Pricing and the Psychology of Consumption

Pricing and the Psychology of Consumption

The way you set prices doesn’t just influence demand. It also guides the way buyers use your product or service—and that can have a lasting impact on customer relationships.

by John Gourville and Dilip Soman

Ask any executive how pricing policies influence the demand for a product or service, and you’ll get a confident, well-reasoned reply. Ask that same executive how pricing policies affect consumption—the extent to which customers use products or services that they’ve paid for—and you’ll get a muted response at best. We find that managers rarely, if ever, think about consumption when they set prices—and that be a costly oversight.

Consider this example. Two friends, Mary and Bill, join the local health club and commit to one-year memberships. Bill decides on an annual payment plan—$600 at the time he signs up. Mary decides on a monthly payment plan—$50 a month. Who is more likely to work out on a regular basis? And who is more likely to renew the membership the following year?

Almost any theory of rational choice would say they are equally likely. After all, they’re paying the same amount for the same benefits. But our research shows that Mary is much more likely to exercise at the club than her friend. Bill will feel the need to get his money’s worth early in his membership, but that drive will lessen as the pain of his $600 payment fades into the past. Mary, on the other hand, will be steadily reminded of the cost of her membership because she makes payments every month. She will feel the need to get her money’s worth throughout the year and will work out more regularly. Those regular workouts will lead to an extremely important result from the health club’s point of view: Mary will be far more likely to renew her membership when the year is over.

For many executives, the idea that they should draw consumers’ attention to the price that was paid for a product or service is counterintuitive. Companies have long sought to mask the costs of their goods and services in order to boost sales. And rightly so—if a company fails to make the initial sale, it won’t have to worry about consumption. To promote sales, health club managers encourage members to get the payment out of the way early; HMOs encourage automatic payroll deductions; and cruise lines bundle small, specific costs into a single, all-inclusive fee.

However, executives may be discouraging consumption when they apply those pricing practices. People are more likely to consume a product when they are aware of its cost—when they feel “out of pocket.” But common pricing practices such as advance sales, season tickets, and price bundling all serve to mask how much a buyer has spent on a given product, decreasing the likelihood that the buyer will actually use it. And a customer who doesn’t use a product is unlikely to buy that product again. Executives who employ those pricing tactics without considering their impact on consumption may be trading off long-term customer retention for short-term increases in sales.
The Psychology of Consumption

Let’s look more closely at why consumption is important and how pricing affects consumption.
Higher consumption means higher sales.

One of the first steps in building long-term relationships with customers, we believe, is to get them to consume products they’ve already purchased. Research has repeatedly shown that the extent to which customers use paid-for products in, say, one year determines whether they will repeat the purchase the next year. One field study, for instance, found that health club members who worked out four times a week were much more likely to renew their memberships than those who worked out just once a week. According to another study, customers who regularly used an enhanced cable television service in one year were more likely to renew their subscriptions in the next year than those who used the service only occasionally.1

Consumption is important to the bottom line in many ways. In businesses that sell subscriptions or memberships—like Time Warner, the YMCA, or the Metropolitan Opera—customer retention is vital. But keeping customers is tough: Most magazines experience renewal rates of 60% or less, and health clubs retain just 50% of their members every year. As competitive pressures intensify and the cost of customer acquisition rises, a key to long-term profitability is making sure that customers actually use the products and services they buy.