Did you watch the Olympics? If so, you probably saw some medal ceremonies. The gold medal winner was of course ecstatic, but let’s talk about the silver and bronze medal winners. Bronze medal winners usually look very happy because they won a medal in an Olympic event, but the silver medal winners often don’t look all so happy because they might be thinking that they got close to winning gold, but instead ‘only’ got second.
You might wonder why I’m telling that story and how it relates to pricing. It’s a perfect example of how our brains process gains and losses differently. Daniel Kahneman (yes, the same person who did research on perceived fairness) and Amos Tversky developed a very powerful theory called prospect theory. Prospect theory is all about how people make decisions based on the potential value of losses and gains rather than the final outcome.
Let me give you two more examples. Let’s say I gave you a choice between $50 or a 50% chance of getting nothing and a 50% chance of getting $100. Chances are that you’d choose the sure $50.
But, what about if I gave you a choice between losing $50 or a 50% chance of losing nothing and a 50% chance of losing $100. Most people would choose the second option.
What’s going on here? The value of the two choices is exactly the same, but why do we choose those options? That’s exactly what prospect theory is all about. In the first example, we view the sure $50 as a gain; while in the second example, we view losing $50 as a loss. Okay, that’s interesting, but how does this relate to pricing?
Think about their findings--that people prefer things framed as a gain rather than as a loss. Let’s look at pricing and rate fences. Assume you decide to use day of week pricing and charge higher prices on the weekends. You could either say that you’re charging 20% more on the weekends or you could say that you’re charging 20% less during the week. They’re the same, but which would customers prefer? That’s prospect theory in action!
If you'd like to learn more, please check out the QSR.com article!