Below is a transcript from an episode of my podcast, Unconsidered. Unconsidered can be heard on all major podcast networks.
Hey, it’s Dallas, and I have a question for you.
But first, let’s set the scene.
Let’s imagine you’re going out to dinner, maybe it’s a first date and you want things to be just right. Or maybe, it’s you and your significant other’s 200th date – and even at 200 dates, this date deserves to be a special one.
You both pick a nice new restaurant – let’s say an Italian restaurant in this case.
Nothing too fancy, but nice enough that you expect a certain type of an experience, quality selection and a certain level of service.
The time has come. You get to the restaurant, you get seated at your nice table – not too close to the kitchen, away from the entrance and away from the restrooms, within eye shot of the bar so that you can feel the energy, but far enough away to not be distracted by the noise.
So far, so good.
And now you have an important decision to make – maybe the most important decision of the night.
What would you like to drink?
You know you and your date prefer red wine – it’s an Italian restaurant after all – and you’ll probably want a whole bottle. So you pull out the menu and you notice that for bottles of red, you have two choices.
The first bottle of wine is $80. The second bottle of wine is $40. The server tells you that the $80 bottle of wine is indeed the better wine. But, the $40 bottle is also good – just not as good as the $80 bottle.
Now for the question – which one do you choose?
I want you to take a little bit longer on this one so you have time to not just think about which bottle of wine you would choose, but also why? Hold in your memory which variables came into play and we’ll be back with a follow up question…
Okay, now… let’s reframe the question a little bit.
Right before you can tell your server which bottle of wine you want, the server tells you about an off-menu bottle of wine – 2016 Dominus Estate Christian Moueix – priced at $200.
Now, faced with three options instead of two, which do you choose? As a reminder, you have the $80 bottle which is now the middle price point, the least expensive option at $40, or the Christian Moueix at $200?
Take a second and consider it….
I don’t know what you chose, I never will because I don’t know you, and you don’t know me and we’ll probably never meet. But, I know that some of you who originally chose the $80 bottle, decided to move up in price to the $200 bottle when the $200 Christian Moueix was introduced.
And, I know that some of you who originally chose the $40 bottle, the least expensive, decided to go with the $80 bottle of wine when the $200 bottle was added.
I also know that none of you moved down a price point when the third tier was added.
How do I know this?
Let’s take a quick break and we’ll dive in…
One of the earliest and most concise pieces of research on what is happening here was published in 1983 by The Journal of Consumer Research. The article was titled “Market Boundaries and Product Choice: Illustrating Attraction and Substitution Effects.”
Researchers in this experiment wanted to understand how a buyer’s decision was impacted by adding or removing choices from a buying decision.
More directly, they wanted to understand how the buyer’s decision could be influenced in a way that causes the buyer to more frequently make a buying decision that favors the seller.
Even more directly – how do we make people spend more money?
How the researchers set out to test this was to develop a baseline by asking the first group of respondents to choose between two options at a restaurant – a better tasting, more expensive meal, or a meal that wasn’t quite as good, but was less expensive.
The more expensive meal in this research was referred to as the Target price – because the restaurant wants to sell as many of these as possible.
The less expensive is called the Competitor price because it takes buyers away from the more expensive meal – which is bad for the restaurant – but, very importantly, it’s a price that gives even the lower spending customers an entry point into the business.
After they ran the first experiment and the baseline was set, they introduced a third option to a new group of respondents. The third option – called the Decoy price – was priced even more expensive than what was previously the most expensive option.
So now we have three price points – the competitor price which is the low-cost, inexpensive option. Doesn’t make the business much money, but doesn’t cost the business anything. The target price which is what the business has the highest margins on and hoping to sell the most of. And the new decoy price which is the most expensive, often overpriced option, not necessarily intended to be bought.
Now, an easy assumption would be that adding the higher priced Decoy would just attract buyers from the Target price – previously the most expensive option – by convincing them to spend a little more on the Decoy price.
And, you’d think the cheapest option would remain unaffected. You would think that if a person is going to buy the cheapest option originally – the competitor price – they would still buy the cheapest option even when more expensive items are added.
What the researchers found is fascinating – and incredibly important for anyone selling anything to keep in their back pocket.
