It’s often true that high-quality goods have higher price tags, and there are a number of rational reasons why this could be the case- higher production cost, more limited supply, higher demand, etc. Higher demand, in turn, is rationally due to increased utility from consuming the high-quality product. It makes sense then, to some degree, that people tend to take price as a signal of quality- after all, we don’t always have perfect information about every product we are considering consuming, and, even if we did, we aren’t really equipped to handle such vast amounts of information.
The downside of this kind of signalling is that it can be gamed. Behold:
I’m now picturing Dan Ariely as Dogbert, since he’s probably in the best position to provide an explanation. He, along with Baba Shiv and Ziv Carmon, found that not only do people believe that a product works better when given a higher price tag, but also that the product actually does work better, at least as far as a stronger placebo effect is concerned. Their data comes from a series of experiments involving SoBe energy drinks:
In three experiments, the authors show that consumers who pay a discounted price for a product (e.g., an energy drink thought to increase mental acuity) may derive less actual benefit from consuming this product (e.g., they are able to solve fewer puzzles) than consumers who purchase and consume the exact same product but pay its regular price.
Now I wonder whether the VC’s $10 million investment worked better for him than the $100,000 one would have. Something to think about next time you are excited about that big sale, right?