Pricing Strategies

Predicting Price-Change Response:

Cognitive Factors

@ SAGE Publications, 2011

Categories of Mental Responses
The market’s response to a price change is
determined by what the price elicits in the
customers’ mind.
Three categories of mental response:
Cognitions
Emotions
Perceptions – first responses, play an
important role in the other responses

@ SAGE Publications, 2011

Price Awareness

Customers rarely have a detailed and

accurate awareness of prices. The first step
in knowing what an item’s price is involves
the perception of the numbers.
Our first response is to the price’s
leftmost digit – can bias
the customer’s thoughts and
feelings.
The remaining digits are the ending
digits. @ SAGE Publications, 2011
Pricing Strategies Based on
Digit Placement
Two common strategies:
Round-number pricing - using one or more
consecutive 0s as ending digits
Just-below pricing – using 99, 98 or 95 as
ending digits
The potency of the left-most digit suggests
that a seller set a price just below the round
number when doing so lowers the left-most
digit.
@ SAGE Publications, 2011
Two Types of Knowledge About Prices
After perception of the digits, the second
step in price awareness is making the
perceived digits meaningful.
Two types of added meaning:
Price-level knowledge
Price-meaning knowledge

@ SAGE Publications, 2011

Price-Level Knowledge

Is the awareness of the level of a price

Is necessary for making a reasonable
purchase decision
Has three prominent sources:
Items that have been purchased
Items that have not been purchased
Beliefs about the factors affecting the price
level

@ SAGE Publications, 2011

Awareness of the Prices of Purchased
Items
Past purchases contribute to the pricing
knowledge used for future purchases.
Factors that influence price awareness:
Price level of the item purchased
Price variation over time
Price variation between brands
Opportunity to learn prices

@ SAGE Publications, 2011

Implications of Pricing Factors

There is more price awareness for:

Big-ticket items
Items whose prices are relatively stable
over time
Items in product categories where there is
little inter-brand variation
Items where the customer had
opportunities to think about its price

@ SAGE Publications, 2011

Awareness of the Prices of Items
That Have Not Been Purchased
Sources of this awareness:
Price information search
Incidental learning
Price information search is:
Tied to consumer motivation to carry out
the search
Constrained by limitations in the
consumer’s awareness of competitors

@ SAGE Publications, 2011

Influence of the Internet on Price
Awareness
In product categories where most major
sellers list their prices on the Internet, there
is likely to be greater price awareness.

Products sold in supermarkets, drug stores

and clothing stores are unlikely to have
sufficient price information posted on the
Internet.

@ SAGE Publications, 2011

Price-Origin Beliefs

Beliefs concerning the factors that cause a

price to be high or low that can be used as
rules of thumb for making price-level
inferences

These beliefs:
Could be more detailed or less detailed
May or may not be accurate

@ SAGE Publications, 2011

Common Price-Origin Beliefs
Items that show higher-quality materials
will have higher prices.
Items that have more useful features will
have higher prices.
Prices of items whose production is more
labor-intensive are likely to be higher.
Larger packages of a product will have
lower per-ounce prices than smaller
packages.

@ SAGE Publications, 2011

The Customer’s Internal Reference Price
(IRP)
A price or price range that is constructed
in the customer’s mind and is used as a
basis for evaluating an encountered price
All three sources of price-level knowledge
can contribute to the IRP – how specific
the IRP is depends on the price-level
knowledge used to create it:
Much knowledge = specific price
Less knowledge = price range
@ SAGE Publications, 2011
When Price Differs from the IRP
A difference between the item’s price and the
customer’s IRP will affect the customer’s
response to the item’s price.

When a customer’s IRP is a price range, the

price must be outside of this range before it
will affect the customer’s response.

@ SAGE Publications, 2011

Managing Price-Level Knowledge
When the seller’s prices tend to be lower than
those of most competitors, it is in the seller’s
interest to increase the customer’s price
awareness.

When the seller’s prices tend to be higher, it is

the seller’s interest to decrease the customer’s
price awareness.

