Business Case Study: IKEA's Billion $ Pricing Strategy

IKEA : How to grow sales by 200% using Pricing Strategies?

Dec 08, 2021

IKEA has now become one of the most innovative companies of the 21st century in the furniture and furnishing industry. And, the most astounding thing about IKEA is that, in spite of furniture being a highly localized business, IKEA has been the pioneer in turning the furniture business into a global success and today, IKEA draws revenue of $45 billion from 445 stores spread across 30 countries.

What’s more important to note is not the growth of the company but the fact that IKEA taught the world how to use the most powerful psychological tactics to exponentially increase sales and today, we are going to discuss one such strategy that makes IKEA stand apart from the competition. And, no matter which business you are in, no matter which field you are in, you can use these powerful psychological strategies to double your profits at 0 costs.

IKEA’s Pricing Strategy

What is the strategy?

How does it make IKEA stand apart from the rest of the competition?

How can we use them to double our profits?

The answer to this lies within a fascinating experiment conducted by Dan Ariely with the students at MIT.

In the first iteration, Dan went to his class of 100 students and asked them to choose between subscription plans for the international magazine called The Economist. So, the three options were,

A digital version for $59,
The print version for $125,
The print and digital versions for the same $125.

As it turns out the 16% of students wanted the digital version, 0% wanted the print version for $125, 84% chose the print plus digital version.

So, for the second iteration, he makes a small change, he thought since nobody is buying the second option, then why keep it there in the first place. So, he removed the $125 print option and presented the same question to another class of 100 students. Now technically, by eliminating the option that nobody chose, the results are not supposed to change. Well, in the second scenario the result changed drastically.

This time, only 32% of the students opted for print plus digital version and 68% of them just opted for the just digital version subscription.

And, that is when Dan realized that something is magical about this unnecessary option that made such a huge difference in the choice of the customers and that is what we call The Decoy Effect.

The decoy effect says that the consumers change their preferences between 2 options when presented with a third option which act as an unattractive option just to make the other option look extremely fascinating.

Now, when we talk about the Decoy Effect, people think about the popcorn example wherein in the movie houses, you get popcorn of small, medium, and large at a price of rupees 300, 650, and 700. Now, because of the Decoy Effect, people tend to choose the 700 rupees variant. Now, although it is technically correct, it is the worst possible example to use. Why? Because if we look at the underlying message that is being communicated to the customers, this is what the options indirectly tell the customers:

Option A: Overpay for the popcorn
Option B: Extremely overpay for the popcorn
Option C: Extreme overpay for the popcorn with a little extra popcorn

And, the basic flow over is that the prices over here can in no way justify the value for the popcorn. Therefore, by default, making the purchase of that popcorn becomes a painful experience. This is a reason, why, we often feel guilty for buying popcorn. And, even some people would not even think about buying popcorn at the theatre.

Understanding decoy effect with the help of popcorn

Now, when this is done in a close and compulsive environment like a theater, it will definitely work, but if the same strategy is used in the free market, this strategy will backfire in a terrible way. And, if you give your customer this kind of painful experience while paying for your product, the customers will never buy from you. And, it will eventually result in heavy losses.

IKEA’s Decoy Effect

That is where IKEA’s genius application comes in. IKEA places 3 cabinets for you. Let’s suppose they are named as cabinets A, B and C.

A costs $40, B costs $60 and C costs $65.

Option A is very small with a very small cabinet, with a very smooth movement but it’s got very small space plus the material used would be very ordinary.

Option C will be a very large cabinet with premium hands, premium material and most importantly, it will offer large storage space, along with that, you will also get a $10 worth of compartment as complimentary if you buy option C.

Now, then there is option B, as large as C, but it is made out of ordinary material, does not have premium handles, and will not get complimentary compartments.

And, here’s where the catch comes in, if you look at the underlying message, that IKEA is trying to communicate using its product, here’s what they say.

Option A says, here’s a budget product with a great value for money, Option C says, here’s a premium product with a large space plus delightful complimentary product, so, high value for money, and lastly, option B, which is almost the same price, but without premium built quality without complimentary compartments.

