Why Things Cost $19.95

Submitted by Dmitri Davydov on Wed, 2008-04-09 18:45.
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Ever wondered why retailers price goods at $4.99 rather than $5.00? Here is the best scientific explanation I read:

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. ...

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