Chapter 4
Price and Value Communication

Strategies to Influence Willingness-to-Pay

In Chapter 2, we argued that developing an effective pricing strategy requires understanding and quantifying the value of your offer in order to set profit-maximizing prices across segments. Yet even the most carefully constructed value-based pricing strategy will fail unless your offer’s value, and how it differs from that of competitors’ offers, is actually understood by potential customers. Customers who fail to recognize your differential value are vulnerable to buying inferior offerings at lower prices supported by loosely defined performance claims. The role of value and price communications, therefore, is to protect your value proposition from competitive encroachment, improve willingness-to-pay, and increase the likelihood of purchase as customers move through their buying process.

In our research, we have found that business managers rated “communicating value and price” as the most important capability necessary to enable their pricing strategies. Ironically, the same study found that the ability to communicate value is also one of the weakest capabilities in most sales and marketing organizations. In retrospect, these results are not surprising because effective value and price communications require a deep understanding of customer value (which most firms lack) combined with a detailed understanding of how and why customers buy (another shortcoming) to formulate messages that actually influence purchase behaviors.

When Amazon.com launched the Kindle e-book reader in October 2007, sales grew rapidly even though Amazon broke from conventional wisdom by not supporting the product launch with a traditional advertising campaign. Amazon management understood that an innovative product like their electronic book reader would quickly generate buzz that would build awareness of it in the marketplace. But, although advertising on television and in print media could reinforce awareness, it would do little to motivate customers who knew of the product but were unwilling to invest in such a radical departure from traditional books. The challenge facing Amazon management was how to help customers overcome the perceived risk that the value of being able to order and read books electronically might not justify the $400 price tag.

Amazon had to communicate the value of the new book reader to customers in a clear and compelling way to overcome the perceived risk— something that advertising alone could not accomplish. Their solution was as innovative as the product. For a fraction of the cost of a traditional advertising campaign, Amazon established a “Meet a Kindle Owner” program in major cities across the United States. Under the program, customers could meet current Kindle owners and try out the reader for themselves. The combination of positive word of mouth from Kindle enthusiasts and the ability to experience the product firsthand was enough to overcome doubts about the Kindle’s value and has led to robust sales growth that has surpassed many analysts’ projections, a clear demonstration of the power of effective value communications.

As the Kindle example illustrates, efffective price and value communications can have a significant impact on purchase intent and willingness-to-pay. The challenge for marketing and sales managers is how to develop effective value messages for different types of products and differences in the buying process that customers employ. It would be absurd to use the same communication approach for breakfast cereal as for computer data servers. Similarly, the approach must vary depending on whether the customer is a first-time buyer in the category or an experienced user, or whether the buyer is an individual, a family, or large corporation. McDonald’s, which understands the customer’s buying process well, targets many of its messages toward children because they are key influencers in the final choice for a family meal. Top salespeople in business markets also understand the need to adapt messages to different people inside a customer’s organization because of the variety of roles that managers have in the buying process.

The purpose of this chapter is to explain how to develop value-based messages to reflect key product characteristics such as the nature of the benefits (psychological versus monetary) and the type of good (search versus experience). We also discuss how to adapt the message for important purchase characteristics such as the stage of the buying process or the number of individuals involved in the purchase decision. Finally, we show how to communicate prices in a way that can have a positive influence on a customer’s willingness-to-pay.

Value Communication

Value communication can have a great effect on sales and price realization when your product or service creates value that is not otherwise obvious to potential buyers. The less experience a customer has in a market or the more innovative a product’s benefits, the more likely it is that the customer will not recognize nor fully appreciate the value of a product or service. For example, without an explicit message from the seller, a business buyer might not realize that a nearby distribution center offering shorter delivery times could reduce or eliminate the cost of carrying inventories. An unsophisticated buyer might not recognize how quickly inventoried items depreciate. Properly informed, the customer would see how much money faster delivery saves, justifying a price premium.

