A Beautiful Mind
On March 4, 1837 on The shores of Lake Michigan, Chicago was incorporated as a city. It took little time for word to get out about the prosperous city. It’s location between the great lakes and the Mississippi River allowed it to flourish as a hub for trade and commerce. For several decades it was it was the fastest growing city in the world.
Entrepreneurs from around the world flocked to Chicago, seeking to make their fortune in the fast-growing metropolis. Melville Elijah Stone arrived in the city in 1875 with a bold new idea. A newspaper. A newspaper in and of itself would hardly be consider bold or new. The city already had several, and by the time newspaper met its end the city had seen over 47 different publications. Most papers in 1875 had a few things in common. They all catered to the city’s elites, and they all charged a nickel. Melville wanted to write a paper for the masses, with stories that would appeal to everyone, and a price that anyone could afford. One cent.
The paper became an immediate hit. Average Chicagoans loved the stories, and more importantly, they loved the price. They only problem they ran into when buying the paper, is that it was sometimes hard to come up with a penny. The coins had become difficult to find as the coins were not commonly used in 1875. Melville was faced with an interesting problem. His customers loved his product. And they loved his price. But they couldn’t find the right coins to pay him with.
Melville Stone is not one to give up easily. He needed to get more pennies into circulation. And to do that, more retailers needed to make change for their customers. Common practice of the day was to price items in whole amounts. Five cents for a candy. One dollar for a sack of flour. Change wasn’t needed because prices were round numbers. Those round prices made transactions easy for customers, but they presented a problem for business owners. It was all too easy for a store clerk to simply pocket a dollar and hand over the sack of flour. The till would never be opened, and nobody would have to know. Melville saw an opportunity to solve that problem for retailers, many of whom were his advertisers, and solve his penny problem.
If a shop owner charged 99 cents for that ck of flour, the clerk would be forced to make change for the customer. In doing so the cash register would be opened and the sale recorded. Business owners would only lose a single penny of profit on the sale, but they could entirely circumvent employee theft. Businesses owners loved the idea. They were quick to adopt the 99-cent model. They cut down on theft. And Melville’s customers had the pennies they needed.
What happened next, is what makes Melville Stone one of the most influential (and annoying) people in the history of retail. As competing national businesses came to Chicago, the local stores who had adopted Melville’s pricing model noticed they were doing significantly better than their competitors. The national competitors soon wanted to figure out why they were struggling to keep up, and before long they too began pricing their products using Melville’s 99 cent model. They took that practice to other markets, and in short order Melville’s pricing model took over retail as we know it.
Psychological pricing has come a long way since its humble beginnings. While it can be difficult to get the exact numbers, it is estimated that somewhere between 65 and 75 percent of all prices end in 9. Our brains are remarkable organs, capable of far more than we sometimes give them credit for. But they also come with weaknesses. Psychological pricing preys on the idea that we read from left to right, and thanks to anchoring bias we assign more value to the first piece of information we receive. Our brains assign more importance to the first digit, say 3, and less importance to the trailing digits like 9.99, thus leading us to feel that 39.99 is closer to 30 than it is to 40.
Many of you may be reading this thinking you are aware of this little trick, and it doesn’t work on you. And you may be right. Many of us have trained ourselves to look past the 99-cent pricing model. But consider these examples.
A 2011 study of financial markets found an excess in buying activity at just below prices ($1.99) vs round dollar prices ($2.00) just above them. This discrepancy in buy-sell can lead to meaningful impacts on the market.
Political Research conducted in the Netherlands suggested that when overall student test scored fell without changing the leading digit (87 to 82), voters were far less likely to approve additional education spending than when a change in scores affected the leading digit (83 to 78).
A 2014 study on the effects of price changes and smoking found that price increases that raised the leading digit were far more successful in lowering the smoking rate, than increases that did not change the leading digit.
Whether you have mastered psychological pricing or not, learning to recognize and control your biases is a vital element of achieving financial success. 99-cent pricing is just the tip of the iceberg. When managing your retirement accounts, you must be prepared to deal with; confirmation bias, information bias, loss aversion bias, hindsight bias, sunk cost bias, bandwagon bias, familiarity bias, and countless more. Your brain can be your greatest asset when it comes to your investments. But if left unchecked it can also become your greatest adversary.