4 Behavioral pricing

The focus is on ‘behavioral aspects of pricing’, or price effects that cannot be accounted for by the intrinsic price itself. After presenting a broad conceptual framework, I concentrate on two distinct streams of research. The fi rst is composed of laboratory experiments examining the impact of price presentation (e.g. externally provided reference price, whether a deal is presented in absolute dollars off or in percentage off the original price) on perceived price savings. The second stream uses secondary data on consumer purchases (scanner data) and focuses on the effects of internal reference prices, reference prices that are created by consumers themselves, on consumer purchase behavior. Introduction Victoria’s Secret frequently advertises ‘Buy two, get one free’. Storewide sales in Talbots, The Gap, Benetton and others are often announced by signs proclaiming ‘20–50% off’ or ‘Up to 70% off’. Are price cuts presented in different ways perceived differently by consumers? If the consumer rationally computes his (her) savings, mental effort could be reduced by simply stating the dollar savings to the consumer. Yet, apparently, the presentation of the promotion has an impact on consumer deal evaluation and hence retail sales. In fact, much research in marketing attests to the effect of price presentation on deal perception (Das, 1992; Lichtenstein and Bearden, 1989; Urbany et al., 1988; Yadav and Monroe, 1993). Non-rational (in the traditional sense) processing of price information is further attested to by Inman et al.’s (1990) fi nding that the mere presence of a sale announcement, without a reduced price, increased retail sales. Hence, an understanding of price presentation effects is insightful for retailers as well as for brand managers. In similar vein, if a consumer is fortunate in frequenting a store multiple times when a particular brand is on sale, and then visits the store when it is not on sale, will she be less likely to purchase it – i.e. will the fact that she has purchased the product at a lower price in the past reduce her probability of buying it at regular price in the future? What if she has bought it at regular price for many shopping trips, and now fi nds it on sale? Will her probability of purchasing the brand increase by the same extent as it would decrease in the previous scenario? Comprehension of internal reference price effects – reference prices that are created by consumers themselves – is important when deciding on price changes over time. In this chapter, we focus on ‘behavioral aspects of pricing’ or price effects that cannot be accounted for by the intrinsic price itself. After presenting a broad conceptual framework, we concentrate on two distinct streams of research, price presentation effects and internal reference price effects, that have just been illustrated. The fi rst typically uses laboratory experiments, whereas the second uses secondary data on consumer purchases (scanner data). For price presentation effects, we report results from a meta-analysis (Krishna et al., 2002) where results from past literature are examined to determine the relative importance of different presentation effects (Section 2). For internal reference Behavioral pricing 77 price effects, we provide a summary of the papers that have been contributed in that area (Section 3). We begin with the framework. 1. Conceptual framework While much research in marketing and economics has focused on the effect of intrinsic price, only in the last three decades has research focused on behavioral aspects of pricing. However, the latter can be just as signifi cant for consumer choice. We identify a few of the behavioral aspects of special relevance to marketing researchers. By no means is this meant to be an exhaustive review of the literature. Figure 4.1 illustrates our conceptual framework. The fi nal dependent variables in our conceptual framework are consumer choice among brands, purchase quantity and purchase timing. Two other intermediary dependent variables are identifi ed – subjective price and price fairness. Subjective price is assumed to be affected by many factors, as can be seen in Figure 4.1. Price fairness has also been attributed with many antecedents. We talk about each in turn. Subjective price We elaborate in detail on price presentation effects (through a published meta-analysis) and on internal reference price effects in Sections 2 and 3. However, two other price presentation effects not included in the meta-analysis are worthy of mention – these are the effects of (i) ’99 cent endings and (ii) temporal pricing and partitioned prices. 99 cent endings Schindler and Kirby (1997) made an analysis of the rightmost digits of selling prices in retail advertisements and found an overrepresentation of 0, 5 and 9. Using the same historical data, they show that this practice cannot be explained by consumers perceiving 9-endings as a round-number price with a small amount given back; instead, it is better explained by underestimation of 9-ending prices with left-to-right processing. Stiving and Winer (1997) provide further proof for the additional utility of 9-endings. Using scanner panel data, they show that 9-ending prices do indeed have additional utility for consumers and that predictive models need to account for this effect for more accuracy. Temporal pricing and partitioned prices Another area of behavioral pricing research where many puzzles remain unresolved is that of partitioned pricing and temporal pricing. Gourville (1998) shows in his paper that pennies-a-day pricing is a better appeal to consumers for charitable donations than a larger amount paid per month. Similarly, Morwitz et al. (1998) show that separating the total price of a product into the base price and shipping charge is better than presenting it as one combined price. In both the temporal-price-framing case (Gourville, 1998) and the partitioned pricing case, consumers are being asked to pay a larger number of smaller dollar amounts, and this is found to be better valued by consumers. These cases go against Thaler’s (1985) segregate losses rule. One explanation may be that very tiny amounts are ignored by consumers – in the pennies-a-day case, all payments are deemed trivial, and in the partitioned pricing case, the shipping charge is small in comparison with the base price and is ignored. Thus, Thaler’s arguments do not extend to these cases. Such a hypothesis nevertheless needs further research.