Reference pricing how effectiv
Reference pricing how effectivThere is a psychological theory that states that people for perceptions based on present and past stimuli (Helson, 1964). This has been extended by marketing academics to include the concept of reference pricing. They do this by stating that consumers, based on their previous exposure to products and their promotion - have an internal 'learnt pricing level that they believe is equitable for a given product (Jacobson & Obermiller, 1990). This essay examines the role of reference pricing in the pricing decision, and particularly the evidence on which this theory is based. It will be concluded that although the reference price provides a starting guideline for making the price decision - there is little evidence to support the theory in actually setting price structures.
Put simply, a reference price is a standard against which observed prices are compared (Biswas & Blair, 1991). There are two types of reference price: internal and external. External reference prices are ones that exist in the environment and are used by consumers to assess the value of an item. Examples of these reference prices include reduced promotional prices and a competitor's price (Biswas, Wilson & Licata, 1993). The second major type of reference price is the internal reference price. These exist in the consumer's mind as either a point or a range of points (Putler, 1992). In either case, the reference price is used to evaluate the value of a price under consideration. The concept of the reference price is consistent with a number of psychological theories including adaptation level theory and assimilation-contrast theory (Kalyanaram & Winer, 1995).
Two important sides to the reference-pricing debate have emerged. Gijsbrechts (1993) takes a cognitive-based approach by saying he believes that it is important to examine three key areas. First, whether the reference price is a point or range. Second, determining how a consumer formulates the reference price (that is whether it is based on the highest, lowest median, etc.) and finally to examine how consumers store the reference price.
An opposing viewpoint takes the behaviorist's approach. These researchers (for example Kalramaran & Winer (1995) and Rajendran & Tellis (1994) believe that it is vital to observe whether the reference price influences consumer's actions and then quantify the effect.
As is expected, the Cognitivists are trying to determine how reference pricing works, while the behaviorists look at determining the influence of reference pricing. There is also a third interested party, the marketing practitioner. This group is concerned with how the reference-pricing concept can be put to best use by them.
One possible problem with reference pricing theory is that it is based on the assumption that consumers have a range of notions of what is "fair" or "appropriate" as a product's price. This means that unless consumers have some awareness of pricing levels, then they can not possibly determine the reference price of a product. Research by Dickson and Sawyer (1990) found that the level of consumer knowledge of price is extremely low. They asked a number of shoppers in a supermarket to recall the price of an item they had just taken from the shelf. Only 55% of consumers were able to accurately (within 5%) able to give a price. They also noted that 20% of consumers had no idea what they paid. This finding indicates that levels of consumer attention, awareness and knowledge of prices seem to be lower than necessary for consumers to have accurate internal reference prices for many products.
Gijsbrects (1993) disputes this and points out a number of reasons why. First, these studies concentrated on convenience, fast moving consumer goods. These goods tend to be low involvement goods, so the consumer doesn't take much note of the price of the product. Second the degree of pricing knowledge varies from consumer to consumer. Those with little price knowledge may have just begun to buy the product, while those who have extensive knowledge may have a very firm reference price. Finally, the lack of knowledge may simply be due to the encoding methods that the consumer uses to form their reference price. He believes this makes it imperative to determining how this encoding works.
A further assumption on which the reference price concept is based is that consumer's must be rational creatures. That is they will follow their most rational instincts about whether a product is good value or not. This leaves no room for impulse purchases and if this were true cognitive dissonance would not be a major problem.
Most reference price literature concentrates on internal reference prices (Putler, 1992), and thus suffers from the problem of studying an unobservable phenomenon. If we are to "understand" reference pricing this is a key flaw. This goes back to a major philosophical debate in science - whether it is important to "understand" how a theory works or if it is simply enough to know it works. Reference pricing research is further dogged by the fact that it is difficult to determine whether the reference price has an effect on a consumer's decision to purchase.
The key concern to marketing practitioners is how they can best put the theory of reference pricing to use in their business. On major flaw in the theory is that it provides little or no guidance or advice on finding out what the consumer believes is an appropriate reference price. This can be contrasted to pricing methods such as cost-plus pricing, where the steps for obtaining this price are laid out in a step by step fashion. Kalyanaram and Winer (1995) found that reference prices have a consistent and significant impact on consumer demand.
Barwise (1995) believes that in order for a marketing theory to be supported, it must be empirically generalizable. In recent research, Kalyanaram and Winer (1995) found that there is now sufficient empirical evidence from marketing literature to support the concept of the reference price. Their research looked at three key empirical generalizations: that consumers use reference prices to make brand choices, that consumers have been more sensitive to "losses" than "gains" and that consumers rely on past prices as part of the reference price formation process. Their research concluded that the evidence available supported each of the generalizations. But having said this, the authors state the concept is not fully validated, and that there is no evidence to suggest that reference prices are actually formed, rather it can be seen that consumers are acting as though they are forming a reference price. This statement suggests that there is still no reason for the validation of reference pricing, and that marketers should be sure to make use of reference prices carefully.
