Last year, J.C. Penney CEO Ron Johnson put an end to “fake prices,” the ones that customers see but rarely pay because of coupons and sales. Instead, the clothing retailer decided to sell items at cheaper everyday prices in an effort to “stop playing games” with consumers. By June, Johnson had conceded that this strategy wasn’t working. Penney brought back coupons in September; the return of clearance racks soon followed. But it may have been too late for Johnson; he got the boot on April 8 after a mere 17 months on the job.
Johnson may have thought he was doing customers a favor by making the shopping experience a more rational exchange of goods for their hard-earned currency. But by not showing marked-down prices, Penney’s removed an element that helps shoppers feel rational. Seeing that marked-down price next to a higher original price provides an important yardstick for gauging whether we should buy something.
The original price of a sale item provides what sociologists and marketers refer to as anchoring. It brings a sense of certainty to the uncertain, giving the shopper a wisp of information for evaluating purchases. Since most of us are pretty disconnected from where our products come from and how they are made, we often use price as a major data point when it comes to evaluating whether that sweater, headset or jar of jam is worth buying. We see a $14 shirt, and conclude based on its price that it must be a low-quality garment made in a sweatshop somewhere by overworked, underpaid workers. On the other hand, seeing a red line through the $50 price tag on a shirt that’s marked down to $14 indicates to us that the shirt is of high quality and that for $14, it is a steal.
The influence of this anchor price is comforting; it lends an air of rationality to our decision making. But in reality, there’s little that’s rational about it. (Or about much of how we decide to part with our money — just ask any casino owner, used car salesman or faux Nigerian prince.) A classic experiment demonstrating anchoring was conducted more than 30 years ago. Psychologists Amos Tversky and Daniel Kahneman of Hebrew University in Jerusalem asked study participants to watch a roulette wheel spin and then to estimate a particular quantity having nothing to do with roulette. In one instance, the wheel was rigged to stop on 10 for some participants, on 65 for others. Then the researchers asked the participants to estimate the percentage of African countries belonging to the United Nations.
Just seeing the roulette wheel number influenced how participants estimated the second number, the researchers reported in a paper in Science in 1974. On average, those who saw the wheel stop at 10 estimated that 25 percent of African countries were members of the United Nations at the time. Those who saw the wheel stop at 65 estimated 45 percent. (The true figure was upwards of 90 percent, depending on how you count countries. Kahneman was awarded the economics Nobel in 2002; Tversky died in 1996).
Anchoring has since been studied in numerous contexts. Its effects show up whether you are making a bid on a house, negotiating a salary or debating whether to buy a shirt. More recently, researchers have investigated where some of this decision making goes on in your brain. In one experiment, scientists gave volunteers $20 and had them look at products on a video screen while an fMRI machine scanned their brains. After seeing a product, such as a box of Godiva chocolates, they saw how much it cost and had to decide whether or not they would buy it.
When the volunteers saw something they liked, there was a burst of activity in their nucleus accumbens, a little area deep in the brain that’s associated with anticipating something good (and also linked to addiction). Their brains also betrayed the thrill of spotting a deal: There was activity in the medial prefrontal cortex, a favorite hangout of the reward chemical dopamine. During those moments, the insula, a region whose duties include the dismal task of anticipating loss and pain, was shut down.
Of course, Johnson made many other changes at J.C. Penney. No single thing can be blamed for his downfall. But the no-sales strategy removed an opportunity for shoppers to get a little dopamine kick and feel rational at the same time. Johnson should have known this — he came to J.C. Penney from Apple, a company that’s used price anchoring masterfully. When Steve Jobs introduced the iPad, he told his audience that if you listened to the pundits, an iPad would cost $999. A big $999 loomed on the screen behind him for nearly a full minute while Jobs went on about price goals. Then the reveal: The iPad would cost $499. The audience went wild.