Reference Prices: The magic that really works
Carefully crafted pricing strategy can lead to better business!
Welcome to the 12th Issue of The Funnel Chemistry.
Yes, I know! The last issue was mis-numbered and I am late this week! I am sorry about that. Will be more mindful of errors next time. I had a couple of commitments that I didn’t say no to hence the delay.
One thing that I enjoy doing for this newsletter is the sketch notes. It is not only challenging to represent content visually, but also fulfilling once the thing is finished. I must thank you for that opportunity! Without your encouragement it would have been quite an effort!
Well, let’s not chit chat anymore and get right to this week’s topic. This email has 1700+ words and would take approximately 7 minutes of your time.
Background
Back during the early 2000s’ I used to accompany my girlfriend (now my wife) on her shopping sprees when she wanted to purchase dresses for herself. For me it was a study in consumer behavior. Specifically to see how the salesman approaches the sale and how they effectively close it.
One of the things that I observed back then is that every salesman who showed sarees or dresses to us asked us what our budget was and began showing items that were priced slightly above our budget lines. Then they used to show us those that were within our budget. Extremely good salesmen could even persuade us to overshoot our budget and buy something we felt was nice.
I used to wonder why these salesman invariably started with items out of our budget? Anyway we weren’t really going to buy them! I used to feel what a stupid tactic it was! Maybe they did it because they were told to do it that way! But then I read about reference prices and everything made so much more sense!
Reference Price
Reference Price is a price point which a consumer uses to compare the price at the point of sale to determine if what he/she is paying is reasonable or not.
There are two types of reference prices, namely Internal and External.
Internal reference prices are formed based on the past purchase experiences of the buyer. As buyers we usually can guess the prices of what we are going to purchase based on past experiences. For instance, if I am going to buy a coffee in Starbucks I know that I may have to spend upwards of ₹300 for a cup of coffee. If I am having a smaller cup in a local store like A2B then I may end up spending ₹20. I know these prices because I am used to purchasing coffee at both the joints. These are my Internal Reference Prices.
External reference prices are formed based on the current available price information at a point of sale. As buyers we may not remember the prices accurately and the price points mentioned at the point of sale give us a reference point. For example, I may walk into Nilgiris to buy mangoes but may not have the memory of the prices from the last season. I get an idea when I see the prices on display at the respective shelf. There maybe three or four varieties of Mango and three or four price points. These price points serve as anchors for comparison.
Reference prices are extremely important for a pricing strategy, especially if you are retailing your products/services offline/online. They directly influence value perception of the product/service being considered and so influence purchase decisions.
Here is my Sketch note on reference prices. One of the extreme forms of pricing that extensively depends on and uses reference pricing is “Pay what you want” model where you allow the customers to choose to pay whatever comes to their mind. Once you go through the use case below, you will see how this model can be profitable.
You can click here, to download a PDF version of this sketchnote.
How Reference Prices work
Let’s say you approached the “Dry Fruits” section/shelf in your favorite retail store intending to buy Cashew Nuts. You know that usually good quality Cashews will cost you upward of ₹700 a Kg. This is your Internal Reference Price. Something around this is what you’d expect to pay.
Now, as you are browsing you find that there are four varieties of Cashew nuts, priced at ₹720, ₹800, ₹900, ₹1050 a kg. As you spend a little time considering which one to buy, the sales assistant in the section comes up and offers assistance. She points to the nuts priced at ₹900 a Kg and tells you that since there are only the last 2 Kg of this variety left, the store is offering a discount of 15% so that the stock is quickly cleared.
The price now is ₹765 a Kg. This sounds like a really good deal isn’t it. You are getting a better quality product which is closer to your internal reference price! Without the discount, you would never have made the leap to the ₹900 variety. At best you would have chosen the ₹800 one.
Now think from a store’s point of view. What if as a store owner, if you could acquire the two varieties of Cashew (the ₹720 and the ₹900 one) at a marginal cost difference. What if your margins are better on the sales of ₹900 variety? What if it was never your intention to sell either the ₹1050 or the ₹800 varieties? They are just there to nudge the customer’s comparison!
That’s a smart thing to do! Simply by arranging and supplying information that is different from your internal reference price, the store could get you to spend more. Of course, the money is worth because you got better quality!
It’s a win-win for both you and the store!
The Ethical Angle for Reference Prices
Since it is possible to manipulate the buyers easily using reference prices, many countries are cautious about how businesses use them. There are pricing regulations that restrict the use of reference pricing and its applications so that buyers are not unduly outsmarted by over-enthusiastic marketers. It is good to be aware of the legal aspects of pricing while designing a pricing strategy and store sales tactic!
Deepening the concept
I present here 4 articles that I have curated carefully to deepen the concept of Reference Prices. This was a little tough because there is a ton of scholarly research out there and very few articles on Reference Prices. To get to the right piece was a little time consuming and required a bit of search tactics too.
This page discusses pricing strategy in general, but has a section on Reference Prices that is in sync with what I have described earlier.
Are You Really Getting a Discount, or Is It Just a Pricing Trick?
We just spoke of the ethical angle of the reference price, and this article from the Harvard Business Review (HBR) is about how reference prices can be misleading! It’s a very short but extremely useful read.
What Amazon Risks by Eliminating List Prices
Another HBR article on reference pricing which speaks why it’s important that two price points (The list price and The our price) are needed to ease out consumer purchases! Again short but brilliant. I have included this article to show that reference prices are relevant even in online e-commerce businesses.
What Shoppers Should Know About Reference Prices
Though this article has been written from a shoppers point of view, there is a clear explanation about what reference prices are and how that affects buyer behavior! Not surpirisingly there is not much advise to the buyer as to how they should respond to these pricing tactics, except saying “Please be mature and use your head!”
How to use this concept
There are a variety of uses of reference prices. Here are some you can use for yourself or your clients as digital marketers!
Tip#1: You can supply a reference price as a manufacturer suggested price or a list price (for e-commerce display) and offer a discount. If the discount is heavy then it is likely to get you some sales. However, you must be careful as you cannot lie about your suggested/list price. Here’s Amazon’s Policy on list prices that you must be aware of! These policies are made such that the platform doesn’t lose its trust with the buyer.
Tip#2: You can use advertising to raise the internal reference price for your product. Advertising on the social media is now economical and can reach out to specific targeted audience. You can use this opportunity to advertise a higher internal reference price to your audience! The idea is not to get sales or leads but to familiarize your audience with a price point that they can use for comparison.
Tip#3: If you were selling a high-end product/service and are thinking of introducing something of a low-end product/service for the same market either for trying the product/service or for capturing the low-end buyers and nurturing them till they are ready to buy the high-end version, then think of having a mid-end product too. But the low-end product must offer a higher value compared to the mid-end product and must look like a value bomb. In fact, your goal is not to sell the mid-end product at all. It is there just for comparison purposes. Works very well to sell on-line courses. When you are upselling then the mid-end product serves as an anchor point for price comparison.
Next Steps
All this knowledge would be really useless if you simply read and forget it. Take time to think through the above tips and see what you can do about them. If you are unable to figure that out, remember that I am a mail away. Hit that reply button and start a conversation with me. I would love to help!
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