Adapting the Message for Product Characteristics

The first step in developing a value message is determining which customer perceptions to influence. We start with an understanding of the value drivers that are deemed most important to a customer segment. The goal is to help the customer recognize the linkages between a product’s most important differentiated features and the salient value drivers. Two product characteristics determine how you should try to influence buyer perceptions of key value drivers: the target customer’s relative cost of search for information about the differentiating attributes of your offering and the type of benefits sought— monetary or psychological.

Relative cost of search is the financial and nonfinancial cost, relative to the expenditure in the category, that a customer must incur to determine differences in features and benefits across alternatives. The size of the expenditure is important because investing even five minutes comparing product alternatives may be too much to make a more informed choice about a $5.00 purchase, but spending an hour researching alternatives before spending $5,000 would seem merely prudent. Several other factors determine the relative cost of search, including search characteristics of the product and the customer’s expertise in the category. The relative search cost is low when the customer can easily determine product differences before purchase. Such products, called search goods, allow buyers to find information and choose among them prior to purchase. Examples include commodity chemicals, desktop computers, home equity loans, cosmetics, and digital cameras. The objective nature of search goods means that value messages can be quite definitive about the linkage between product features and the value drivers they impact. This concept of explicitly linking product features to benefits is illustrated by GE’s “Energy Smart” campaign in which each package of GE flourescent bulbs contains a claim about the savings a consumer could earn through reduced power consumption when she uses the bulb (Exhibit 4-1).

In contrast, experience goods have differentiating attributes that are more difficult to evaluate across brands, requiring the customer to invest substantial time and effort to evaluate the products before purchase. Examples include most services such as management consulting, auto repair, and investment advice, as well as some products such as pharmaceuticals and home entertainment systems. The nature of experience goods makes it more difficult for marketers to establish clear linkages between features and the expected benefits. Consequently, instead of making explicit linkages between features and the associated value drivers, marketers of experience goods will focus on broader assurances of value intended to reduce the perceived risk of purchase and to increase awareness of the potential benefits.

The relative cost of search declines significantly for expert customers with extensive knowledge about the product category. A technophile can read the feature specifications for a personal computer and quickly infer how it will perform various tasks. A more typical buyer, however, would have to try different brands to make the same inferences. As a result, less sophisticated buyers often develop strategies to lower search costs such as purchasing a brand name or relying on the advice of an expert. The endorsement of an expert can be very powerful, even in business markets. For example, Kaiser Permanente, a western U.S. health maintenance organization, has a reputation for being a well-informed buyer of the most cost-effective medical products. The company often tests drugs and devices itself and will not buy a more expensive product without economic justification. Consequently, when other hospitals and health maintenance organizations (HMOs) learn that Kaiser Permanente has adopted a more expensive product or service, they assume that its price premium is cost-justified.

The relative cost of search diminishes as a customer’s expenditure for the product increases. The relative cost of search is high for an individual buying an automobile because so much of the car’s performance cannot be determined prior to purchase. However, for a fleet buyer planning to purchase 2,000 cars, the relative cost to evaluate different brands, including buying one of each and trying it for three months, is not prohibitive.

The content of value messages for high cost-of-search products, such as those on the right-hand side of Exhibit 4-2, should differ from those for low cost-of-search products in the left-hand column. High cost-of-search products are often more complex, and the value derived tends to be more uncertain prior to purchase. Personal services are one example. How can a hair salon communicate the value of its services to new customers? Unlike grocery stores, which frequently offer free samples for search goods such as packaged foods, a salon cannot offer free trials because the cost would be prohibitive. Although advertising might help new customers to become aware of the salon and its location, it would be difficult to craft an ad to clearly demonstrate the differential value relative to competitors, because the quality of a haircut can only be assessed after it has been purchased. Instead of using direct feature-benefit linkages, sellers of experience goods design value messages to reduce the uncertainty associated with their product’s benefits. This can be done in a variety of ways such as relying on expert endorsements, using a high price to signal high value, providing money-back guarantees, or leveraging a known brand image to create an assurance that the customer will get high value following his purchase. Community banks have long used feature-benefit associations by focusing their messages on their key differentiators from national banks, such as personal service and understanding the needs of the local community. Advertising messages, for example, might display a happy family at a picnic in an ad related to home mortgages, parents with a graduate in cap and gown communicating the value of college loans, or a couple enjoying a vacation associated with their retirement account.