@ SAGE Publications, 2011

Increasing Price-Level Awareness
Increasing price-level awareness can be
done by:
Simplifying the price structure
◦ Price points
◦ Price simplification
Using media advertising

@ SAGE Publications, 2011

Decreasing Price-Level Awareness
Decreasing price awareness can be done by
complicating:
 Prices
◦ Difficult price format
◦Partitioned price
 The product
◦ Branded variants

@ SAGE Publications, 2011

The Influence of Ending Digits
on Price Knowledge
A price’s ending digits are those digits to the
right of the price’s leftmost digit.
It has been found that using:
◦ Round-number pricing acts to increase
awareness
◦ Just-below pricing acts to decrease it
Just-below pricing also tends to bias the
cognitive processing of price information.

@ SAGE Publications, 2011

Price-Meaning Knowledge
The knowledge of what the price may
communicate about the product, the seller
and/or the offer
Two forms:
Price-Quality Effects
Price-Ending Meanings

@ SAGE Publications, 2011

Price-Quality Effects

Consumers (at least sometimes) use the

level of a price as a cue to the quality of the
product or seller.
Price-quality heuristic: assumption that
products with higher-quality materials or
more useful features will have higher prices
If a large amount of buyers use the price-
quality connection, then elasticity is low.

@ SAGE Publications, 2011

Are Price and Product Quality Related?
One study suggests that for products used
to satisfy objective-performance needs,
price level is very limited in its ability to
predict quality.

When subjective performance is critical,

the relation between price and quality
could be stronger.

@ SAGE Publications, 2011

Managing Price as a Quality Cue
Price level is used as a cue particularly when
the customer finds it difficult:
To evaluate product quality directly
When the consumer believes that large
quality differences exist

Despite the price-quality cue, the seller cannot

always set higher prices.

@ SAGE Publications, 2011

Constraints on Setting Higher Prices
Within the price-quality relationship, the seller
must keep in mind that:

A consumer may like a product, but his/her

budget limits purchase
The price can influence the experience of the
product’s quality only within a certain
range

@ SAGE Publications, 2011

Price-Ending Meanings

The use of round-number pricing supports

the image of high quality in a product or
retailer and suggests the image of classiness.
The use of just-below pricing suggests that
the item has been discontinued, is being sold
at a relatively low everyday price or is of
low quality.

@ SAGE Publications, 2011

Sharp-Number Pricing
A pricing strategy that minimizes the use of
both round-number and just-below pricing,
such as $3.17, $8.44 or $176.54
Suggests to consumers that the retailer is
engaged in a careful price-setting process
Encourages acceptance of the seller’s price
in a negotiation
Is more common among low numbers

@ SAGE Publications, 2011

Pricing Strategies

Predicting Price-Change Response:

Emotional Factors

@ SAGE Publications, 2011

Importance of Emotional Factors
Price-related feelings:
Have a strong effect on the buyer’s response
to a price
Are usually negative since a price involves
giving up something of value
Can be conceptualized by the pain of paying
– how much it hurts to pay

@ SAGE Publications, 2011

The Perception of Prices

The buyer’s perception of money is flexible –

we tend to perceive money in terms of gains
or losses.
Reference point:
The frame of reference in these perceptions
Is often the status quo
Is entirely in one’s mind and can change
quickly (reference-point shift)

@ SAGE Publications, 2011

Framing in the Perception of Prices
Since the buyer’s feelings are related to
perceived gains and losses, the seller should
consider how to manage the buyer’s
perceptions.
Framing: the management of the factors
that influence the set of gains and losses that
comprise the buyer’s perception of price;
methods relate to price format

@ SAGE Publications, 2011

The Value of Gains and Losses
Prospect-theory value function: a description
of how people feel about gains or losses, or
the value they place on gains or losses of
various sizes
Two important aspects:
The incorporation of the Weber-Fechner
Law
The postulation of loss aversion

@ SAGE Publications, 2011

The Weber-Fechner Law
There are “diminishing returns” for the
mental effects of a stimulus – each additional
unit of external stimulation will add less to
the mental effect of the stimulus than its
predecessor.
Applied to pricing: each additional dollar
will add less to the pain of paying than its
predecessor

@ SAGE Publications, 2011

Loss Aversion
Loss aversion: the tendency of a loss to hurt
more than an equal-sized gain feels good

Example: A salary increase of $2,000 will

feel good. A salary decrease of $2,000
would hurt more than the increase felt good.