Not only did people choose to spend more when the decoy price was added – moving up from the Target price up to the Decoy price – even more surprising, was that when the decoy price was added – more people from the least expensive meal group chose to move up to the middle price point – from the competitor price to the target price.
The higher priced decoy actually created what’s called a double positive effect.
The amount of buyers choosing the least expensive option decreased, the percentage of buyers who chose the target price increased, and some buyers even chose the new decoy price.
Adding the decoy price increased the probability of respondents choosing the target price.
This phenomenon became known as The Decoy Effect. It’s also sometimes referred to as The Attraction Effect.
By adding an irrelevant option to an existing set of choices, the percentage of people buying the more desirable choice – to the seller – actually increases.
To fully understand the power of the decoy effect and how it works, we have to first understand what is known as rational choice theory.
Rational choice theory tells us that when individuals are faced with a decision, most often the first thing they will do is evaluate their own self-interests to make that decision, and typically that decision will be made in a manner that leads to their greatest benefit.
Basically, people will do whatever is best for them.
Rational choice theory gets a little bit more complex when we take into consideration that what is best for one person, may not be best for the next – or even the majority.
This is because how a person decides what is in their best interest – or what is a rational choice for them – is completely up to their personal preferences.
For example, one person may decide cutting alcohol out of their diet is in their best interest because it will protect their health over the long term. Another person may decide that happy hours – and thus alcohol – are important to relieving their stress, networking with colleagues and growing their social circles, creating a net positive in their life.
While these decisions are the complete opposite of each other, both individuals feel their decision is the best decision – or, the rational choice – as it achieves the best result for themselves.
People will do what they believe is best, and most rational for them. We’re all uniquely the same in that regard…
Now that we understand rational choice theory it’s easier to see why the decoy effect is so important – and you can see why when it’s used correctly – it becomes one of the most valuable marketing and manipulation tools we have available.
Because as marketers, business owners, or sales people, we don’t always want the buyer to make a rational decision – that is, a decision that is in their best interests. We want them to make a decision that favors us – the business – a decision that is in our best interests.
For example, If everyone walked into the Apple store and bought the most reasonably priced iPhone, with storage for only what they need, and used that phone for 6 years until it reached its end of life – that may be the best and most rational thing for the buyer – but Apple wouldn’t be a Trillion dollar company.
Trust me, I understand that it’s often believed it’s the ethical and responsible thing for businesses to actually sell the customer what is truly in their best interest, but frankly, that’s not always the case…
For example, an alcohol company doesn’t want you to stop drinking alcohol in the interest of your health – so they make it look fun, social, exciting. They build attraction by associating alcohol with things you love like vacations, concerts and sports. They make drinking alcohol seem like something you want to do – even a reward you deserve – despite that it may actually run against your best interests.
And you do. Because we make a lot of irrational decisions in our day to day life.
The decoy effect – which again, is the ability to build attraction to the target price or target decision – is the tool that allows us as marketers and business owners to compete against – and overcome – a buyer’s default, rational choice. To spend more, to shop more frequently, and to do both of those things with us – the business owner.
This happens because the decoy price creates a shift of the perceived value of a product or service. The decoy price makes the target price seem more attractive and seem more rational. The higher, irrational decoy price does this by making the target price seem like the safer choice by raising the perceived value of the target price, relative to the cheaper competitor price.
The decoy price creates a bell curve – attracting everyone to the middle, target price, rather than forcing a this or that decision – option 1 or option 2.
When a purchaser feels like the target price is the safer choice – because the decoy price is too expensive, and many of us don’t want the cheapest option either because that’s its own kind of risk – the target price makes it much easier for the purchaser to justify their decision to themselves and those around them.
Because when the buyer chooses the middle, they can say, “Well, I didn’t overspend and I wasn’t cheap. I went right in the middle. I was safe.”
A feeling that they – without the decoy price – may not have had before or after their purchase.
And most people don’t get in trouble with their bosses, or their significant others, for making the safe decision.
That’s why we call it the safe decision…
So, what if you’re not in the restaurant business? What if you’re not trying to maximize your margins on a nice dinner or a bottle of wine? Maybe you offer a piece of software, or maybe you – like me – have a service offering which is priced as a recurring monthly retainer. How can you, knowing what we discussed here, take advantage of the decoy effect to increase sales and revenue for your business?
