The Science of Growth: How Behavioral Economics Drive Corporate Performance

This is the first of several articles on the subject.

As much as we may want to believe we are rational beings, we humans are not. For reasons I will explain below, we make decisions, especially purchase decisions, that the seller can influence. Naturally, the way every seller wishes to influence the buyer is to increase the buyer's willingness to buy, which increases sales volume or the closing rate, if that is your preferred measure, and to increase the buyer's willingness to pay, which opens up the possibility of higher, more profitable prices. Leveraging behavior science can also increase customer satisfaction, as buyers receive a product or service that they perceive better meets their needs. Companies using behavioral science effectively can achieve all three objectives simultaneously. This is the Paradox of Price.

Warren Buffett once said, “Price is what you pay, value is what you get.” So, if the seller can increase the buyer’s perception of value, prices can increase without loss of sales volume.

So what is behavioral science then? Well, it is scientific research that seeks to understand how we humans behave. This is more involved than many of us think, as we are not, as mentioned above, rational beings. Behavior science has proven that every human decision is influenced by a wide range of factors and in this series of articles we are focusing on the factors that influence a potential buyer’s purchase decision. Some of those influences are external to the decision maker and affect the purchase decision at the moment of decision, while others build influence over a long period. Some influences are internal to the decision maker, e.g., memories of prior purchases and experiences with brands, purchase channels, or salespeople. Some are memories of what a person has seen, heard, and read about the products of service choices they are presented with, and of messages (advertising or comments from family members, friends, colleagues).

Specifically, when it comes to leveraging behavioral science to drive sales volume growth and pricing, there is a subset called behavioral economics, which has generated four Nobel Prize winners. (The Nobel Peace Prize is the best-known Nobel Prize, but there are five other Prizes; in Physics, Chemistry, Psychology or Medicine, Literature, and, relevant to this article, Economic Science.)

Let's examine what behavioral economics means for companies and their efforts to sell products or services, either in the consumer market or to other businesses.

Emotions

It is well established that the vast majority of purchase decisions are emotional. Thus, virtuality every purchase we (and, more importantly, your customers) make, including B2B purchases, is emotional. The purchaser considers the options presented, and the limbic system in the brain makes the decision. The limbic system is a network of deep brain structures primarily responsible for processing emotions, forming long-term memories, regulating basic drives (such as hunger, mating and the fight-or-flight response), and driving motivation. In this case, it decides what is best value vs price. The decision that feels right. But because we see ourselves as rational beings, we also use the prefrontal cortex to add rationality to the decision, once it is made. We, and your customers, add this rationale for ourselves, and for those who might be interested in why we made the purchase decision we did. (The exception to emotional purchase decision is when selling to governmental agencies, which, by law or rule, is required to buy from the lowest bidder. However, this rule is starting to get compromised as agencies realize that always select the lowest bidder get them a sub-par product or service.)

This means that the company with the most emotionally compelling marketing messages will achieve the highest closing rate. This emotional message can be positive or negative. It is also well known that a message that evokes fear (e.g., fear of missing out, fear of something bad happening if a purchase is not made, etc.) is often more effective at driving sales volume than a purely positive message.

Unbeknownst to most companies, it is possible to effectively measure which messages drive a higher closing rate than other messages. This is a quicker, more accurate, and more comprehensive way to optimize messaging than testing. Which is what almost all companies do. (Spoiler alert: measuring which message leads to the highest closing rate is a core service at Sjofors and Partners.)

References

Behavioral science has also established that every purchase decision we make (and that your customers make) is made in the context of references. Some of those references are the messages and some are the result of the influences we all are subject to. That we just discussed.

When it comes to pricing specifically, we (and your customers) compare prices as we look at the choices we have. No surprise here. However, what few companies leverage is what Behavioral Economists call Price Anchoring. What this means is that when we are exposed to a product or service family with one product or service at a high price and one or two products or services at a lower price (for a less feature-rich product or service), the first price we see is stuck in our minds as an anchor point. This works even if the products are not identical, and means that if the first price a potential customer sees is the lowest, consequent higher prices will appear less affordable. Conversely, if the first price the customer sees is high, subsequent prices will appear more affordable, increasing the closing rate for those products or services.

It means, among other things, that companies with a good-better-best offering should present it as best-better-good. This can be done easily for those who sell from their website, as well as for companies that sell via custom proposals. It also works for companies selling via price lists and for restaurants (think of the menu as a price list.) The key is that the most expensive choice must be the price the potential customer read first - only then does it act as an anchor point that drives up sales volume. Since we read from top to bottom and from left to right it means that the anchor price shall be on top and/or to the left.

The most extreme and effective way of price anchoring I have seen was when Apple launched the Watch. There were $17,000 and $349 versions. The difference was the case. While the electronics were the same, one had a case in solid gold. Guess which one! Every journalist who followed this launch talked about the nerve of selling the same electronics for $17,000 and $349. And for everyone reading what they wrote, $349 became increasingly affordable. One reason the Apple Watch is now the market-dominant smartwatch. Did Apple sell many of the $17,000 version? I don’t think they did, but it was not there to be sold. It was there as a price anchor.

Recall

Behavioral economists have found that we perceive our risk of making a purchase to be 2.25 times as influential on the purchase decision as our perceived benefit from said purchase. We are risk-averse. We can call this sales friction.

And this is where “brand” comes in. If you think about it, a brand is nothing more than a promise of trust and consistency, something that reduce the risk of a purchase. When a buyer are about to buy something the he or she trusts, it also increases willingness to pay, thus allows for higher prices, and, because of the trust, higher customer satisfaction. Behavioral scientists also discovered that the brand we are most familiar with, or the brand we most recently saw, or was exposed to, is the most effective in increasing our trust in that particular brand among the brand choices we are about to make. This is why large consumer goods companies relentlessly push just the brand name and logo (often large signs along freeways and main roads, or on sports stadiums). Or, with brand advertising (no value statement, just the brand and logo) in media outlets focused on business. To increase our chances that just their brand would feel more familiar than other brands because it is the brand we saw the most, or the brand we saw most recently.

This is already a long document and I will continue this review of behavior science and pricing in consequent articles, but what does we covered here mean for your business?

It means that the price of your product or service is highly intertwined with marketing. The messages and marketing channels you use, the way price is presented to potential buyers and the frequently an style of any advertising your company does. “Just” publishing a price without knowing how marketing affect willingness-to-buy and willingness-to-pay inevitable means that money you rightfully could earn is left on the table. Having that knowledge typically lead to a doubling of sales growth and 25%-40% higher margins. And market leadership. Something you probably want…

In our next article, we are going to continue and cover various behavioral science topics and how it affects how you optimize your marketing and pricing strategy. Watch out for that!

Per Sjofors
Founder
Sjofors & Partners