How to Implement Decoy Pricing to Increase Profit Margins
Decoy pricing is a common strategy used by companies to steer consumer attention towards a specific item by introducing a third product, hence the reason why it is called decoy pricing. This pricing method is designed to increase revenue by maximizing sales of high-profit goods.
With the goal of boosting the bottom line, pricing methods set item rates that satisfy the company and customers. Depending on the company, decreasing or increasing prices can boost sales and profit margins.
It is reliant upon management to determine how to manipulate prices to generate the most profit based on various industry factors, such as demand and market price. In decoy pricing, an item is priced not just to promote its sales, but the sales of other items.
5 Steps for Decoy Pricing
The decoy pricing method aims to maximize the sales of a designated target product by introducing a low-priced decoy item with a perceived lower value. Decoy products can also be priced higher than the target product but only offer slightly better quality.
Strategically grouping similar products at different price points "forces" the consumer to buy the high priced item without realizing it. While consumer preference is predictably irrational, by offering a slightly more expensive good with additional features next to the product that offers fewer accessories, the customer recognizes the better value. This marketing strategy is known as the decoy effect.
For example, a customer looking for a television sees two options - one retails at $230 and has a 42-inch, high-definition screen, while the other is $430 and has a 60-inch, high definition screen with multiple inputs and a free streaming service subscription. While not apparent at first, the more expensive television has a better value and may be what the consumer prefers.
However, if a third option is presented, and the decoy was offered at $390 with a 55-inch, high definition screen, and limited ports, the value becomes more evident. If the customer only spends $40 more, they can get a larger screen, more inputs, and a streaming service.
Decoy marketing can be implemented by offering a three option plan. The middle option, or preference two, which is asymmetrically dominated, increases the target item's perceived value to sway the buyer's preference. General steps for decoy pricing are-
1. Determine the Target Item - Management should determine what item they would like to sell more based on its features and profit margins.
2. Present 3 Products - Once the target item is determined, two other similar products that vary in features and quality must be offered.
3. Price Products According to Model - Two goods should be priced lower than the target item and offer fewer features to portray lower quality. One product should be significantly lower in price and quality, while the decoy item is priced seemingly high but offers better value. The target product, which is presented third, is then priced the highest but clearly advertises higher quality.
4. Ensure Your Pricing is Intentional - It is vital to price products to aim sales at the target item, not the decoy. The target item's price should reflect its quality, so it seems reasonable to the buyer.
5. Price Decoys Similar to the Target Item - The cost increase from the decoy and target item should be the smallest difference between all three products. The target item should only be slightly higher than the decoy to make its value obvious to customers.
Psychology Behind Decoy Pricing
Decoy marketing is not a devious trick, rather a calculated tool based on human cognitive bias. People make decisions based on their judgment of standard and quality. The decoy pricing model takes advantage of this tendency by using the following-
When a person is required to make a decision, they use the context of the situation to help them. Therefore, the way an option is presented by another directly affects how the person is going to react.
When it comes to retail, the way the buyer perceives an item's price and quality ratio will affect their decision-making. Choosing one product over another based on the value is known as cognitive bias. However, targeting cognitive bias in decoy pricing relies on the compromise and attraction effects.
The compromise effect explains that consumers will lean towards buying the product that falls between the least and most expensive products, known as the median. The buyer decides that the cheaper good must be low quality, while the costly item has unnecessary added features. Therefore, the median must be of adequate quality without excess components.
However, within the compromise effect, the decoy item is the median. To create a balance and redirect attention to the target product, another product must be incorporated.
Applying decoy pricing would require adding another item that is of the highest quality and significantly more expensive to counteract the compromise effect. This additive would make the target item the median, directing consumers' attention back to the desired product.
The attraction effect, or asymmetric dominance effect, is a phenomenon that occurs in decoy pricing when a third option is offered. If two relatively similar items have significantly different prices, most customers prefer the least expensive product. However, if a third option with more value and a high price tag is introduced, buyers tend to choose the high-value item.
The previous television example uses the attraction effect to guide consumers to purchase the television with the highest quality and cost. To the customer, the price tag is reasonable because they are getting more for their money. This can affect how marketers create effective advertisements.
Things to Consider When Using Decoy Pricing
Success from pricing strategies depends on the company's insight on competition, market demand, and cost of goods.
Even in decoy pricing, companies should consider their competitors' prices to determine if their own prices are too high or low. Items on either end of the spectrum could send customers away by being perceived as low quality or too expensive.
With time, product demand ebbs and flows, and businesses need to be able to offer flexible prices. As demand for an item increases, companies can raise their prices to optimize profit. However, if demand plummets, businesses should be willing to apply discounts to items to maintain sales.
Cost of goods is another element businesses must always consider when pricing as it directly affects profit margins. Price tags should be high enough to compensate for the product's wholesale price and inventory costs while incurring a profit. However, supply costs are continually changing as vendors also manipulate their prices to match demand and competition.
If suppliers raise prices or businesses want to find more affordable vendors to increase their profit margins further, companies should implement stock ordering software.
Ordering systems keep a close eye on inventory purchasing costs as well as other vendor catalogs to ensure the company is working with the most affordable suppliers. Management can search by products or local vendors to find a good deal, allowing them to offer their customers economically priced goods. By keeping inventory purchase costs low, businesses can stay competitive within their industry and boost their profit margins.