The principle of prospect theory from psychology surprisingly applies to pricing strategy, revealing that customers' perceived value is not always aligned with actual value. This disconnect creates an opportunity for companies to capture more value without changing their offerings. The mechanism behind this is rooted in the way customers weigh gains and losses, which influences their willingness to pay. For example, the Danish company, Lego, successfully leveraged this principle by introducing a limited edition series, creating a sense of scarcity that increased customers' perceived value. However, this strategy can backfire if not executed carefully, as it may lead to customer resentment if the scarcity is perceived as artificial.
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Economics & Markets
Pricing Blindness Kills Margins
Most companies unknowingly leave money on the table.
Key insights
Prospect theory can be applied to pricing strategy to increase margins.
Customer perception of value is not always aligned with actual value.
Creating a sense of scarcity can increase perceived value, but must be executed carefully.
Why it matters
Ignoring this principle can result in significant revenue losses, as companies may be underselling their products or services.
Moreover, failing to understand customer perception of value can also lead to overinvestment in features or quality that do not translate to increased willingness to pay.
Use this tomorrow
1
Open your last 10 customer feedback sessions and count how many times the discussion revolved around the value proposition versus the price, to gauge the alignment between customer perceptions and actual value.
Go deeper
The concept of prospect theory, developed by Kahneman and Tversky, explains how people make decisions under uncertainty, and its application to pricing strategy can provide a competitive edge. By understanding how customers perceive value, companies can tailor their pricing and product development strategies to capture more value.
A key nuance in applying prospect theory to pricing is recognizing the importance of context and framing effects, as the same product can be perceived differently depending on how it is presented and what alternatives are available.