When we discuss pricing a bottle wine and introducing a decoy price, we’re discussing what is called a “fixed utility model.” It’s considered fixed because the margin on a $40 bottle of wine and a $200 bottle of wine – in terms of percentage – is relatively the same, depending on the restaurant’s mark up.
And, in case you’re wondering, the markup on a bottle of wine in a restaurant is usually 200-300% – making that $200 of wine $50 at Costco. But remember, we tell ourselves we’re paying for the experience – that’s what drives this irrational choice. That’s what restaurants are tapping into.
But anyway, it’s also considered a “fixed model” because there is no other variable beyond the price. Meaning, if you buy the $200 bottle of wine, you’re not gaining extra features or any additional services in exchange for spending more – just a hopefully, better bottle of wine.
But, most of our businesses are quoting services that contain multiple items, each containing multiple dimensions.
For example, a flooring business would be quoting square footage, multiplied by the cost of the flooring type. That’s two variables, or two dimensions. A marketing agency may be quoting multiple service lines – web, seo, design – and then multiplying those service lines by labor hours. Or enterprise software companies like Slack and Basecamp offer additional features at different price tiers.
When you look at their pricing pages, and almost any other software company, you’ll notice something similar – there is usually a tier that is highlighted, or labeled “Best Value” or, “Most Frequently Bought”. This is, if you’ve learned anything here, their target price. Anything to the right of it is likely a decoy, anything to the left likely a competitor price.
You’ll see this in the airline industry, hotels, your cellphone company – on and on.
While additional variables in your pricing – whether it’s labor, features, higher-quality products at higher price points – can make deploying decoy pricing a little bit more challenging, the authors of “Market Boundaries and Product Choice” proved that it still works. Even as variability is added, decoy pricing can still be used on both the bottom tiers and top tiers to push buyers to the middle tier of pricing – where the target price sits – resulting in more purchases of the target price and higher overall revenue.
Whether we realize it or not, a lot of us have been doing this already.
What I’ve intentionally avoided saying until now, hoping some of you would get there before me is – good, better, best. Sound familiar?
Good, better, best. Competitor, Target, Decoy. Honda, Mercedes, Ferrari. Right?
As a business owner I’ve experienced countless standoffs during early client meetings, you know the ones – “What’s your budget?”, “I don’t know, what should we spend?”
It’s extremely common in these situations for everyone to agree that a good, better, best approach to the pricing is the rational outcome for everyone – the safer option. In fact, if you’re the business owner or the one on the sales side of the conversation, you should encourage this approach, and give a little internal celebration when you walk away from the meeting knowing that you get to craft three distinct price points.
Because if the research we talked about today holds true (spoiler alert: it does), a good, better, best approach – competitor, target, decoy – means you’re now more likely than at the start of the meeting to get the price you want to get for your services.
The next step is developing a framework to deliver your good, better, best model. Keep in mind that while landing on this approach should go in the win-column for the business owner, it’s incredibly important that you don’t take advantage of the situation. You do still need to honestly and ethically create your price points. You do still need to be prepared for the buyer to select any one of the three options you’re presenting, and you do still need to be able to deliver on all three prices.
What you can do is think of it this way:
When presented back to the buyer, this gives them the illusion of choice. The illusion of power. It gives them the chance to feel like picking the middle is safe. It will give them the chance to go back to their bosses, their wives, co-workers and state as a matter of fact that they reviewed several options, did their due diligence and chose what they deemed to be the best priced option.
It also eliminates so much negotiation. It allows the business owner to say, “well, if price is a concern, we have the low cost option. Again, we know they don’t want that.
You’re happy because you charged what you wanted to charge and sold what you wanted to sell. The buyer is happy because they feel safe and secure in their decision while also feeling like they negotiated effectively.
This is your double positive.
Dallas McLaughlin
The Business Owner's Guide To
As a business owner you are inherently a decision maker and it’s a function of your job to make consistently good decisions in critical moments. But no two decisions are exactly same. Having a deep understanding of how decisions are made and having the tools to create consistent decision making frameworks are necessary to make more rapid and impactful decisions on a daily basis.
