“Fairness” in Pricing

A recent HBR article titled “Understanding Fairness is the Key to Keeping Customers” caught our eyes this week. From the headline we expected another rant on what a “fair” price is, conflating ethics with price setting. We were relieved to discover it’s actually a more tactical guide to the perception of fairness in pricing. Customer perception of a price, whether it can be described as “fair” or not, is obviously one of the key drivers of elasticity, and is ignored at retailers’ peril.

So why do we hold the idea of a “Fair price” in such disdain? Largely because it’s simply unproductive. Here’s why:

1) In economics, market prices are a balance of the product’s value, alternatives, and information. The idea of “fair” requires judgments of the profit one should make, or things like whether a poor person should pay less than a rich person, etc. The minute any of these things change a market price, deadweight loss is created.

2) It often leads to a 50/50 split, whether that’s the market price or not.  Humans, as compared to homo economicus, use rules of thumb, and one such rule is that fairness equals equality.  Should retailers split potential profits with customers 50/50 in the name of being fair?

3) Conversations get weird.  When people mention a “fair” price, they often mean “what they expected to pay.”  And their prior expectations have been influenced by any number of factors, but rarely are they anywhere close to shelf price.  Need evidence?  Ask those around you what a gallon of whole milk costs (According to BLS, $3.48 is the US city average for Aug. 2013).  Then ask them why it costs that amount, and you’ll often hear a litany of justifications but rarely will they include things like “value,” “worth,” or “willing to pay.”

We couldn’t agree more with the ending thought:

"...fairness is hardwired into humanity and ignoring its business implications is costly."