startup

The Magic of Irrelevant Third Option in Product Pricing

Last week, I had my first class at Kellogg. This class was about leadership, but professor Loran Nordgren presented an interesting insight from his research on relativity. Professor Nordgren’s research has been published in leading journals such as Science and has been widely discussed in prominent forums such as the New York TimesThe Economist, and the Harvard Business Review

I really enjoyed his class. That’s why, in this article, I will discuss a few key takeaways from the class that might help you:

  • Adding an Extreme Third Option – Anchoring Bias
  • The Economist Pricing – Adding a Slightly Worse Option

Relativity is important to frame the options for your audience. People value their perceived value based on a reference point. The same choice can be perceived as low and high in different contexts. This concept becomes all the more important in tiered pricing strategies. 

Adding an Extreme Third Option – Anchoring Bias

You walked into a PC store, and you have two options.

  • Product A: Prices at USD 800 dollar this product meets all your requirement.
  • Product B: Priced at USD 1200 dollar this feature incremental benefits. It has slightly higher RAM and backlight keyboard.

You don’t need the extra RAM or graphics card. In facts, you don’t get the technicalities, so you don’t want to do in details.

Slide1

You will probably pick the product A. Sure some people would choose the expensive option, but the majority will go with Option A.

However, what if I add a premium version prices USD 2000. This version is slightly better looking and has higher RAM and storage. Please note two important points here. First, these are just incremental benefits. Second, the third option is overpriced with respect to the incremental benefits it offers.

Slide1

Rationally speaking, adding this irrelevant option shouldn’t matter. However, the option changes the frame of reference for the consumer. While benefits of each option didn’t change, you will be happier not buying the cheapest option thinking the option B is the better deal. The context sets your perception.

The Economist Pricing – Adding a Slightly Worse Option

Dan Ariely, the author of the book “Predictably Irrational”, spoke about the curious case of pricing of The Economist.

Economist pricing

The price of both the “Print Subscription” and “Print and web subscription” are same. In a survey conducted by him at MIT, 84% chose option C and 16% chose option A. None chose option B. That’s peculiar.

If no one chose option B, then why did Economist kept the second option?

The second option was added just to make the third option look better. The presence of slightly worse but similar to option C makes Option C looks better. Don’t believe me! Then keep reading 🙂

Ariely conducted one more experiment. This time removing the option B – Print Subscription. This time 68% of students chose option A. As higher prices option C was chosen only 32% time, it means loss of revenue for The Economist. That’s why option B is important. 

Therefore, next time if you need to convince your friend to go to a Chinese restaurant, you know what to do. Just present the following options:

  • Average Italian restaurant
  • Poor Chinese restaurant
  • A good Chinese restaurant  

He/she would most likely go with option C. 

That’s it for today. Hope you also enjoyed the content of the class 🙂

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