- Royal Caribbean allows customers to purchase more goods and services to use on the cruise while they book it – a strategy designed to increase its revenue.
- It makes those onboard expenses seem smaller at the time of purchase and changes the way customers think about their spending habits once they’re on the cruise.
- The phenomenon is explained by a behavioural-economics theory that businesses use all the time.
How much should a TV cost?
It seems like a simple question, but it can be difficult to answer. Of course, it depends on factors like size and quality – but once you’ve determined those, it’s still hard to figure out what the price should be without referring to other TVs you seen, owned, or read about in the past.
Even then, a 55-inch Samsung TV for $US700 might seem more or less expensive based on context. If you’re spending $US3,000 on speakers, furniture, and video game consoles to accompany the TV, paying $US700 for the screen itself might seem like a bargain.
But if you’re browsing at Best Buy and see the $US700 TV next to a $US500 TV, the $US700 one may seem more expensive.
This tendency contradicts a classical economic theory that says we determine the value of goods and services as an absolute dollar amount and evaluate any good or service against that, regardless of circumstance. So if you value a TV with the capabilities of a 55-inch Samsung model at $US700, you’d be willing to pay up to $US700 for it in any context.
We think about prices in reference to other prices
But behavioural economics, a hybrid discipline that fuses economics and psychology, suggests otherwise.
In 1979, the psychologists Daniel Kahneman and Amos Tversky released an influential paper called “Prospect Theory: An Analysis of Decision Under Risk” that introduced the idea of a reference point as a benchmark to evaluate investments.
Reference points can arise from several factors – for example, you might compare a TV against other TVs in a store, the last TV you bought, and the total price of the goods and services you plan to purchase in addition to the TV.
Michael Bayley, the CEO of Royal Caribbean, uses reference points to increase how much money customers spend on the company’s cruises, allowing them to purchase more goods and services to use on the cruise while they book it.
The idea was that spending $US100 on a drink package, for example, would seem less expensive if you bought it alongside a $US1,500 cruise ticket.
If your reference point for what that cruise should cost is $US1,800, then buying the drink package to make your total pre-cruise expenses $US1,600 still feels like a deal.
And once you’re on the cruise, you’re less likely to consider the cost of the drink package when buying other items, meaning you’re likely to spend more overall.
“What we found is if you spend $US100 before you sail, that’s spent and gone – you don’t even put it in your budget for when you’re on vacation,” Bayley told Business Insider in an interview. “So every pre-cruise revenue dollar that we generate will often generate 50% more onboard revenue for that customer.”
The strategy worked, and it was one of the reasons Royal Caribbean doubled earnings in the three years since Bayley became CEO at the end of 2014.
Businesses influence the frameworks we use to think about prices
Royal Caribbean is far from the only business that uses reference points to influence your spending behaviour. Walk into any store, and they’re everywhere.
“These are used on price tags, these are used in advertising, this is used inside retail stores on signage – all of which are ways to try and get you to anchor on a particular price, so it is against that price that you would then evaluate the current offering,” Priya Raghubir, a marketing professor at New York University’s Stern School of Business, told Business Insider.
When a bookstore runs a “buy two get one free” promotion, it’s encouraging you to use the price of three books as your reference point for buying two. So even if the total cost of the books is more than you would have been willing to pay if each had been discounted separately, you still feel as if you’re coming out on top.
And when a clothing store advertises a $US20 discounted shirt by urging you to compare it to another one that costs $US40, it wants you to use $US40 as the reference point for that particular shirt, even if no other store would sell it at that price.
Raghubir says that being aware of your tendency to use reference points still won’t make you immune to pricing strategies designed to increase your spending, not even for the economists and psychologists who study them.
“These biases are really strong,” Raghubir said. “Even if you are aware, you are unable to control their influence.”
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