@ SAGE Publications, 2011

Four Possible Perceptions of Price
Perception of a Price as a Single Loss

Perception of a Price as Two Losses

Perception of a Price as a Loss and a Gain

Perception of a Price as a Gain Forgone

@ SAGE Publications, 2011

Perception of a Price as a Single Loss

Occurs when the price is equal to, or in the

range of, the customer’s IRP; is the
simplest perception
The size of a price change in percent terms
will be an important factor in determining
the buyer’s pain of paying.
Purchase aggregate: a set of related
purchases that consumers consider as one
purchase
@ SAGE Publications, 2011
Perception of a Price as Two Losses
Occurs when a product’s price exceeds a
consumer’s IRP
The first loss is the expected price.
The second loss is the perceived surcharge.
A price perceived as two losses will be
more negatively evaluated than that price
perceived as one loss.

@ SAGE Publications, 2011

Avoiding the Perception of Price
as Two Losses
The seller can avoid negative evaluations of a
price that is perceived as two losses by:
Monitoring the IRPs of consumers
Downsizing the product or the number of
items in the product’s package
Downsizing relies on the disinclination to
adjust IRPs when a package size decreases.

@ SAGE Publications, 2011

Perception of a Price as a Loss and a
Gain
Occurs when a product’s price is less than a
consumer’s IRP
The loss is the expected price.
The gain, or perceived discount, would be
experienced when the customer notices that
the price is lower than his or her IRP.
Is more positively evaluated than a price
perceived as a single loss

@ SAGE Publications, 2011

Implications for the Seller

A price perception of a loss and gain

should be encouraged - the key is to
manage the customer’s IRP.
When price awareness is low and a price
has been decreased, the seller can create
this awareness by advertising an external
reference point.

@ SAGE Publications, 2011

Application of the External Reference
Price
It is most likely to be effective when what
is being claimed is a discount of moderate
size – around 20-40 percent.
Discount claims without an external
reference price will be interpreted as a 10-
15 percent discount.
Claims of lower or higher amounts are not
advisable.

@ SAGE Publications, 2011

Using the External Reference Price When
Prices Haven’t Decreased
In this use, the external reference price
suggests a high IRP is appropriate because
of the higher prices charged by competitors.
Semantic cues are critical
Examples of specific cues:
“Chain drug stores charge …”
“K-Mart’s price …”

@ SAGE Publications, 2011

Perception of a Price as a Gain Forgone
Occurs when a price is not perceived as a
loss at all due to income received at about
the same time
Perceiving a price as a gain forgone results
in a more favorable evaluation of price than
perceiving it as a single loss.
Seller’s can create this link at times of
monetary gain, i.e. tax refund time.

@ SAGE Publications, 2011

Effects of Fairness Judgments on the
Value of a Loss
The value of a loss can be affected by:
The size of the loss
The degree to which the loss is judged as
fair
The concept of equity is important to fairness
– the sense that both participants receive
benefits equal or appropriate to what they
contributed to the exchange.

