Psychological pricing

Psychological pricing or price ending is a marketing practice based on the theory that certain prices have a psychological impact. The retail prices are often expressed as "odd prices": a little less than a round number, e.g. $19.99 or £6.95 (but not necessarily mathematically odd, it could also be 2.98). The theory is this drives demand greater than would be expected if consumers were perfectly rational. Psychological pricing is one cause of price points.

Overview
According to a 1997 study published in the Marketing Bulletin, approximately 60% of prices in advertising material ended in the digit 9, 30% ended in the digit 5, 7% ended in the digit 0 and the remaining seven digits combined accounted for only slightly over 3% of prices evaluated. In the UK, before the withdrawal of the half penny coin in 1984, prices often ended in 99½.

In a traditional cash transaction, fractional pricing imposes intangible costs on the vendor (printing fractional prices), the cashier (producing awkward change) and the customer (stowing the change). These factors have become less relevant with the increased use of checks, credit and debit cards and other forms of currency-free exchange.

The psychological pricing theory is based on one or more of the following hypotheses:
 * Consumers ignore the least significant digits rather than do the proper rounding. Even though the cents are seen and not totally ignored, they may subconsciously be partially ignored. Some suggest that this effect may be enhanced when the cents are printed smaller (for example, $1999).
 * Fractional prices suggest to consumers that goods are marked at the lowest possible price.
 * Now that consumers are used to psychological prices, other prices look odd.
 * When items are listed in a way that is segregated into price bands (such as an online real estate search), price ending is used to keep an item in a lower band, to be seen by more potential purchasers.

The theory of psychological pricing is controversial. Some studies show that buyers, even young children, have a very sophisticated understanding of true cost and relative value and that, to the limits of the accuracy of the test, they behave rationally. Other researchers claim that this ignores the non-rational nature of the phenomenon and that acceptance of the theory requires belief in a subconscious level of thought processes, a belief that economic models tend to deny or ignore. Research using results from modern scanner data is mixed.

Now that many customers are used to odd pricing, high-end retailers such as Nordstrom psychologically-price in even numbers in an attempt to reinforce their brand image of quality and sophistication.

Research
Kaushik Basu used game theory in 1997 to argue that rational consumers value their own time and effort at calculation. Such consumers process the price from left to right and will to tend to mentally replace the last two digits of the price with an estimate of the mean "cent component" of all goods in the marketplace. In a sufficiently large marketplace, this implies that any individual seller can charge the largest possible "cent component" (99¢) without significantly affecting the average of cent components and without changing customer behavior.

Kenneth Wisniewski and Robert Blattberg at the University of Chicago's Center for Research in Marketing showed that when the price of margarine was lowered from 89 cents to 71 cents, sales volume increased a mere 65%, but when it was lowered from 89 to 69 cents, sales volume increased by 222%.

In another study, the perceived value of all the numbers between 1 and 100 were studied, and 77 was shown to have the lowest perceived value relative to its actual value.

Schindler & Kibarian (1996) tested odd pricing using three versions of a direct mail catalog for women's clothing. The catalogs were identical except for the prices, which ended with 00, 99, or 88. The version with prices ending in 99 generated 8% more sales volume and had more purchasers than the 00-ending version. The 88-ending catalog produced a similar sales volume and number of purchasers to the 00-ending version.

Historical origins
Exactly how psychological pricing came into common use is not clear, though it is known that the practice arose during the late 19th century. One source speculates that it originated in a newspaper pricing competition. Melville E. Stone founded the Chicago Daily News in 1875, intending to price it at one cent to compete with the nickel papers of the day. The story claims that pennies were not common currency at the time, and so Stone colluded with advertisers to set whole dollar prices a cent lower &mdash; thus guaranteeing that customers would receive ample pennies in change.

Others have suggested that fractional pricing was first adopted as a control on employee theft. For cash transactions with a round price, there is a chance that a dishonest cashier will pocket the bill rather than record the sale. For cash transactions with an odd price, the cashier must make change for the customer. This generally means opening the cash register which creates a record of the sale in the register and reduces the risk of the cashier stealing from the store owner.

A third theory is that the practice arose during that period as an attempt by merchants to appear to be significantly underselling the competition while in fact lowering prices by only a small margin.