One of the most effective ways to influence value perceptions for experience goods is to subsidize trial. Health clubs offer free trial memberships. Suppliers of baby products pay hospitals to give away samples of baby formula to new parents. New brands of food products often spend significantly to induce trial with coupons, trial sizes, and free samples in addition to advertising. Their messages strive to increase buyer confidence that the product, when tried, will deliver enough psychological value to justify the choice. The challenge for marketers is to ensure that the discounts provided to induce trial do not undermine pricing to existing customers. This is why, advertisements for new trial promotions such as those used by companies such as Verizon, Comcast, and others showcase the performance, value, and packaging of their cable TV, Internet, and telephone services are accompanied by numerous restrictions in the fine print.

Type of benefits sought also influences communication strategy. Measurable monetary benefits such as profit, cost savings, or productivity motivate many purchases and translate directly into quantified value differences among competing brands. But, for other purchases, especially consumer products, psychological benefits such as comfort, appearance, pleasure, status, health, or personal fulfillment play a critical role in customer choice. Although the value of both psychological and monetary value drivers can be quantified, the way in which that data should be used in market communications differs. For goods in which monetary value drivers are most important to the customer, value quantification should be a central part of the message because the data calls attention to any gaps between the customer’s perceptions of value and the actual monetary value of the product.

Exhibit 4-3 shows an example of a value-based selling tool used by sales people to develop customer-specific monetary value estimates with the

EXHIBIT 4-3 Spreadsheet Value Communication Tool

customer in the course of a sales call. Notice that the data and assumptions, derived from the value estimation model, are well documented and quite detailed. While inexperienced salespeople sometimes fear that they will be challenged if they make value claims, more experienced salespeople relish the opportunity to engage in give-and-take conversations about precisely how much value their product creates. Only in that context can a salesperson justify a price premium that might otherwise seem unacceptable to a business buyer who is not the actual user of the product.

When the important value drivers for a purchase decision are pyschological rather than monetary, it is best to avoid incorporating quantified value estimates into market communications, because value is subjective and will vary from individual to individual. However, one should not conclude that subjective values, such as those that a customer might reveal in a conjoint research study, cannot be influenced by communication. There are two ways to do this. One is to focus the message on high-value benefits that the customer might not have been thinking about when considering the differentiating features of the product. The second is to raise perceptions of the product’s performance benefits that cannot be easily judged prior to experiencing them. Batteries all look and feel the same, even after one begins to use them. Not until they are entirely consumed can one actually know the life, and even then one would have no comparison unless two brands were bought and used side-by-side. Exhibit 4-4 shows the storyboard for a Duracell commercial. The advertisement is effective in clearly specifying the linkage between the Duracell battery’s key differentiating feature of longer life with the benefits that might bring to a variety of customers. Notice that the ad does not mention price or estimates of monetary value its goal is to establish Duracell’s differentiation.

In many cases, you may need to communicate both economic and psychological benefits for the same product to the same customers. Hybrid car buyers may want to feel good about protecting the environment, a psychological benefit a manufacturer could promote by reporting the car’s reduced pollution ratings while showing it driving through unspoiled scenery. However, the price premium that buyers will pay for a hybrid car also depends on how much money they expect to save from improved gas mileage, an economic benefit the company could communicate by comparing the car’s fuel efficiency with that of non-hybrid models.

