MADE

One of the biggest misconceptions about pricing is the notion that people base most buying decisions on rational economic calculations. The truth is that they’re based far more on psychology most of the time.

There’s several ways to look at this. One is from a value standpoint. Most people would probably rather pay $4.50 for a cup of coffee at some run-of-the-mill coffee shop than accept a free cup. A free cup of coffee is probably a stale cup of coffee at most places. In general, people assign lower value to things that are free.

Take something as seemingly simple as a $10 magazine subscription. There’s a psychological chess match behind that price. If you observe the magazine industry carefully, you’ll notice that most consumer magazines that charge a yearly subscription fee tend to charge right around $10. But it costs more than $10 to get 12 issues to your mailbox. The cost of printing and mailing 12 issues to your mailbox is about $15. And when you factor in the cost of acquiring you as a subscriber, it’s about $30. But magazines make up most of that cost through advertising anyway. Many of them make such a large proportion of their money through ads that they might as well give the issues away for free. This is where we get into the realm of psychology.

$10 isn’t just $10. It’s also a psychological compromise. It’s meant to please two different audiences: advertisers and consumers. Someone who’s paid for a subscription is far more valuable to an advertiser than someone who gets free magazines because the act of pulling out your credit card and paying means that you want it. A paying customer makes an emotional investment that’s going to make him pay closer attention to what’s inside the magazine (including the ads) than the person who gets it for free.

But why pay at all? Isn’t free better? Well, not exactly. As I alluded to earlier, the human brain is hardwired to assign value to things that cost something. The simple reason for that is that a price signals that the product was difficult enough to make that the person who made it at least wanted to recoup the cost involved in making it. Things that are hard to make tend to be better designed and more intricate than things that are easy to make because they require a unique combination of skill and dedication; both relatively rare qualities in the real world. $10 seems to be the price point where consumers think that the product has value but isn’t too expensive and where advertisers think it’s not too low to devalue the product.

The price=value equation holds steady in the real world of atoms. But the cyberworld is where things get weird. The psychology there takes a strange turn. What if I started charging you $5 to read my articles? You definitely wouldn’t read them. Ok, what if I charged a penny to read them? You still wouldn’t read them.

Economically, a penny is a tiny investment. But psychologically, a penny means much more. Any price at all will stop most people dead in their tracks because of what George Washington University economist Nick Szabo calls ‘mental transaction costs”. It’s simply the cost of thinking. If given a choice, most people would rather not think than think because thinking requires energy and concentration. It’s hard. The economic implications of that are huge. When you introduce a price to something, you force people to think to themselves, “Is this worth paying for?”

The thing about the Internet is that there’s such an abundance of information and media and it’s so easy to get from one place to another that most people don’t think it’s worth their time and mental energy to think about whether something is worth paying for unless it’s clearly worth paying for. They can just move on to something else in a second.

In general, it has been easier to get people to pay for music online than written content. But the fact is that the vast majority of music isn’t good or unique enough to overcome people’s aversion to thinking “Is this worth paying for?” However, the greater enemy is just sheer abundance. There’s so much other stuff competing for people’s time online. We usually don’t expect to devote enough time or mental energy to convince ourselves that things are worth paying for.

Recommendations from trusted or familiar people on social networks and blogs helps, but the kind of systemic filtering that the record labels traditionally provided still isn’t there. It’s likely that most of the money in music will always be made in the real world because the perception of value there is high enough to overcome people’s mental transactional cost thinking.

An extension of this whole idea is in the area of online buzz. It’s not nearly as valuable as people think it is. A band that gets a ton of plays on YouTube won’t necessarily translate that into real money. It’s not necessarily due to lack of effort on the band’s part. It has more to do with the fact that from a viewer’s standpoint, the cost of viewing a video, hitting the “Like” button or posting a link on Twitter is extremely low. Viewing a video doesn’t make you a fan. The cost of attending that band’s concert, on the other hand, is much higher and meaningful. Not only does a fan have to pay money ,but he has to plan, which requires mental effort. And then he has to physically get himself there which involves a lot more than meets the eye. All of these events have time and space implications which aren’t nearly as significant online.

I’m not saying that online buzz isn’t useful. It’s truly replacing radio as a gauge of popularity. But I am saying that the ultimate measure of success should always be whether someone is willing to pay money for something; not because you want to get rich, but because a payment is one of the purest forms of endorsement. When people pay for something, they’re giving away much more than money. It’s all the things they had to go through to get that money, from dealing with the asshole boss day after day to the all-nighters they had to pull in college to get the degree to get that good job. That’s why money is always an emotional topic. So a payment should always be the ultimate endorsement.