Reference pricing is a pricing strategy that uses a pre-defined reference point to set the price for a product. In the following, we will explore the role of reference prices in pricing decisions to understand reference-based pricing.
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Definition of Reference Prices
Reference-based pricing is known as a pricing strategy based on some reference point. This point is in most cases understood as the price which users compare with the price of a product. Hence, the price of the product which is more expensive becomes the reference price for your product. This already indicates the important role of reference prices in pricing decisions: before setting a specific price for a product, an extensive research of competing products is necessary.
The prices of competitors’ products should provide some basis for your own pricing strategy, as also consumers will eventually evaluate your prices with those reference prices.
Role of Reference Prices in Pricing Decisions
As indicated above, a reference price is what a buyer considers a reasonable and fair price for a product. Most often, these evaluations are based on the prices of alternative products.
Reference prices are a critical issue in pricing decisions. The important role of reference prices has been proven by an experiment in which subjects 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 it became the mid-priced choice. This makes the crucial role of reference prices in consumers’ evaluations and thereby the importance for pricing decisions clear.
Especially for product line pricing, reference prices play a very important role. Adding a premium product to the product line may not necessarily result in overwhelming sales of the premium product itself. However, it will enhance buyers’ perceptions of lower-priced products in the product line and encourage low-end buyers to trade up to higher-priced models.
Influencing Reference Prices
As the role of reference prices for consumers’ perceptions is such crucial, marketers have sought ways to influence reference prices in consumers’ minds.
The first and most obvious way is based on the product characteristics and communication thereof. As reference prices do usually come from competing products, one can try to enhance the perception of the product so that it will be compared to more superior and more expensive products.
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 (“Previously $999, Now $699!”).
Also the order in which consumers see different prices influences their perceptions. When forming their reference prices, buyers tend to give greater weight to the prices they see first.
For that reason, the role of reference prices in pricing communication should not be underestimated. For instance, in personal selling 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.
Within a retail store, the role of reference prices has implications for product display. For instance, a grocery store might sell more low-priced (but high-margin) private label products 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.
By understanding the importance of reference prices in consumers’ evaluation processes, marketers should be better able to define pricing strategies.