The Psychology of Price Anchoring
What's price anchoring? “How do you sell a $2,000 watch? Put it next to a $10,000 watch.” That's price anchoring.
An entire field of study is developing around how the human brain determines value. Neuroeconomics is a nascent field at the confluence of economics, psychology, and neuroscience in the study of human decision-making. Learning how to apply the lessons of neuroeconomics can be part of a successful business strategy for builders.
Researchers at Duke University made an interesting discovery: The same area of your brain that determines your emotions about a purchase also determines the value you associate with the purchase. Scientists previously thought separate areas of the brain were responsible for processing emotions and economic decisions.
Brains do some pretty funny things when making a buying decision. If you understand your customers’ brain activities, then you can use this knowledge to help increase your sales and deliver on value.
Early impressions form a bias
Here’s an old adage in advertising: “How do you sell a $2,000 watch? Put it next to a $10,000 watch.”
This is an example of price anchoring. Anchoring is a cognitive bias that describes the common human tendency to rely too heavily on the first piece of information offered (the “anchor”) when making decisions. During decision-making, anchoring occurs when individuals use an initial piece of information to make subsequent judgments. Once an anchor is set, the brain makes adjustments based on that anchor. In other words, when interpreting new information there is a bias formed by the anchor.
If you are selling watches or wine, then price anchoring works to create demand for a lower-priced item when compared to a higher-priced item. The purpose of this post is not to show you how to become the $2,000 watch (the lower-priced item). The idea is to persuade your customers to buy the $10,000 watch (you), even when compared to the $2,000 watch (the “other guy”).
The key to price anchoring for a construction company is the same whether you are a general contractor or a specialty contractor. You set the standard to which all others will be compared.
If you’re not first, you’re last
To use price anchoring to your advantage, even if you are the higher price, you have to be first. If your price is higher than the customer wants to pay, that customer will still use your price as a reference to base his/her buying decisions.
An example of anchoring:
“..the initial price offered for a used car sets the standard for the rest of the negotiations. Prices lower than the initial price seem more reasonable even if they are still higher than what the car is actually worth.”
Being first and being high is much less of a liability than being last and being high. When you are the first to the table, you have the unique opportunity to educate the customer on the value that comes with your price. You have the opportunity to set the expectations for the customer. You have the opportunity to create an experience for the customer.
When you are late to the price game, the anchor has already set the tone for the experience. You want to be that anchor.
How to set the anchor for a construction project
1. Set the bar high
When someone asks you for a ballpark or estimated price, make the number high. First, this is a technique that you should use to determine the budget and commitment of the buyer. Second, anchoring a high estimated price will raise the value of the final sale price.
William Poundstone, author of Priceless: The Myth of Fair Value, says:
“People tend to be clueless about prices. Contrary to economic theory, we do not really decide between A and B by consulting our invisible price tags and purchasing the one that yields the higher utility. We make do with guesstimates and a vague recollection of what things are ‘supposed to cost.’ ”
Poundstone tested this theory. Real-estate experts and undergrad students were asked to appraise a home for sale. The researchers provided the experts and the students with the typical information a buyer would have as well as four listing prices for the home. Then they split into groups, and each group was asked to give their appraised value.
Here were the results:
Even the experts got it wrong. In general, the real estate agents (with 10+ years experience in those markets) seemed to tie their appraisal value to the listed price.
Get to an estimated price as soon as possible, and set that estimate high. When you receive more specific information about the project, you will be able to come off the high estimated “anchor” price. You’ll look like a hero.
2. Use precise numbers
An estimate is a guess based on experience. An estimate is not a bid, quote, or proposal. Start using your guess as a price anchor.
To move from an estimate to a bid, quote, or proposal you need precise information about the project. If you take this precise information and return a rounded number for the work, then you will be subconsciously communicating to your customers that you don’t know what you are doing.
Carmen Nobel writes in her post When Negotiating a Price, Never Bid with a Round Number:
“According to a recent study of mergers and acquisitions by Petri Hukkanen and Matti Keloharju, investors who offer ‘precise’ bids for company shares yield better market outcomes than those who offer round-numbered bids.”
“[This] research builds on several previous social psychology studies showing that people place more value on precise numbers than on relatively round numbers. People tend to assume, true or not, that someone must have crunched lots of data to come up with an amount so specific. A round number, on the other hand, suggests that a person is just ballparking it — offering an approximate valuation based on vague knowledge.”
