Reference prices play a crucial role in the decision-making process of consumers and businesses alike. They serve as a benchmark for comparing the value of products and services in the market, helping buyers determine whether a particular price is reasonable or not. Understanding the importance of reference prices can help businesses make informed pricing decisions and develop effective marketing strategies.
What is reference price?
In retail, reference price refers to the cost at which a store owner or merchant sells a particular product, often offering a significant discount compared to its previously advertised price. This pricing strategy, also known as competitive pricing, involves setting the product's price just below that of a competitor's product to make it more appealing to consumers.
There are two types of reference prices: internal and external. Internal reference prices are formed by consumers based on their past experiences and knowledge about the product. For example, if a consumer expects a sandwich to cost around $5 based on their previous purchases, that would be their internal reference price.
Another example, is a clothing store introduces a new dress at a high price of $100, then offers a 50% discount after a few weeks. Customers perceive the discounted price of $50 as a good deal compared to the initial reference price of $100 when they first saw it at the store.
External reference prices, on the other hand, are provided by marketers to influence consumers' decisions. These can be displayed through advertisements, price tags, signs, or labels, and can even be influenced by the prices of surrounding items in the store or website. The customer will compare the price of a competitor's product or the previously advertised price. For example, if a smartphone is priced at $800, and a similar model from a competitor is priced at $900, the external reference price for the first smartphone would be $900.
Another example is a smartphone manufacturer releases a new model with advanced features at a higher price than its previous models. Consumers may compare the new model's price to the prices of older models or competitor products to determine if it's worth the investment.
Why are reference prices important?
One of the primary reasons reference prices are important is that they influence consumer perception of value. When a product is priced below its reference price, buyers are more likely to perceive it as a good deal and may be more inclined to make a purchase. For retailers, it helps create a perception of value and encourages customers to make a purchase, believing they are getting a good deal. On the other hand, if a product is priced above its reference price, consumers may view it as overpriced and opt for a more affordable alternative.
Reference prices also play a significant role in shaping consumer behavior. Marketers often use discounts and promotions to create a sense of urgency and encourage buying. By offering a product at a lower price than its reference price, businesses can trigger a positive emotional response in consumers, making them more likely to buy the product. Therefore, for consumers, reference pricing can help limit the scope of information search, saving on search costs and cognitive efforts, ultimately impacting their purchase decisions and post-purchase evaluations.
How can reference prices help scale your business?
Reference prices can help businesses maintain a competitive edge in the market. By understanding the reference prices of their competitors' products, companies can strategically price their offerings to attract customers and gain market share. This competitive pricing approach can lead to increased sales and revenue for the business.
In addition, reference pricing models can help reduce costs for both businesses and consumers. For example, in the healthcare industry, reference-based pricing can save up to 40% on healthcare spending by limiting the maximum payable amount for coverage. This approach ensures that businesses and consumers pay the lowest possible amounts for goods and services, promoting cost efficiency and affordability.
Other types of reference prices, including:
- Fair Price: The price that customers believe a product should cost based on its perceived value.
- Typical Price: The average price of similar products in the market.
- Last Price Paid: The price a customer paid for a similar product in the past
- Upper-Bound Price: The maximum price most consumers would be willing to pay for a product
- Lower-Bound Price: The minimum price consumers would be willing to pay for a product
- Competitor Price: The prices of similar products offered by competitors
- Expected Future Price: The anticipated price of a product in the future
- Usual Discounted Price: The common discounted price for a product
Final Thoughts
Understanding reference prices and their impact on consumer behavior is crucial for businesses to effectively price their products and services, attract customers, and increase sales. Reference prices are essential in shaping consumer behavior, driving competition, and promoting cost efficiency.
However, it is essential for consumers to be aware that external reference prices can sometimes be misleading, as marketers may use them to manipulate shoppers' decision-making processes. To make informed decisions, consumers should consider other factors beyond the product's price, such as their internal reference prices and practical aspects like their current needs and affordability.