Another example of combining financial and psychological value messages occurred when Johnson & Johnson had to justify a substantial price premium for its new and unique drug-coated coronary stent, used to keep clogged arteries open. J&J priced its stent at $3,500—250 percent higher than traditional uncoated stents and well in excess of the cost of the drug used to coat the stent. Such aggressive pricing aroused critics in the medical professions and in the public press, who accused the company of price gouging and challenged J&J to reconcile the value of the new product with its price. J&J did so by explaining the economic benefits to medical professionals. Stent implantation surgery costs more than $30,000, including the cost of the stent. But in

20 percent of cases, an uncoated stent reclogs in less than a year, requiring a repeated procedure at another $30,000 cost. With J&J’s new drug-eluting stent reducing the likelihood of reclogging, the surgery repeat rate fell to around 5 percent. Thus, the objective differentiation value from the smaller reclogging rate was $4,500: the 15 percent rejection rate difference multiplied by the cost of a second surgical procedure. In addition, patients received substantial psychological value in avoiding the risk and discomfort of a repeat procedure, a benefit J&J emphasized to the public. The combination of economic and psychological justification enabled J&J to not only win a larger reimbursement from payers when surgeons used its drug-eluting stent but also to defuse the initial hostility and resistance to its price.

Adapting the Message to Purchase Context

Value-based communications must not only be adjusted for product characteristics such as cost of search and benefit type, but also for the customer’s purchase context. Consider the challenge facing Lenovo, a leading maker of netbook computers. Netbooks are small computers with limited computing power designed to provide inexpensive access to the Internet and basic home office functions such as word processing. The value drivers for Lenovo’s net-books are well understood. Their light weight and small size make them highly portable for travelers or students. They are exceedingly reliable because of their simple design and the fact that they run only mature operating systems such as Microsoft’s Windows XP.

Given the relatively clear linkage between product attributes and customer value drivers, crafting a value message would seem to be a straightforward exercise. But consider how the message would have to be adjusted depending on the specifics of the purchase context. Suppose the target customer was a long-time laptop buyer who was thinking about replacing his five-year-old Dell computer. Since this customer has not been in the market for a new computer since before netbooks were introduced, he might not even know what a netbook is, much less that Lenovo is a leading manufacturer. At this stage of his search, the communication objective is not to demonstrate the superior value of Lenovo’s products, it is simply to make him aware of the benefits of netbooks that could make them a preferable option. This might be accomplished by purchasing numerous search terms on Google such as “new laptops,” “laptop comparisons,” or “laptop performance”—so that text ads for Lenovo netbooks appear next to search results for those terms—and then providing a link to a site describing the latest innovations in personal computing such as the advent of netbooks.

Having learned of netbook computers as a potential option for replacing his Dell laptop, the customer is ready to gather basic information about various alternatives so that he can narrow his options to a manageable set. The goal at this stage of the buying process is to create some assurances that Lenovo’s product is differentiated and worthy of further investigation. This might be accomplished with messages describing the numerous awards the product has won or the high ratings it receives from third-party sites such as CNET.

It is not until the customer has progressed from awareness and through consideration of the product that he is ready to receive and process detailed product-related value messages. So, once again, the Lenovo marketing managers must be ready to adapt market communications to detail the superior performance of their computer versus other netbooks as well as versus full-sized laptops. This might be accomplished through product comparison tools on the Lenovo website or by working with channel partners to promote differentiated features of the product. Finally, after progressing through a number of steps in his buying process, the customer may be ready to think about price-value tradeoffs and to make a purchase.

The Buying Process

The Lenovo example illustrates the need to adapt value messages as customers move through the stages of their buying process. In some instances, such as for frequently purchased goods such as grocery items, the buying process is relatively short, and and the only opportunity to communicate value might be at the shelf front through label comparisons and point-of-sale displays. For purchases involving more complex, higher involvement goods such as computers, vacations, or automobiles, the buying process can be quite lengthy and involve extensive search and evaluation of information. In either case, the challenge is the same: how to adapt the value messages to influence customers’ learning about goods as they move through the stages of the buying process.

