Never include free shipping - a starter guide to partitioned pricing
Should you include shipping in your price? Or service fees? Or the mandatory insurance – or any of the other of a million features? The answer is: No – but it does depend. Read this and understand the psychology behind.
Now, most companies worry about finding the optimal price for their product and service – and then get frustrated when their customers use price as the primary tool to compare the options available to them.
But really: who can blame them? It’s difficult to get a hard answer to whether tuna or swordfish is the better option. But it is easy to see which price is best: $19.95 or $24.95.
Luckily you can use your pricing structure to nudge your customers into considering the value of your offering in terms of quality and personal relevance.
And ironically you don’t try to move the customers focus away from price – instead you use the custmers own excessive focus on price to make them consider a series of meaningfull choices which allow them to see the overall value of your offering.
This method is called ‘Partitioned Pricing’ and it has a special application called ‘Drip Pricing’:
Non-Partitioned Pricing: Sweater: €143 – shipping included
Partitioned Pricing: Sweater: €129 + €14 in shipping.
Drip Pricing: … is asking for the shipping fees at a later stage in the purchase process
So partitioned pricing is the practice of dividing up the total price into sub components. Drip Pricing is delivering those sub components sequentially – drop by drop.
Both are part of what Behavioural Finance calls ‘choice architecture’ and we will cover several pricing methods in this category in the following weeks. In this article, however, we will focus on how price partioning can help move focus away from prices and towards value.
Price partioning – the Morwitz study on online auctions
Let's say you own an auction house in fierce competition. How can you optimise your pricing?
First and foremost, you should adopt the interestings findings that Morwitz and her colleagues had on a series of online auctions.
In a range of findings, the team could show how customers’ perception of the products attractiveness and their subsequent demand would change depending on whether the starting price was a combination of basic price and shipping, or if there were split prices for product and delivery, i.e. a basic price and an add-on.
Their studies showed that lower opening prices combined with higher shipping costs attracted more bidders and yielded higher revenues than auctions with higher opening prices and lower freight costs. The consumers were influenced by the framing, so they focused on the base price and either ignored or forgot to include shipping costs, so the auction house earned more by partitioning the prices.
Partitioned pricing increases the perceived value of your goods or services
Paradoxically, this form of split pricing can also motivate your customers to look a little more at the quality of your various offers, especially when each sub price is a mandatory extra cost.
Bertini og colleagues were interested in knowing under which circumstances customers would chose a more expensive air line ticket. So they asked test participants to choose between two flights from Boston to San Juan:
1 Stop – No food, beverages or entertainment: $165
Direct – Food, beverages and entertainment included: $215
They tested four variations on how the more expensive flight was presented, to see what might induce people to choose it over the cheaper option. They created two levels of amenities, on the theory that six movie channels and a full-service lunch rather than an old sitcom episode and coffee or tea might cause more people to choose the higher fare over the lower one; and they tried price partitioning - some participants saw the higher cost as a lump sum and others saw it broken down ($205 for the flight plus $10 for the nonoptional amenities).
They found that the quality of the extra amenities on board made no difference to those who saw the price as a total lump. The proportion that chose the higher price did not change as the researchers raised the quality.
But for those who saw the split, quality increases to onboard services had a significant effect: the better service package attracted more customers to choose the more expensive journey.
This indicates that people are not inclined to recognise an improved service or extra benifit in their decision-making process unless they can see that an explicit charge is made for it.
Presenting a price as a series of smaller mandatory charges invites customers to a closer analysis of what it is they are buying and therefore increases the likelihood that they will revise their default consumption behaviour and fixation on price.
Drip Pricing – spacing out your price partitioning
One specific form of price partitioning that is widely used by anyone from grocery delivery firms to teleoperators is drip pricing.
So how does it work: Let’s say you want to buy a direct flight from Boston to San Juan and have seen a $205 price that you think is good. You spend some time typing in your information on a couple of consecutive subpages, and either during or at the end of the process you discover an additional $10 charge for mandatory amenities such as lunch and inflight entertainment.
In short: the price is higher than you first thought.
But often you – and everyone else - end up buying the trip anyways even though you might not have done that if you had known the full price at the start.
So drip pricing is partitioned pricing spread out over time. Each additional sub component of price is presented sequentially to the customer – sometimes as a mandatory information and sometimes as an optional extra purchase.
Drip pricing works, because it reduces the consumer's perception of the total price of the product or service.
Behavioural economics offer explanation of the psychology behind drip pricing, namely the biases escalation of commitment and endowment effect.
Escalation of commitment means that as you progress from one stage of the purchase to another, you’re already so engaged in the process that you complete the purchase despite feeling annoyed – helped along by the endowment effect that increases your sense of ownership of the products the more time you spend imagining it’s yours.
How to Partition your prices and drip them
To use Drip pricing you need to go through two steps:
You need to figure out which of your features and process elements your customers are willing to pay the most for.
