Reference Pricing – How People Respond to Good Deals?

This post will explore some of the behavioral economic underpinnings of how people respond to good deals. As the experience of buying something on sale is common to nearly everyone, I expect you will find several observations to be very intuitive, but I hope to get you thinking about them in some novel ways.

You will learn:

• What exactly is reference pricing.
• What benefits can reference pricing bring yo your business.
• Several tricks on how to implement it in your sales strategy.

Let's go.

What is Reference Pricing?

Here’s a sleazy trick you may have seen before. A store is having a huge sales event, and everywhere you look are big signs where the original price is slashed and the new price is tantalizingly low. Except it isn’t really, because that “original price” is artificially high. Likewise you may have noticed that the “suggested retail price” of some products is often undercut by retailers, suggesting that it too may be higher than it needs to be. Both of these tricks are meant to make you feel like you are getting a good deal, which any retailer or salesperson knows is extremely important to most customers.

There are a broad range of ways to influence how much a customer will like a deal. For instance, a stream of research by Margaret Campbell found that people are more likely to think they getting a great deal when they are in a good mood or when they have a high opinion of the store from which they are buying.

In 1999, Richard Thaler (co-author of Nudge) suggested that people tend to be almost as interested in “buying” a deal as they are in buying the associated product. In other words, when customers are deciding whether or not a product is worth the price (for example, an expensive pair of shoes), the value they place on the purchase itself (“Am I getting a good deal?”) can be as powerful as the value they place on the actual product (“Am I getting good shoes?”).

The most direct way to influence perceptions of a transaction is through careful use of reference prices. Basically, it is important to present your customers not only with the price they will be paying, but also with a relevant price that makes the real one look good by comparison. This is the purpose of posting the original price during a sale. The obvious takeaway is that whenever your product is discounted, make sure your customers can see what the price was before you slashed it. Don’t just tell them “It’s X% off!”

Of course there are any number of tricks that can be played with reference pricing, and they don’t need to be sleazy. For example, if your firm competes on price, then drawing attention to the higher prices of competitors’ products is a well-established and powerful tactic. Taking this a step further and treating the competition’s price as a reference, if your potential customers have the sense that your competitor is charging a “normal” or “usual” price, your cheaper product will be seen as an even better deal. Even if your prices do not differ from your competitors’, offering even a modest discount and then comparing the new price to the competition will be especially persuasive.

Another fruitful approach is to use the prices of similar or related products to make the price of your target product look good. For example, even if they are not on sale, a $125 pair of shoes look like a great deal next to a $190 pair of shoes.

This type of reference has an added bonus: presenting your customers with similar products will also lead them to pay more attention to the deals you offer them. It was proved that shoppers are more interested in how much they can save when a product was advertised alongside similar products.

Using reference pricing strategies

Suppose Zappos wants to encourage sales of a given brand of dress shoe. They could use either strategy shown above: they can offer a sale and display both the old and the new prices, or they can display and advertise the shoe as part of a favorable comparison. They could also do both:

Or for bonus points, they could combine this idea with suggestions from the Compromise or Decoy Effects. Below is an example of using a $99 pair of shoes as a decoy:

Remember that the use of reference prices is not limited to products that are actually on sale. The essential thing to remember is that customers are very sensitive to comparisons, so the more that you can present them with favorable comparisons, the more they will think of your store as a place they can get good deals.

Takeaways

1. People make purchasing decisions based on how much they value the deal, not just how much they value the product.
2. Whenever possible, give your customers a reference price that makes your deal look good by comparison.
3. Make sure the reference price is relevant, whether an old price, a competitor’s price, or the price of a similar or related product.

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