Having a small advantage over your competitors can make a big difference in a busy marketplace.
For that reason, advanced pricing strategies can bring you bigger returns with minimal effort. One of the most important — yet least understood — pricing strategies is the use of decoys.
A Calculated Rip-Off
Imagine you’re shopping for a laptop and you see 3 models:
- Laptop A is $499. It has a 12″ screen and 128 GB hard drive.
- Laptop B is $599. It has a 14″ screen and 128 GB hard drive.
- Laptop C is $489. It has a 12″ screen and 32 GB hard drive. It’s otherwise identical to laptop A.
Laptop C is laughably bad, right? Why not pay the extra ten bucks for another hundred gigs of space?
That third option is a decoy. The manufacturer created it not because they wanted to sell it, but because they wanted to make the first option look better in comparison.
If it just came down laptops A & B, you’d pick one based on whether you think the larger screen is worth an extra $100. But adding the decoy has made the 12 inch version seem like a better deal, subtly nudging you towards that option. (It’s safe to assume laptop A has a higher profit margin.)
How It Works
The decoy effect is a pricing strategy used when sellers want to persuade customers to buy one particular product among several similar ones. Few people actually buy the decoy, because it’s a lousy deal. Its true benefit is to alter the market share of the other products.
The decoy option, which is also called the “asymmetrically dominated” option, shouldn’t logically make a difference in the customer’s choice — but psychologically, it does.
In general, the ideal setup for decoy pricing involves three products:
- Product A is the product that the seller wants to showcase.
- Product B is an alternative; it might be higher quality and also more expensive.
- Product C is the decoy. It’s slightly worse than A, but can’t be compared to B.
C might be the same price or slightly cheaper than A, but offer significantly less value. C is still a viable low-cost option compared to B, but it’s obviously worse than A.
The fact that C is a bad deal means product A looks better when you compare all three. As a result, more people buy A when the decoy is present, than they would otherwise.
How To Use It
First, narrow down your offerings to two choices. Research shows that having more than 3 options makes it too hard for customers to compare them. So decide on 2 options that you want to offer.
Between those two, there is likely one that you’d prefer to sell. It might be because it’s easier to make, or because you have a higher profit margin on that option, or any other reason. The superior choice from your perspective is the one that you will target with a decoy.
Create a third option (or package) that is similar to your preferred option, yet clearly a lesser value.
This is why it is called an asymmetrically dominated choice — your preferred option is a better deal, “dominating” the decoy, but the other option (e.g., laptop B) does not dominate the decoy. In other words, laptop A ($499) dominates laptop C ($489), but to compare laptop B ($599) is apples and oranges.
Customers who compare all three options will see your preferred option as the best value. Thus, offering the decoy — which you have no intention of selling — steers customers towards your preference.
Decoy pricing makes use of a quirk of human psychology. People place a lot of importance on what is right in front of them, even though one or more of the options might be irrelevant from a logical perspective.
By offering a decoy, you can guide customers towards the product that you would prefer them to buy — the one that is most similar to the decoy, but clearly a better value. This pricing strategy can make a big difference in your profits, as well as give you more control over the products you sell.
Appendix: The Research
The decoy effect violates the most basic assumption of economists: that humans are fundamentally rational. How can an undesirable option make people more willing to buy a desirable one? It shouldn’t make a difference, right?
However, it’s proven that the presence of a decoy can affect how much customers value the other products on their “short list.”
The largest body of research into this began with Tversky and Simonson in 1992 — but economists, psychologists, and marketing experts had documented the decoy pricing effect as early as Huber in 1982. Although decoy pricing shouldn’t work if people are perfectly rational, it does — adding a decoy really does change the proportions of people choosing the other products, and researchers in different fields have shown that it occurs in many different markets.
Photo by Cheryl Kohan / Creative Commons