Getting the price right

The general wisdom that higher starting prices lead to higher final prices does not always hold true, according to new research by LBS and Kellogg School of Management. In auction situations, the paper argues, less often means more.

by London Business School

In buyer-seller negotiations, the starting price is the defining element of the transaction which psychologically limits and constrains counter offers. Auctions however, such as those taking place on eBay, are a much more dynamic process.

The number of agents is basically unlimited and influenced by the starting price. The lower it is, the more initial bids a product is likely to receive. And with more bids, the probability of a higher price goes up.

This in turn triggers two processes. The research found that early bidders are more likely to bid repeatedly to recover their early investment of time and energy (their 'sunk cost'), which drives prices up. The study also found that this frenzy of bidding suggests that the item is valuable and worth bidding on. In other words, bidding activity causes even more bidding activity.

The only exception to the rule of low starting price is when there is a barrier to entry or few interested buyers. Lower starting prices in these circumstances will only lead to low final prices. In those situations, a high starting price or negotiation with prospective buyers would generate better outcomes.

The research was published in the July issue of Journal of Personality and Social Psychology by Prof Gillian Ku of LBS, and Professors Adam Galinsky and Keith Murnigham of Kellogg School of Management at Northwestern University.

New research suggests lower starting prices can actually result in higher final sale price
Prof Gillian Ku, Prof Adam Galinsky and Prof Keith Murnigham
London Business School, Kellogg School of Management
Journal of Personality and Social Psychology, July 2006

Review by Emilie Filou

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