So, not so much of a value for money as compared to option C. so, this way option B act as a decoy, so that, when comparing option B with option C, option C looks like an amazing deal. Now, while most sellers only think about the people who directly buy option C, IKEA understands that a 22-year-old boy, who just moved into the city, will not be able to afford a $65 product, which is why he would buy a $40 product. But, when he does, IKEA wants to make sure that he does not regret the purchase. So, even though, it’s a low-margin product in the race of upselling, IKEA will never ever try to rip off its customers who’ve got low purchase power.

And, the best part is, the decoy effect over here does not just make option C look great, it also made option A look great.

Because the customers feel like, they would have overpaid by choosing option B, which is 50% costlier as compared to option A.

So, by default, the budget buyer buys the smaller drawer set, and the premium customers, buy the $65 product. Why? Because they compare it with the decoy. And, this clean execution of the decoy effect gives IKEA brand 3 wonderful superpowers:

Irrespective of their purchase, both types of their customers get valued for their money.
The premium customers have been tactfully influenced to buy the $65 product. And, because the $60 product was such a bad deal, the premium customers actually feel very good about the purchase.
And, most importantly, when the 22-year-old boy, is extremely satisfied with his $40 purchase. Tomorrow, when he grows up and makes a handsome income, he will again choose IKEA, but, this time as a premium customer. Because, he was given value for money that he was promised, even at the $40 price tag.
Therefore, the customer retention of the IKEA brand increases to a large extent.

This is actually how the decoy effect is applied. So, while most sellers use pricing strategy with the sole intent to upsell. The IKEA team constantly keeps learning and carefully deploys its strategies in such a way that it drives profit, but, at the same time, it retains its brand value. And, the wittiest thing over here is that IKEA does this literally for every single one of its 12,000 products, starting from affordable drawers all the way up to the premium beds and even wardrobes.

Now again, this might look easy to some people but here’s something that nobody will tell you if you take a step back guys, you would realize it is extremely difficult to maintain this fine balance between profit and brand value. Especially, when you are as big as IKEA, with 445 stores spread across 30 countries with 2.1 billion visitors who are coming from different cultures from all across the world.

And, the only reason, they’re able to execute this strategy is because of IKEA’s powerful philosophy of democratic design and lifelong learning culture.

Every time, IKEA enters a country, the IKEA team specifically studies every little aspect of that place, starting from the average balcony size, all the way up to the average spoon size. This is done just so that, IKEA could fit into the cultural framework of any country. Therefore, even when you apply this strategy, always make sure that you constantly keep learning about the customer’s reactions and keep a very close eye on the customer’s culture, purchase power and their spending habits. Because only then, one can understand, how to strike a balance between profit and brand value.

Steps to apply the Decoy Effect

Here are 5 very important steps that are needed to be followed when applying the Decoy Effect to products:

Do a research and find out, which is the most popular and profitable product in your store.
If it is a premium product, find a budget substitute for the same product such that people who cannot afford the premium one can still fulfill their needs with a budget one. Why? because budget customers will soon become your premium customers. Therefore, engaging with them should never ever be underestimated.
The next step is to create a decoy. The most important is that decoy must not be a degraded version of your premium product. However, the premium product should have a way better offering than your decoy, so, if you are selling drawers, it’s ok to have a non-premium material, but it shouldn’t be like the drawers are rigid and they’re really badly functional because even the decoy is going to reflect the brand value. So, always try to make the premium product more attractive with the complementary offering rather than, purposefully, degrading the decoy.
This step would be to price your product in such a way that the premium product looks way better than the decoy and the budget product. Option A looks like the obvious choice for the customers with a lower choice power. This way, your high-margin product would look extremely lucrative driving very high sales and at the same time, the budget customers will also be very happy to get the value for their money. In fact, those people will be even happier because they didn’t have to pay 50% extra just to get a bad deal on the decoy.
Lastly, do not add more than 5 products and make sure that the price of the decoy is very close or even equal to the premium product. This is how, one can apply the decoy effect to their products and when done right, it can increase both, your conversion rates and both your profit margins to a large extent.

Disclaimer: In the greed of more profits, please don’t use misuse the decoy effect. Because, always remember, in a free market, the customers are just one step away from leaving you forever.

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