — it disappears.

Now the price is just a lower loss — but still a loss. Whereas bonus gifts are always framed in a consumer’s mind as a gain.

So here’s how the scale then looks: 
— Loss (price) 
— Gain (product/service)
— Extra gain (bonus/gift)

If you get more sales by offering a discount than a bonus/gift, you are probably not using the best bonus/gift for your market. Try testing several different ones. You can probably cut your discount AND increase unit sales all at the same time — with the right bonus.

And you know what a rocket lift that would give your profits!