"Why Things Cost $19.95"

Even wonder why retailers price goods at $4.99 rather than $5.00? There may be a good reason:

Why Things Cost $19.95, by Wray Herbert, SciAm Mind Matters: ...[M]ost of us are motivated by the desire for a fair deal, and we employ some sophisticated cognitive tools to weigh offers, fashion responses, and so forth—all the to-and-fro in getting to an agreement.

But how does life’s dickering play out in the brain? And is it a trustworthy tool for getting what we want? Psychologists have been studying cognitive bartering for some time, and several basics are well established. For example, an opening “bid” of any sort is usually perceived as a mental anchor, a starting point for the psychological jockeying to follow. ... What makes us settle on a response?

University of Florida marketing professors Chris Janiszewski and Dan Uy suspected that ... some characteristic of the opening bid itself might influence ... bidding behavior. In particular, they wanted to see if the degree of precision of the opening bid might be important to how the brain acts at an auction. Or, to put it in more familiar terms: Are we really fooled when storekeepers price something at $19.95 instead of a round 20 bucks?

Janiszewski and Uy ran a series of tests to explore this idea. The experiments used hypothetical scenarios, in which participants were required to make a variety of “educated guesses.” For example, they had subjects think about a scenario in which they were buying a high-definition plasma TV and asked them to guesstimate the wholesale cost. The participants were told the retail price, plus the fact that the retailer had a reputation for pricing TVs competitively.

There were three scenarios involving different retail prices: one group of buyers was given a price of $5,000, another was given a price of $4,988, and the third was told $5,012. When all the buyers were asked to estimate the wholesale price, those with the $5,000 price tag in their head guessed much lower than those contemplating the more precise retail prices. That is, they moved farther away from the mental anchor. What is more, those who started with the round number as their mental anchor were much more likely to guess a wholesale price that was also in round numbers. The scientists ran this experiment again and again with different scenarios and always got the same result.

Why would this happen? As Janiszewski and Uy explain..., people appear to create mental measuring sticks that run in increments away from any opening bid, and the size of the increments depends on the opening bid. That is, if we see a $20 toaster, we might wonder whether it is worth $19 or $18 or $21; we are thinking in round numbers. But if the starting point is $19.95, the mental measuring stick would look different. We might still think it is wrongly priced, but in our minds we are thinking about nickels and dimes instead of dollars, so a fair comeback might be $19.75 or $19.50.

The psychologists decided to check these lab findings in the real world. They looked at five years of real estate sales in Alachua County, Florida, comparing list prices and actual sale prices of homes. They found that sellers who listed their homes more precisely—say $494,500 as opposed to $500,000—consistently got closer to their asking price. ... Furthermore, houses listed in round numbers lost more value if they sat on the market for a couple of months. So, bottom line: one way to deal with a buyer’s market may be to pick an exact list price to begin with. ...

Comments

[Marcello]

This study suggests that people think in terms of "significant figures".

In scientific writing, if I say that something is 19.99, this means _implicitly_ that I believe the last digit is important i.e. accuracy of +-0.01 (no more than +-0.05), meaning a change of that amount is "significant". If we write 20, then it suggests an accuracy of +-1 (maybe even +-10) is "significant", while 0.01 is not.
So if people really do use this implicitly, even if not consciously, then what the authors here assert makes plausible sense - if 1 penny is significant to the price, then one would think of changes in terms of this multiple. Clearly sellers would like their customers to think of 1c as an important multiple, and not $1 ...

Aside : For those of us teaching university science students, this could give us an alternative approach to teaching the "sig figs" concept, which students really don't seem to grasp - we should relate everything to the cost of iPods, or whatever kids are buying these days :-)

[cm]

I think the conventional wisdom is that it's about the leading digit or number of digits. That is, 19.95 would put it in the "10+", not "20+" range.

But maybe that is so old a hat that it will be soon rediscovered as a groundbreaking novelty.

[Kaleberg]

Weird. When I see $19.95 I usually round it to $20 and forget the difference. Who wants to do math with all those significant digits? Maybe the effect is because most people can't round $19.95 to $20?

[lee]

When the very large patio umbrellas first came out, they were in very much in demand. Home depot sold them for $999.99.

[Patrick]

For another theoretical answer to this question see:

Kaushik Basu: "Why are So Many Goods Priced to End in Nine? And why this Practice Hurts the Producers", Economics Letters, 1997.

[marcello]

On second thought, CM's explanation seems more plausible than mine- its all about the first digit. a ten-spot + something rather than a twenty+ something.

dang - thought there was something there to help those 1st years ...

[Patricia Shannon]

Marcello shows us the difference between Icky, who recently claimed to have an M.A. in math, and a real scientist/mathematician and grownup. When someone else came up with a more plausible explanation, Marcello immediately recognized and acknowledged it.

[Pedro J.]

In The Armchair Economist the author give a nice historical account of this custom. It forces the employees to open the cash registers rather than put the money in its own pocket.

[Holly W.]

Fascinating. I love these articles about behavioral economics. And this is useful advice if I ever need to sell something, too.

[Callahan]

Sales types believe that $19.95 sounds better than twenty bucks. That's all there is to it.

[T-Bone]

I'd say it should be expected that the participants who were given a round number would be more likely to give a round number in response. But it is interesting that they would also give a lower number. Maybe next time I see "The Price is Right", I'll watch to see if the first contestant's guess tends to have an effect on the 2nd contestant. :D

But the home prices data seems to be a different animal than retail pricing. I'd think someone pricing a home at a round number likely would have picked that number out of the air. While I'd expect an exact number to be the result of closer scrutiny of value, and be less negotiable.

And that's probably the truth in many cases. The owners of homes that list a round price probably are more willing to negotiate. And that may explain much of those results. But the question is, how much influence does that have on the expectations of buyers? Would listing for 496,500 actually get you more than listing for 500,000? Perhaps.

[Bruce Webb]

"Even wonder why retailers price goods at $4.99 rather than $5.00? There may be a good reason:"

Yeah, it has been proven to work, retailers can see the effect in their sales. And I don't know that it can be explained simply on the $20.00 vs $19.99 leading number effect. Because gas prices show the same dynamic when the price difference of .1 cents couldn't possibly matter. Yet apparently gas at $3.37.9 sells better than $3.38. Somehow I think we are trying to extract too much rational behavior here, people react to marketing signals at levels too small be be explained by some sort of mental calculation.

Though for what it is worth I would think T-Bone has the housing piece probably right.

[Real Person from the Real World]

I had a marketing teacher in my graduate program who said it was the French who first started pricing things like this, in the 1800s.

[cm]

Bruce Webb: I have yet to see a station not listing a price ending in 9/10 of a penny, at least in areas where stations are proximate enough to compete to begin with.