@ SAGE Publications, 2011

Customer Fairness Judgments
The degree to which a consumer judges a
price as fair will influence his/her pain of
paying that price:

Most painful when it is judged as unfair

Less painful when it is judged fair
Least painful when it is judged as “more
than fair”

@ SAGE Publications, 2011

When is a Price Increase Considered
Fair?
When an item’s price exceeds the IRP and
the consumer experiences a perceived
surcharge, the feeling about the surcharge
will depend on whether:

The price is one of long standing

The consumer is new to the market
The seller’s costs are perceived to have
increased

@ SAGE Publications, 2011

Price Increase and Seller Action
When increasing prices, sellers should:
Provide information on the reason of the
price increase particularly when costs rise –
a price rationale
Develop the consumer’s feeling of
control as to whether they pay the price

@ SAGE Publications, 2011

Other Determinants of Fairness

Other customers and what they are paying

When customers observe other customers
paying lower prices for the same product,
they tend to question the fairness.
General impressions of the seller’s motives

Customers will judge increases as unfair

when companies have questionable
reputations.

@ SAGE Publications, 2011

Factors That Can Enhance the
Value of a Gain
The value of a gain can be affected by:

The size of the gain

Dangling
Perceived responsibility

@ SAGE Publications, 2011

Dangling

Retail advertising works to draw the

consumer’s attention to the offered
discounts.
Dangling: the practice of putting a
discount or other offer in the consumer’s
mind in a way that is vivid and immediate.
These vivid images causes the reference
point to shift so that passing up the
discount involves incurring a loss.
@ SAGE Publications, 2011
Perceived Responsibility
Perceived discounts can take on an
emotional potency beyond the amount of
money involved.
One reason: customers feel responsible
for having obtained the discount
Feelings of personal responsibility are
important when customers perceive prices as
involving gains.

@ SAGE Publications, 2011

Implications for Sellers
The more the customer feels personally
responsible for a discount, the more pleasure
he/she feels from the discount.
Consumers tend not to perceive themselves
as personally responsible for the parts of
prices that they perceive as losses.

@ SAGE Publications, 2011

Pricing Strategies

Predicting Price-Change Response:

Economic and Competitive Factors

@ SAGE Publications, 2011

Price Sensitivity

The market’s responsiveness to a price

change is its price sensitivity.
When a price change causes very little sales
response, the market is “insensitive” –
when a price change causes a very large
response, the market is “sensitive.”
The market’s response must be estimated to
make price modification decisions possible.

@ SAGE Publications, 2011

Factors That Determine a Market’s Price
Sensitivity
Economic
Competitive
Cognitive
Emotional

@ SAGE Publications, 2011

The Price Elasticity Measure
A numerical measure of the market’s
response to price change
Is represented by the ratio:
E = %∆ Unit sales
%∆P
Is independent of how sales and price
changes are measured and can be compared
over various situations

@ SAGE Publications, 2011

Price Elasticity Calculations
The numerator is the percent change in sales
units resulting from the price change:
%∆ Unit sales = [(S – S0) / S0] x 100

The denominator is the size of the price

change in percent terms:
%∆P = [(P – P0) / P0] x 100

@ SAGE Publications, 2011

Interpreting Price Elasticities
The price elasticity will usually be a
negative number.
A score of -3 shows “higher” or “greater”
elasticity than a score of -1.2, despite
common math rules.
“More elastic” indicates more stretching of
sales in response to a price change.

@ SAGE Publications, 2011

Demand Curve and Price Elasticities

A demand curve shows the relationship

between various prices a product can have
and the sales that would occur at that price.
The market’s response to an item’s price is
not a smoothly varying function of that
price – price elasticities measured at low
price levels might differ from those at high
levels.

@ SAGE Publications, 2011

Using Price Elasticities in Price-Change
Breakeven Analysis
Must know whether or not the sales
response to a price change will exceed the
critical sales level
Using a similar situation as a guide, a
usable estimate of the response can be
obtained by rearranging the equation:
%∆ Unit sales = E x %∆P

@ SAGE Publications, 2011

Using Price Elasticities in Price-Change
Breakeven Analysis
The %∆ Unit sales can be converted into a
unit change in the level of sales, which can
then be compared to the price change’s
breakeven level.
It is also possible to evaluate a prospective
price change by converting the breakeven
sales level into a breakeven price elasticity
(EBE).

@ SAGE Publications, 2011

Observed Price Elasticities
One aspect of a manager’s ability to
estimate a price elasticity is to be familiar
with aspects of price elasticities that have
already been observed and obtained from
company records or from published sources.