Exhibit 4-5 illustrates the four basic stages of the buying process: origination, information gathering, selection, and fulfillment and describes the customer’s learning process at each stage. Origination is the stage at which the customer becomes aware of a need and begins the search for a suitable offering to satisfy it. Origination of the buying process can be initiated in a variety of ways. Consider the example of a new car purchase. A customer might initiate a buying process because:

• Her 10-year-old car has broken down for the second time in a month
• A neighbor has just purchased a new convertible, and it seems like a fun idea to buy something more exciting than the customer’s current sedan
• The family is expecting their first child, and they need more space and are concerned about safety
• The owner just lost her job and can’t afford to make payments on her current car

The objective for value communications at the origination stage is to use value as a lever to encourage customers to consider a purchase within the category. Hyundai Motors did this admirably during the 2008-09 recession. At a time when North American new car sales had dropped by more than 50 percent, Hyundai developed a promotional campaign that boosted sales of its cars by 38 percent. The “Hyundai Assurance” campaign enabled a customer to purchase a new car and then return it with no penalty if he subsequently lost his job in the next year. It encouraged tens of thousands of customers to initiate a buying process for a new car because it was actually less risky than continuing payments on an existing car. In this case, Hyundai identified an emerging value driver (uncertainty about future income), developed a promotion to address the need, and then invested heavily in communicating the program to consumers.

The next stage of the buying process, information gathering, is a critically important stage for complex goods with a high cost of search. Historically, distribution channels were central to the search for information as customers turned to salespeople to explain their products and facilitate product comparisons. The prominent role of salespeople gave sellers considerable power to communicate value and influence the purchase decision. In recent years, however, the balance of power has shifted toward the customer because of the explosion of data available from websites and social networking channels. Instead of relying on potentially biased messages from the seller, customers can, with little effort, gather information from objective third parties and current users.

The ready access to information reduces the cost of search and places a greater burden on the seller to provide accurate and relevant information to the customer. The communication objective at this stage of the buying process is to increase the salience of the value drivers upon which your product has an advantage. Kodak has done an admirable job of highlighting critical value drivers in its advertising for computer printers (Exhibit 4-6). Most customers are well aware of the traditional pricing model for printers in which the printer is sold at a low price (often near cost) and the replacement ink cartridges are sold at a premium. By highlighting the high quality and low prices of its ink cartridges, Kodak encourages customers to consider the total cost of owership, including the price for ink. The greater the weight customers put on the cost of ink cartridges, the more they are likely to choose Kodak’s printer over a competitor’s.

Selection, the next stage in the buying process, involves winnowing the alternatives to a manageable number in order to conduct a more detailed product evaluation that ultimately leads to choice. The communication objective is to create awareness of your brand and its superiority in terms of the

most salient value drivers. When it launched the Scion in 2008, Toyota did an excellent job of facilitating awareness of the car’s advantages durng the selection stage. The Scion is a small, boxy vehicle targeted at 20-something first-time car buyers. Toyota recognized that this segment valued individuality and designed the Scion so that it could be configured in tens of thousands of ways by changing bumpers, lights, and a host of other options. But Toyota did not stop at simply providing a product that met the needs of its customers; it communicated those benefits through a highly interactive website containing visualization and design tools that enabled potential customers to customize their own vehicle and see precisely how their new car would look. Because Toyota adopted a fixed-price policy for the Scion (a departure from its other models), customers could explore different car configurations to stay within their budget while getting a car made just for them.

The final stage of the buying process, fulfillment, involves the selection of a purchase channel and then actual purchase. The value communication goal at this stage is to justify the price by using value to create a favorable framing for the price. For goods in which monetary value drivers are most relevant, marketers can use quantified estimates of value to frame price as a discount from value received instead of a premium over a competitor’s price. Framing price in this way focuses on what a customer gains by purchasing your product (the discount from value) instead of what they lose (additional price over competition) and can have a powerful psychological influence on the purchase decision.

For goods in which psychological value drivers are most relevant to the customer, the goal is to develop messages that clearly demonstrate high value relative to price. This can be done through a variety of means, such as benchmarking against other products with well-understood value propositions. Exhibit 4-7 shows such an approach for a nutritional supplement called Glucofast that helps to stablize blood sugar levels for diabetics. While the value of such a product could be quite high, the intangible nature of the value drivers makes comparison to price difficult. The company cleverly reframed the value by comparing it to the cost of a cup of coffee, implying that any reasonable person would naturally want better health for less than she spends for a hot drink.

