Reference Prices

A reference price is what a buyer considers a reasonable and fair price for a product. Reference prices are a critical issue in product line pricing decisions as illustrated in in which subjects in a controlled experiment were asked to choose among different models of microwave ovens. Researchers asked half the subjects to choose between two models (Emerson and Panasonic); the other half chose from among three models (Emerson, Panasonic I, and Panasonic II). Although 13 percent of the subjects were drawn to the topend model, the Panasonic II, the largest impact from adding that third-model choice was on the Panasonic I, which gained 17 additional share points when it became the mid-priced choice. The implications of product-line pricing are clear. Adding a premium product to the product line may not necessarily result in overwhelming sales of the premium product itself. It does, however, enhance buyers' perceptions of lower-priced products in the product line and encourage low-end buyers to trade up to higher-priced models.

EXHIBIT 4-9 Reference Price Effects of a High-End Product

Reference Prices

Another way in which marketers can influence reference prices is by suggesting potential reference points. For example, buyers' reference prices can be raised by stating a manufacturer's suggested price, a higher price charged previously (“Was $999, Now $799!”), or a higher price charged by competitors (“Their price $999, Our price $799!”). Research indicates that advertisements suggesting reference prices are very effective in influencing consumer durable product purchases (video cameras), particularly among less knowledgeable buyers who rely more on price to determine quality when making buying decisions. Other studies have found that providing buyers with a suggested reference point enhances perceptions of value and savings, even if the advertised reference point is exaggerated. Although buyers may discount or question the credibility of such claims, the claims still favorably influence perceptions and behaviors.

Precisely how a product vendor presents pricing information is important. The order in which customers see pricing data influences their thinking about reference prices. In seminal research on this effect, two groups of experimental subjects saw the same sets of prices for a number of products in eight product classes. One group saw the prices in descending order (from the highest to the lowest); the other group saw them in ascending order (from the lowest to the highest). Researchers then asked each subject how much the same individual product in each product class was priced “high” or “low” relative to its value. From those judgments, the researchers calculated average reference prices for each product. The result: subjects who saw the prices in descending order formed higher reference prices than those who saw them in ascending order, even though both groups saw the same set of prices.

When forming their reference prices, buyers apparently give greater weight to the prices they see first.

These results clearly have important implications for price communication. In personal selling, this reference price effect implies that a salesperson should begin a presentation by first showing products above the customer's price range, even if the customer ultimately will choose from among cheaper products. This tactic, known as “top-down selling,” is common for products as diverse as automobiles, luggage, and real estate. Direct-mail catalogs take advantage of this effect by displaying similar products in the order of most to least expensive. Within a retail store, the order effect has implications for product display. It implies, for example, that a grocery store might sell more low-priced (but high-margin) house brands by not putting them at eye level where they would be the first to catch the customer's attention. It may be preferable to have consumers see more expensive brands first and then look for the house brands.

Finally, promotional deals such as coupons, rebates, and special package sizes can influence reference prices strategically. Some marketers have argued that new products should be priced low to induce trial and thus build a market of repeat purchasers, after which the price can be raised. But if the low initial price lowers buyers' reference prices, it may actually affect repeat sales adversely. This is the result that some researchers have found. In one well-controlled study, five new brands were introduced to the market in two sets of stores. During an introductory period, one set of stores sold the new brands at a low price without any indication that this was a temporary promotional price; the control stores sold the new brands at the regular price. As expected, the brands sold better during the introductory period where they were priced lower. During the weeks following the introduction, however, both sets of stores charged the regular price. In all five cases, sales during the post-introductory period were lower in the stores with the low initial price than in the control stores. Moreover, total sales for the introductory and post-introductory periods combined were greater in the control stores than in the stores where the low price initially stimulated demand. This and other studies showing similar results demonstrate the importance of discounting tactics. The seller should clearly establish a product's regular price and then promote the discount as a temporary price cut. Otherwise, initially low promotional prices designed to build an audience for product trials can establish low reference prices that will undermine the product's perceived value at regular prices later on.

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