How are pricing and perceived value of a product related?

Price acts as a huge quality signal. One of my favorite studies on the subject is one done by Professor Dan Ariely. He had a hypothetical painkiller he called Veladone Rx. In reality, in this experiment, it was nothing more than a sugar pill. There was no actual active medication in it. But the participants didn’t know that. It was paired with literature that said “clinical studies show over 92% of patients report relief in 10 minutes.”

In the first variant, people were told that the drug cost $2.50 per pill. In the second variant, people were told each pill only cost 10 cents. Both groups were then subsequently given small electric shocks after taking the pill, in order to gauge the effectiveness of Veladone Rx. What do you think happened between these two groups? It was the same exact pill, and isn’t medicine...well...medicine — even though this is a sugar pill?

It turned out 39% more people reported reduced pain from the higher priced pill! 85% reported reduced pain from the high priced pill, and only 61% from the 10-cent pills. Remember: It was the exact same pill! The only thing that differed was the price they were told it cost.

Professor Ariely ran another experiment like this, but this time with a beverage called SoBe. This SoBe drink had ingredients that could purportedly help with mental acuity and performance, and students who were given the drink were told that at the time of consuming it. The experiment, though, was on the price they were told. Similar to the Veladone Rx example, one group of participants was told the drink normally cost $1.89. 

They were getting it for free as part of the experiment and didn’t have to pay, but that’s the reference price they were told. 

The second group, though, was told the exact same drink normally cost 89 cents. The students were told it was discounted from $1.89 to 89 cents per can because of a university discount. Again, they weren’t actually paying at all, they were just told different reference prices. For the exact same drink.

Then the students were asked to do a series of different mental puzzles. The result? The people who were told the cheaper reference price ended up performing 30% fewer mental puzzles than the other group! They subconsciously inferred how effective the product must be if it was cheaper and discounted.

This is quality signaling at play. This is when customers infer meaning about the product based on attributes of it or its environment. From these examples, we can see that just the number we choose to charge customers actually plays a huge role in whether or not they get value out of it. Higher prices can actually increase perceived effectiveness, regardless of product attributes.

What’s the psychology that powers this? Oftentimes, when we have purchased really expensive things, they’re really good products! There can absolutely be a correlation between price paid and the actual quality of the product or service. So we’ve formed this mental shortcut over time that expensive things are likely better.

For your marketing, this means you should sometimes actually raise prices to help people find your product even more valuable. On a related note, be wary of using too many promotions, because it could erode perceived value over time.

The price is traditionally based on two things:

1. How much value the thing is or has created
2. How much the provider splits that value capture with the customer

Some strategies say minimize #2. That would be Google Ads (take a small slice of a huge pie).

Other strategies say maximize #2. That would be Warner Bros. Studios (take a bigger slice for the risk of fronting cash on a blockbuster movie).

I weirdly view those two levers as independent (you can measure #1 somewhat objectively within a range, #2 is more a strategy choice).