Multiple Participants in the Buying Process

The buying process frequently involves more people than just the customer, since others participate by providing information, facilitating search, and influencing the purchase decision. Multiple participants are, in fact, the norm for purchases of high involvement goods characterized by complex offerings and, often, higher prices. Multiple participants are also common in most business markets, where purchasing is managed by professional procurement managers using sophisticated information systems and aggressive negotiation tactics. The addition of individuals to the buying process complicates the job of value communications because it forces marketers to adapt and deliver multiple messages at different points in the buying process.

To illustrate how value communications can be adapted for multiple individuals in the buying process, we turn to the example of a chemical company attempting to sell the value of a new chemical additive for a steel mini-mill. Suppose that the chemical provided an incremental $18 per ton in monetary value for the steel producer. However, the $18 is an aggregate, company-level estimate that is not equally relevant to the different stakeholders in the customer organization (see Exhibit 4-8). For example, the marketing manager may appreciate the total value estimate, but he is impacted directly only by the fact that the chemical additive enables him to penetrate new market segments. The melt shop foreman will value the reduced scrap rate, worth $2 per ton, but he will be less pleased about the $5 cost created by the additional process steps needed to incorporate the additive into the steel slurry. In the end, the melt shop foreman may be negatively disposed toward the product because it lowers his organization’s financial performance even though the overall value is positive. Finally, note the value impact for the procurement agent is neutral because her functional area has no operational involvement with the additive; she is only involved in negotiating the price.

The need to adapt marketing communications to the product and the customer’s context makes creating effective value communications more challenging today than ever before. It is not sufficient to adapt the content of the message to the customer’s learning needs at different stages of the buying process. You must also ensure that it is delivered to the right person at the right time in the buying process. Accomplishing this task requires meaningful insight about what value is created, how that value is generated across the organization, and when the participants in the buying process are ready to receive the value messages. Our research shows that successful value communications requires close coordination beween marketing and sales—a trait lacking in many of the organizations we surveyed. For those companies that make the investment to strategically communicate value, the return, in the form of more profitable pricing, can be substantial.

Price Communication

Although it is easy to understand how value can be influenced, particularly the perceived value of psychological benefits, prices would seem to be hard data that are relatively easy to compare and communicate. But research over the years has repeatedly shown that people do not necessarily evaluate prices logically. Customers can perceive the same price paid in return for the same value differently depending on how it is communicated. We will examine four aspects of price perception and their implications for price communication: proportional price evaluations, reference prices, perceived fairness, and gain-loss framing.

Proportional Price Evaluations

Buyers tend to evaluate price differences proportionally rather than in absolute terms. For example, one research study asked customers if they would leave a store and go to one nearby to save $5 on a purchase. Of respondents who were told that the price in the first store was $15, some 68 percent said they would go to the other store to buy the product for $10. Of respondents who were told that the price in the first store was $125, only 29 percent would switch stores to buy the product for $120. Similar studies have replicated this effect, including research with business managers as respondents. When the $5 difference was proportionally more—33 percent of the lower price—it was more motivating than when it was proportionally a small part, 4 percent of the higher price.

Psychologists call the tendency to evaluate price differences proportionately the Weber-Fechner effect. It has clear implications for price communication. For example, auto companies increased the motivational power of their rebate promotions when they offered the option of free financing instead of a fixed-dollar rebate only. Despite the fact that the present value of the interest saved was no more, and often less, than the value of the fixed-dollar rebate, free financing proved more popular. Why? Because eliminating 100 percent of the financing cost motivated consumers more than a 5 percent discount on a $20,000 car. Similarly, hotel chains have found it more effective to offer “free breakfast” or “free Internet access” with their rooms rather than offer a slightly lower price.

An important implication of the Weber-Fechner effect is that price change perceptions depend on the percentage, not the absolute difference, and that there are thresholds above and below a product’s price at which price changes are noticed or ignored.¹ A series of smaller price increases below the upper threshold is more successful than one large increase. Conversely, buyers respond more to one large price cut below the lower threshold than to a series of smaller, successive discounts. For example, one full-service brokerage house raised its commissions every six months over a three-year period with little resistance from customers. Seeing this success, its competitor tried to match these increases in one large step and received intense criticism.