You need to structure the choices to optimise conversion.
The firs step is essentially Partitioning your prices while the second step is figuring out how you sequence – drip – the prices to the customer.
How to divide to maximize perceived value
To figure out what your customers are willing to pay for you can plot all your features and process elements into this diagram:
The horisontal axis is pretty straightforward: your customers value things they actually perceive as a real benefit. This could be extra luggage allowance, better food, flexible checkin and so on. On the other hand they hate paying for what they consider to be features that add no value to them such as ‘checkin fees’, airport taxes, online ticket fees and added credit card fees.
In a restaurant setting this translates to the dessert being an actual real benefit while the mandatory $10 seating charge is considered non-value adding.
The vertical axis has to do with whether an element is optional or mandatory.
The top right hand quadrant is where you want to put some high value items like good lunch, 24 hour phone service, full insurance and everything else your customer actually wants and which carries a price.
The lower right quadrant is for the things you need to include to run your service – such as shipping fees, credit card fees, government taxes and so on. Your customer accepts these, are used to them and understand why you must charge it and why it is mandatory.
The top left quadrant is either completely empty, used for decoy offers (more on this in a later article) or used to sell add ons that are only valuable to a smaller subset of customers – booster seats for children for example.
The bottom left quadrant you just keep empty – because if there is something the customer hates its being forced to pay for something they see have zero value to them.
Small ‘papercut’ fees that the customer is just too exhausted to revolt against can be a solid revenue source and is considered necessary in some industries – like banking – they are also a major destroyer of goodwill.
Your customers will experience it as misleading and over time avoid buying from you again. They become annoyed, especially when they sense that you aren’t being straightforward about the total cost.
If you are having customer retention problems and are using these sorts of fees then give us a call.
Sequencing and Transparency
Now take a look at your diagram: you have some mandatory (valuable) features and then you have a bunch of optionals.
The mandatory ones you simply charge for as early and as transparently as possible. If people have to choose between mandatory options (like shipping), then include them as optional categories (see below).
Study after study shows that it is only in hypothetical scenarios that consumers are more likely to buy when you hide additional fees in the purchasing process.
Rather, when companies disclose all fees the buyers are more likely to purchase add-ons and to return to buy again. On the other hand, not disclosing additional fees as we often see in financial services is viewed to be deceptive and increases your customers’ feeling of regret with purchase, their resentment, and of being treated unfairly.
So: if you are going to charge for something – be transparent about it.
(and transparent means actively and loudly telling them – not disclosing it in the term sheet or mid-paragraph)
The Four-by-Four Rule of Drip Pricing
Now take all your optional features and process elements and group them into categories that make sense to your customers.
If you are an airline this might be “Luggage”, “Food”, “Entertainment” and “Insurance”. If you are an insurance company this might be “Additional Items Covered”, “Co-Pay / Self-Liability”, and “Payment Schedule” and so on.
Then ask your customers to choose for one category at a time. First they choose "Luggage", then "Food" and so on.
The rule of thumb is that:
No more than 4 categories – and no more than 4 items in each category.
So: don’t offer people more than 4 different items to choose from at any one time – and don’t take them through more than 4 choices. There is an abundance of research that shows that choosing get’s harder the more options we have and we tend to regret our choices more after we’ve chosen. So keep it simple. And 3 is better than 4.
Include an option of 'No Purchase' in each category (this counts towards your max of 4) unless you absolutely can't avoid not to
What about B2B? If you are selling industrial pumps and your customers expect 500 different item codes then of course you’d have to go about it differently – in this case introduce the drip pricing to set up shipping, payment and service options. But the psychology works just the same.
Is that it? Is it this easy?
No: To develop the right version of partitioned pricing to suit your business, it requires you to do some testing and to fit it to your particular circumstances.
But the underlying principle holds true almost universally: split up your customers purchase into sub components to increase their perception of value.
And be transparent about the choices they face to increase their sense of loyalty and fairness.
And avoid mandatory fees that the customer sees as having no value – these you just hide in the base price.
In addition you will see your drip pricing affected by a host of other factors such as:
how the price increase is presented (in dollars or as a percentage);
if the price is viewed as numerical total for each price increase or as an add on with a description of what the add-on is for;
how the options in a given category are sequenced;
the relative value and price of the options in a given category;
whether the customer is able to see the total price along the way, and
a range of factors linked to the seller’s reputation and the customers’ previous experiences.
These elements are all important and can impact your drip pricing materially. But that is in almost all cases a risk you are going to run whether you partition your prices or not – that’s simply the intricasies of price psychology.
The partitioning itself – and the drip sequencing – are powerfull tools to showcase the features and value in your product or service. You should consider using them.
Founding Partner, Behavioural Strategy
Bertini and Watheieu 2010
Morwitz, Greenleaf, and Johnson 1998
Morwitz and Santana 2000