No matter how much homework your customer thinks they have done, you are the expert. You will determine the price of the project based on the scope, quality, and schedule that your customer requests.
Use the specifics of your price to aide in establishing your authority with your customers.
For example, you and I both know that a complete gut and remodel of the 7×10-foot bathroom your potential customer just described will cost somewhere between $15,000 to $20,000. You tell your customer the project will cost about $25,000. This estimate sets the anchor price high.
If you then prepare a proposal that prices the project with a rounded number like $18,000, your potential customer may subconsciously think you didn’t do your homework. “How can something so complex be exactly $18,000?” your customer will be thinking.
Don’t ever use a round number. Using a round number suggests room for negotiation. Even if you don’t calculate every nail, 2×4, and hour of labor, you should still produce an exact number.
Instead of proposing a project price of $18,000, you should give them a written proposal that shows the price to be $18,173.89. The former number says you are just guessing. The latter says you have done your homework and you know exactly what the project entails.
If, by some stroke of mathematical luck, your calculated price is a round number, then make the price a precise number. There’s is almost no risk in doing this. If your customer is not going to buy from you at a price of $18,173.89, then that same customer was not going to buy from you at $18,000.
“Precision also indicates determination.” — Carmen Nobel
Here’s an easy experiment you can do to prove this point. The next time you call a company meeting, tell your employees that the meeting starts at 7:06 am. If they ask you why, you simply tell them “because that’s when it starts.” How many employees will feel the pressure to show up on time to a meeting that starts precisely at 7:06 am as opposed to 7:00am?
3. Use the power of context
Gregory Ciotti writes in the Huffington Post:
“Is there ever a time that one Budweiser is worth more than another? Logic would dictate that this answer be no, but bar hoppers know that just isn’t the case. Where you buy is just as important as what you buy.
“In a Vanderbilt University study published in the New York Times Magazine, customers were willing to pay higher prices for a Budweiser if they knew it was coming from an upscale hotel versus a run-down grocery store.
“According to economist Richard Thaler, it was context that had the effect here. The perceived prestige of the upscale hotel allowed it to get away with charging higher prices.
“It struck subjects as unfair to pay the same.”
This explains why people will pay more for a product at certain location and less for that same product at another.
You may be selling a product as part of your business, but most likely you are selling a service as well.
Provide potential customers with an experience that justifies your premium prices. Perception goes a long way toward influencing their evaluation of your prices.
Here’s how to add to the context of selling your anchor price:
- Promptly answer calls and requests.
- Respond to requests and changes in a timely manner.
- Provide a clear path of interaction and communication.
- Place high-quality branding on everything — shirts, hats, notepads, vehicles, website, etc.
- Produce detailed scopes of work, proposals, designs, and contract documents.
- Employ people who speak with respect, look customers in the eyes, and have a firm handshake.
- Maintain safe, clean, and orderly job sites.
- Use advanced tools, equipment, and construction techniques.
A low-priced construction business may have some or most of the items listed above. Those businesses are the run-down grocery store.
Your business is the upscale hotel, where customers expect to pay more because you have all the items listed above. Your business puts them on display at all times. You are selling the experience others can’t provide.
No tricks, just science
The use of price anchors in your construction business is not deception or trickery. The techniques presented in this post are pure behavioral science. Marketing professionals were using the science of neuroeconomic principals before the word neuroeconomics existed. The human brain is wired to make purchasing decisions from the same area that also controls human emotions.
Prince anchoring will stimulate the emotional part of your customers’ brains during the sales process. This sales technique will also give you an advantage over your competition that did not set an anchor.
Anchor high. Sell value. Deliver an experience.
More about running a successful business:
How to Grow a Construction Business, Part 1 — Growth may be the goal, but undisciplined growth will put you out of business.
How to Grow a Construction Business, Part 2 — Labor is typically the single largest expense in a construction business. Make sure you’re keeping track of it correctly.
How to Grow a Construction Business, Part 3 — Data is key. Knowing which data to analyze and how to review it will drive the growth of your construction business.
How to Grow a Construction Business, Part 4 — You probably aren’t as good a communicator as you think you are. Meeting frequently with your team is essential.