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 Exhibit 4-9 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 top-end 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

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

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.

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.² 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.³ Although buyers may discount or question the credibility of such claims, the claims still favorably influence perceptions and behaviors.⁴

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.⁵ 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,⁶ 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.

Perceived Fairness

The concept of a “fair price” has bedeviled marketers for centuries. In the Dark Ages, merchants were put to death for exceeding public norms regarding the “just price.” Even in modern market economies, putative “price gougers” often face press criticism, regulatory hassles, and public boycotts. Consequently, marketers should understand and attempt to manage perceptions of fairness. But what is fair? The concept of fairness appears to be totally unrelated to issues of supply and demand.⁷ Naturally assumptions about the seller’s profitability influence perceived fairness, but not entirely. Oil companies have often been accused of gouging, even when their profits were below average. When Hurricane Katrina disrupted gasoline supplies in the American south, gas station owners who raised prices were soundly criticized as “price gougers” even though they had only enough supply to serve those who wanted the product at that price. In contrast to the situation faced by oil companies, popular forms of entertainment (Disney World, for example, or state lotteries) are very profitable and expensive, yet their pricing escapes widespread criticism.

As these examples illustrate, research shows that perceptions of fairness are more subjective, and therefore, more manageable, than one might otherwise think.⁸ Buyers apparently start by comparing what they think is the seller’s likely margin now to what the seller earned in the past, or to what others earn in similar purchase contexts. In a famous experiment, people imagined that they were lying on a beach, thirsty for a favorite brand of beer, and that a friend was walking to a nearby location and would bring back beer if the price was not too high. Researchers asked the subjects to specify the maximum amount that they would pay. Subjects did not know that half of them had been told that the friend would patronize a “fancy resort hotel” while the other half had been told that the friend would buy from “a small grocery store.” Although these individuals would not themselves visit or enjoy the amenities of the purchase location, the median acceptable price of those who expected the beer to come from the hotel—$2.65—was dramatically higher than the median acceptable price given by those who expected it to come from the grocery store—$1.50.⁹

Presumptions about the seller’s motive influence customers’ perceived fairness judgments. A seller justifying a higher price with a “good” motive (for example, funding employee health insurance, improving service levels) makes the price more acceptable than does a “bad” motive (for example, exploiting a market shortage to increase stockholder profits). Research suggests that companies with good reputations, such as Disney, are much more likely to get the benefit of the doubt about their motives. Those with unpopular reputations (for example, oil companies) are likely to find their motives suspect.¹⁰

Finally, perceptions of fairness seem to be related to whether the price is paid to maintain a standard of living, or is paid to improve a standard of living. People consider products that maintain a standard to be “necessities,” although humanity has probably survived without them for most of its history. Charging a high price for a necessity is generally considered unfair. For example, people object to what they perceive as high prices for life-saving drugs because they feel that they shouldn’t have to pay to be healthy. After all, they were healthy last year without having to buy prescriptions and medical advice. People react similarly to rent increases. Yet, the same individuals might buy a new car, jewelry, or a vacation without objecting to equally high prices or price increases.¹¹

Fortunately, perceptions of fairness can be managed. Companies that frequently adjust prices to reflect supply and demand or to segment buyers with different price sensitivities are careful to set the “regular” price at the highest possible level, rather than at the average or most common price. This enables them to “discount” when necessary to move product during slow times (a “good” motive), rather than have to increase prices when demand is strong (a “bad” motive).¹² Similarly, because buyers believe that companies should not have to lose money, it’s often best to blame price increases on rising costs to serve customers. Buyers believe that is fair, such as when petroleum prices increase. Landlords who raise rents should announce property improvements at the same time. Innovative companies raise prices more successfully when they are launching a new product and say that they are recovering development costs.

Gain—Loss Framing

A final consideration in price communication involves how the price is presented to customers, who tend to evaluate prices in terms of gains or losses from an expected price point.¹³ How they frame those judgments affects the attractiveness of the purchase. To illustrate this effect, grounded in prospect theory, ask yourself which of the following two gasoline stations you’d be more willing to patronize, assuming that you deem both brands to be equally good and you would always pay with a credit card.