To further examine the empirical generalizability of the reference price concept, the five characteristics (as proposed by Barwise, 1995) of a good empirically generalizable theory will now be applied to the concept. These five characteristics are: scope, precision, parsimony, usefulness and a link with theory. The theory is based on generalizations, but how do they stand up to empirical testing? Do they have a practical, predictable use? A theory should be tested through experimentation in order to determine its validity. Only when the theory is seen to hold through replicable experiments will it be accepted.
According to Barwise, a good empirical generalization should have scope. It should hold under a wide range of conditions and be routinely predictable. The problem found by Gijsbrects (1993) is that different product classes have greatly different levels of price recall. He found that knowledge of prices among high involvement products, regularly purchased brands and items of budgetary importance were high while others were not. This suggests that the reference price concept may be suited to only some product classes, such as regularly purchased F.M.C.G.s. A further problem with the concept's scope is that the level of price vigilance among is consumers vary widely (McGoldrick & Marks, 1987).
While the reference price concept does appear to affect a products demand (as shown by Kalyanaram and Winer (1995) there is some debate over how accurate the estimates of these observations are. For example the researchers noted that there is no evidence to support the fact that consumers used reference prices in making purchase decisions. Gijsbrects (1993) notes that rather than affecting purchase probabilities - the reference price concept yields a better fit in consumer brand choice models. There is also considerable debate over whether reference prices are a single point or a distribution of points (Biswas & Blair, 1991). Indeed some theorists suggest that there are up to eight definitions of reference price (Jacobson & Obermiller, 1990). Until such problems can be sorted out, the accuracy of any reference price research must be questioned.
Another characteristic (according to Barwise, 1995) of a good theory is that it should have elements of parsimony. In essence the theory should be simple and avoid including any excess variables. The reference price concept is reasonably simple to understand, but it does encompass a wide range of variables - both internal and external. This may detract from the simplicity of the model.
A fourth characteristic is usefulness. This raises some difficult issues. That is what constitutes usefulness. As already alluded to the reference price concept would be very useful to marketing practitioners. If a possible pricing level was compared to a similar products reference price, practitioners could determine the markets response the change in the variable. For example if the price were above the market's reference price demand would be expected to be low. But given there is no empirical method suggested by researchers for determining the market's reference price, this theory becomes less useful. Another problem is that the concept does not allow the marketer to factor in variables such as costs and profit into the price equation. As will be outlined shortly there are methods for overcoming this problem. Before the reference price can become truly useful, accurate methods for determining the reference price must be found.
The final criteria suggested by Barwise (1995) for evaluating theories is to examine the concepts link with theory. That is how strong is the theory's basis empirically. Barwise (1995) believe that a theory is "better" if it can be explained by - or at least linked to theory. As mentioned previously the reference price theory finds support from psychologists and theories such as adaptation level theory and assimilation-contrast theory. Barwise goes on to state that a good theory may explain a number of disparate empirical generalizations. As mentioned Kalyanaram and Winer (1993) found three empirical generalizations that seemed to be explained by reference price concepts. Gijsbrects (1993) also outlines five empirically based findings that tend to support the concept of a reference price.
Given that there is some indication that reference prices affect demand (however tenuous this may be). What use can the concept be to marketers? Some authors believe that the reference price is of most use when combined with more conventional pricing methods. This allows the limitations of each method to be overcome. For example a marketer may establish a pricing level using the conventional pricing methods such as cost-plus and then use a reference price (if available) to fine tune the price.
To summarize the debate as it stands, the empirical evidence suggests that a large portion of consumers have very little knowledge about individual item prices and do not seem to be interested in pricing information. This suggests that in many instances, reference prices are not very accurate. There is still debate over whether they are used at all. The key is that consumers are very heterogeneous, and they all have different levels of pricing awareness, and encoding processes. This makes it difficult to determine an individuals reference price.
Gijsbrects (1993) noted that many researchers are beginning to doubt the validity of the reference price, but he states "is the end of reference pricing near? Probably not." (p.122). This statement has much validity. It has been seen that reference price theory has little to offer marketers by way of setting price levels. But when knowledge of reference prices is applied to other pricing methods such as cost plus pricing - it can help shape more appropriate pricing levels for a firm.
References
Barwise, P. (1995). Good Empirical Generalizations, Working Paper, Center for Marketing: London Business School.
Biswas, A. & Blair, E. (1991) Contextual effects of reference price in retail advertisements. Journal of Marketing, 55(July), 1-12.
Biswas, A., Wilson, E.J. & Licata, J.W. (1993). Reference Price Studies in Marketing: A synthesis of research results. Journal of Business Research, 27, 239-256.
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Gijsbrects, F. (1993). Prices and pricing research in consumer marketing: Some recent developments. International Journal of Research in Marketing, 10, 115-151.
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