@ SAGE Publications, 2011

Category vs. Brand Elasticities

The category price elasticity is the percent

change in sales for an entire product
category divided by the percent change in
the average price for an item in that
product category.
The brand price elasticity is the percent
change in the sales of that brand divided
by the percent change in its price.

@ SAGE Publications, 2011

Brand Elasticities Typically Observed

The process of estimating a product’s price

elasticity can start by noting the range of
brand price elasticities already observed. In
one study, the median elasticity value was -
2.22, and 80% of the values fell between 0
and -4.
Elasticities falling outside of this range cast
doubt on the price change plans.

@ SAGE Publications, 2011

Economic Factors Affecting
Price-Change Response
The typical range of price elasticities is still
large, so a more detailed estimate is
necessary.
Economic factors can have an important
effect on customer’s price-change response
– these involve the financial implications to
the customer of responding to the
prospective price change.

@ SAGE Publications, 2011

Four Economic Factors
Amount of money involved in the price
change
Amount of the price change that the
customer will actually pay
Customer’s switching costs
Customer’s search costs

@ SAGE Publications, 2011

Questions to Determine the Implication of
Economic Factors
Does the price change involve what the
customer would consider a large amount of
money?
Will the buyer actually incur the full
extent of the price change?
Are the customer’s switching costs low in
the product category?
Are the customers’ search costs low in the
product category?
@ SAGE Publications, 2011
The Implications of Economic Factors

If the answer to each question is “yes,”

then the factors would suggest a higher
brand elasticity – if all or a majority
suggest a high price elasticity, then an
estimate of the brand price elasticity is
more likely to be closer to the -4 end of the
typical range.
The opposite would be true for responses
of “no.”
@ SAGE Publications, 2011
Role of Competitors in
Price-Change Response
Anticipating how competitors will respond
to the price change is key to predicting the
market response.
The price differential between two
competitors is the difference in their prices
for a particular product.

@ SAGE Publications, 2011

Three Basic Competitive Stances

A competitive stance is a company’s

posture or set of response tendencies.
Three Basic Competitive Stances:
Cooperative – will match the price change
Aggressive – will maintain the price or
make a smaller
change
Dismissive – will maintain the price

@ SAGE Publications, 2011

Determining the Stance of Your
Competitors
Must collect relevant information to
anticipate their reaction to your price change
Possible historical indicators:
Past responses towards your company
Past responses towards other companies
Past behaviors of key executives

@ SAGE Publications, 2011

Determining the Stance of Your
Competitors
Other characteristics that provide helpful
information:
Relative size
Parallel pricing
Degree of brand differentiation
Differences in unit costs
A competitor’s strategic goals

@ SAGE Publications, 2011

Sources of Competitive Information

The marketplace
Pricing
Advertising
Trade show displays
Trade associations
Trade publications
Security analysts’ reports
Customers

@ SAGE Publications, 2011

Communicating Competitive Information
Explicit private communication is illegal.
Price signaling: when publicly available
pricing information is intentionally
managed to have an effect on competitors
Price signaling techniques:
News releases
Press conferences
Other forms of publicity

@ SAGE Publications, 2011

Three Categories of Price Signaling
Strategies
Strategies to signal competitive strength

Strategies to signal that a company has

limited goals for initiating a price decrease

Strategiesto encourage competitors to match

a planned price increase

@ SAGE Publications, 2011

Issues Regarding Price Signaling
(1) Legality – determinations of legality have
hinged on two factors:
The circumstances of the signaling
The consequences
Most attention has been given to signals
for price increases.
(2) The degree to which it actually works

@ SAGE Publications, 2011

Applying Game Theory to Managing
Price Competition
Pricing behaviors themselves can
communicate information.
Game theory involves examining possible
patterns of behaviors in order to help predict
and manage price competition.
A payoff matrix is a useful tool to simplify
this process – two competitors, two prices,
four possible price situations.

@ SAGE Publications, 2011