• Station A sells gasoline for $2.20 per gallon, but gives a $0.20 per gallon discount if the buyer pays with cash.
• Station B sells gasoline for $2.00 per gallon, but charges a $0.20 per gallon surcharge if the buyer pays with a credit card.

Of course, the economic cost of buying gasoline from either station is identical. Yet, most people find the offer from station A more attractive than the one from station B. The reason is that people place more psychological importance on avoiding “losses” than on capturing equal size “gains.” Also, both the gains and losses of an individual transaction are subject, independently, to diminishing returns, as one would expect from the Weber-Fechner effect we discussed earlier: A given change has less psychological impact the larger the base to which it is added or subtracted.

In our gas station example, cash buyers prefer A, where they receive the psychological benefit of earning a discount, a “gain” to them. Paying the same $2.00 net price per gallon at station B, which offers no explicit discount, does not provide a psychological benefit. Credit card buyers also prefer station A, mainly because station B’s credit card surcharge creates a “loss,” a negative psychological benefit to be avoided. Paying the same $2.20 net price per gallon at station A, which requires no explicit surcharge, does not provide a psychological benefit, positive or negative.

Buyers otherwise indifferent to paying by cash or credit will not be indifferent to stations A or B despite the sellers’ economic value equivalence; such buyers would always pay cash to get the lowest price but would likely choose A to get the psychological satisfaction unavailable at B. Prospect theory has many implications for price communication:

• To make prices less objectionable, make them opportunity costs (gains forgone) rather than out-of-pocket costs. Banks often waive fees for checking accounts in return for maintaining a minimum balance. Even when the interest forgone on the funds in the account exceeds the charge for checking, most people choose the minimum balance option. People find it less painful to pay for things such as insurance or mutual funds with payroll deductions instead of buying them outright.

• When a product is priced differently to different customers and at different times, set the list price at the highest level and give most people discounts. This type of pricing is so common that we take it for granted. Colleges, for example, charge only a small portion of customers the list price and give everyone else discounts. To those who pay at or near the full price, the failure to receive more of a discount (a gain forgone) is much less objectionable than if they were asked to pay a premium because they are not star students, athletes, or good negotiators.

• Unbundle gains and bundle losses. Many companies sell offerings consisting of many individual products and services. For example, a printing company not only prints brochures but also helps design the job, matches colors, schedules the job to meet the buyer’s time requirements, and so on. To maximize the perceived value, the seller should identify each of these as a separate product or service and promote the value of each one explicitly (“Look at all you get in our Deluxe Package!”), unbundling the gains. However, rather than asking the buyer to make individual expenditure decisions, the seller should identify the customer’s needs and offer a package price to meet them (“One price brings it all to you”), bundling the loss. If the buyer objects to the price, the seller can take away a service, which will then make that service appear as a stand-alone “loss” that will be hard to give up.

Strategists who think only in terms of objective economic values might find these principles far-fetched. One might argue that buyers in these cases could easily think of the same choices as entirely different combinations of “gains” and “losses.” That is precisely the point that prospect theorists make: Buyers can frame the same transactions in many different ways, each implying somewhat different behavior. Researchers have shown that changing how people think about their gains and losses in otherwise identical transactions consistently alters their behavior.

Summary

How customers respond to your pricing is determined by more than the value delivered by your product and the price you charge. It is also influenced by how they evaluate your product and your price. If you leave those judgments to chance, you are likely to be paid much less or sell much less than you could. Most customers lack the time or the incentive to fully inform themselves about their alternatives and to evaluate the information they do have. If you want them to recognize your value, you have to make the process easier for them by supplying them with information about your offer and what you think it should mean to them.

You also need to actively manage how you communicate the price to minimize adverse feelings about paying it. By controlling the visibility of price differences, the formulation of references, and the perceptions of fairness, you can reduce negative reactions to your pricing without reducing your overall margins.