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Retailers use ‘decoy effect’ to lure consumers into buying pricier products: study

Posted 2021-08-09
When UBC Sauder School of Business Associate Professor Chunhua Wu (he/him/his) set out to buy a diamond engagement ring, he had no idea it wouldn’t only charm his bride-to-be: it would also inspire ground-breaking research into a product pricing strategy called “the decoy effect.”

Also known as the attraction or asymmetric dominance effect, the decoy effect happens when consumers are offered different options for a particular product, and are naturally nudged toward a pricier choice.

For example, a half-carat diamond might be priced at $3,000, while a higher quality one-carat diamond is $10,000. But if the seller also offers a 1.05-carat diamond for $9,500 — in other words, higher quality for a lower price — it entices the consumer to compare the two more expensive products, and increases the chances they’ll opt for the better deal. (In this instance, the 1.05-carat diamond is referred to as the “dominating” option, while the one-carat option is the “decoy.”)

When Dr. Wu started shopping for diamonds, he first went to big-brand stores like Tiffany & Co., but soon realized there were online marketplaces where buyers could compare thousands of precious stones from a range of sellers. As he scanned the options, he noticed that prices were in constant flux, and that sometimes, higher quality diamonds were being sold for less.

That observation, in turn, inspired a study called Profiting from the Decoy Effect: A Case Study of an Online Diamond Retailer, which was published in the journal Marketing Science. For the study, Dr. Wu tracked sales data for each diamond on one of the world’s largest online jewelry retailers, and observed instances where certain diamonds were “dominating” other less attractive options.

“We show this effect is quite real in the marketplace — and in terms of economic significance, it really helps the marketplace gain additional revenue,” explains Dr. Wu.

In fact, the study found the decoy effect not only boosts sales; it increases the retailer’s gross profit by 14.3 percent.

For decades the decoy effect has been well-documented in lab studies, but in recent years, researchers have questioned how robust that effect is in the real world, or whether it’s an artifact of lab experiments. The new UBC Sauder School study is the first of its kind to clearly demonstrate it in action.

“Before this study, we didn’t know how significant the decoy effect was in the real marketplace, and there were quite a few papers debating whether it was even a real phenomenon,” says Dr. Wu, who explains that in lab settings people are given limited options and asked to choose, which isn’t how consumers experience real shopping environments. “So, we’re excited about the findings.”

The decoy strategy is used in everything from magazine subscriptions to food sales; however, Dr. Wu says diamonds were the perfect product to study because other consumer items have different attributes – such as different packaging and different branding, which makes them hard to compare in an “apples-to-apples” way.

“The diamond market is ideal for this type of research because quality is universally determined by physical attributes,” says Dr. Wu, pointing to what the industry calls “the four Cs”: cut, carat weight, colour and clarity. “So, the physical attributes are the same, they’re the same quality, and they’re from the same marketplace. So, it’s very simple for consumers to compare which ones are better and which are worse.”

What’s more, because there are so many diamonds available on online marketplaces such as Blue Nile, James Allen and White Flash, it’s easy to see a pattern of dominating and decoy options.

Dr. Wu notes that budget-minded consumers are more likely to discover the existence of decoys, and the effect is less likely to persuade them to buy; in higher-priced segments, buyers are less likely to discover decoys, and have a stronger motivation to buy immediately when they see what they perceive as a good deal.

The findings could have significant implications for retailers who typically price individual items based on factors such as cost and demand. “Now retailers can really think about the combinations of offerings they want to introduce to the market and how they price them,” says Dr. Wu.

Some savvy retailers already seem to be doing just that, he adds. For example, the price difference between top-tier Apple iPhones can be relatively small, and the features are significantly greater than the lower-grade offerings, which draws consumers to make choices at the higher end.

“These kinds of combinations are manipulating consumers’ minds in a subtle way. They're already targeting consumers to purchase more premium versions,” says Dr. Wu. But the decoy effect isn’t all bad news for consumers: it can also pay off in the long run.

“If consumers spend more time searching and comparing,” says Dr. Wu, “there’s the potential to find a really good deal.”

Interview languages: English, Chinese