St.

Nicolas College BS IN BUSINESS ADMINISTRATION

LESSON 6 Predicting Price-Change Response- Emotional Factor

A buyer’s emotions and feelings also play a very important role. Even if a customer has accurate
knowledge about the level of a price, that knowledge alone does not tell us how the buyer will feel
about that price. The strong effect of price-related feelings on the buyer’s response to a price makes it
important for the seller to be able to anticipate these emotional factors.

Since a price involves giving up something of value, the feelings associated with paying it will usually
be of the negative variety. The pain of paying—how much it hurts to pay a price—is a useful concept
for considering the emotional factors in price-change response. Since we cannot know the pain of
paying a price from the price level alone, we need to understand what determines how much of this
pain a price is likely to evoke in the customer’s mind.

FRAMING IN THE PERCEPTION OF PRICES

Although the money involved in a price is very concrete and specific, the buyer’s perception of this
money has a surprising amount of flexibility. Even when a price involves a single sum of money, it
does not have to be perceived by the buyer as a single sum.
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of Business and MARKETING MANAGEMENT
Technology PRICING STRATEGY

An illustration of how a Frame of Reference (the Surrounding Letters) Can Affect How the Ambiguous
Character Is Perceived.

We tend to perceive money in terms of gains and losses—money we get (a gain) or money we lose
(a loss). The frame of reference in these perceptions, referred to as the reference point, is often the
status quo.

An important aspect of this view is that the reference point that defines gains and losses is entirely in
one’s mind and thus can quickly change. Such a change is referred to as a reference point shift.

Because a buyer’s feelings can be so strongly related to perceived gains and losses, it is in the
seller’s interest to consider what can be done to manage how buyers perceive the seller’s price. The
management of the factors that influence the set of gains and losses that comprise the buyer’s
perception of a price is referred to as framing. Note that the methods used in framing do not affect
the level of the price. They have to do with only the issue of price format—how the price is expressed
when it is communicated to customers.

THE VALUE OF GAINS AND LOSSES

The recognition that a price is perceived as a set of gains and losses raises the question of how
buyers are likely to value each of these gains and losses. Our understanding of this has been
advanced by the Nobel Prize- winning work of the psychologists Daniel Kahneman and Amos
Tversky. This work is often referred to under the term prospect theory, since Kahneman and Tversky
referred to possible alternatives in a decision as “prospects.” A key result of their research is the
prospect theory value function. This is a succinct description of how people feel about gains and
losses or, more precisely, the value they place on gains or losses of various sizes.

A graph showing the prospect theory value function can be seen in the figure below. The horizontal
axis of the graph represents the size of the gain or loss. At the reference point, there is neither a gain
nor a loss. The segment of the horizontal axis to the right of the reference point indicates gains; the
farther it is from the reference point, the larger the gain. The segment of the horizontal axis to the left
of the reference point indicates losses; the farther it is from the reference point, the larger the loss.

The vertical axis of the graph represents the value that a person places on a gain or loss. At the
reference point, there are neither positive nor negative feelings. The segment of the vertical axis
above the reference point indicates positive value; the farther it is from the reference point, the
greater the pleasure. The segment of the vertical axis below the reference point indicates negative
value; the farther it is from the reference point, the greater the pain.

As can be seen in the figure below, the prospect theory value function curves gently upward to the
right of the reference point, indicating the degree to which gains of various sizes are positively valued.
The value function curves sharply downward to the left of the reference point, indicating the degree to
which losses of various sizes are negatively valued. There are two important aspects of the prospect
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theory value function: (1) the incorporation of the Weber–Fechner Law and (2) the postulation of
loss aversion.

The Prospect Theory Value Function

The Weber-Fechner Law

Named after two pioneering researchers of the nineteenth century, the Weber–Fechner Law is one of
the oldest and most reliable laws in psychology. It holds that there are “diminishing returns” for the
mental effects of a stimulus. In other words, each additional unit of external stimulation will add less to
the mental effect of the stimulus than its predecessor.

Applying the Weber–Fechner Law to pricing would go as follows: Each additional dollar will add less
to the pain of paying than its predecessor. Thus, adding a given dollar amount to the price of an
inexpensive item will increase the pain of paying more than adding that amount to the price of an
expensive item.

Loss Aversion

As was previously mentioned, the loss portion of the prospect theory value function curves downward
more sharply than the gain portion of the function curves upward. This represents loss aversion—the
tendency of a loss to hurt more than an equal-sized gain feels good.
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of Business and MARKETING MANAGEMENT
Technology PRICING STRATEGY

Four Possible Perceptions of A Price

Prospect theory’s description of the value of gains and losses provides guidance as to some
fundamental possibilities concerning how the consumer can perceive a price. It is easy to appreciate
that a price can be perceived as a single loss. However, because of the “behavior” of the consumer’s
reference point, a price may also be perceived as two losses, a loss and a gain, and even as a gain
forgone. Each of these will be discussed in turn.

1. Perception of a Price as a Single Loss

The simplest perception of a product’s price is as a single loss. This is likely to occur when the price
is equal to, or within the range of, the consumer’s internal reference price (IRP). It will also occur
on those occasions when a consumer has an IRP that differs from the product’s price, but the
consumer does not think about this IRP or bring it to mind. In these situations, the consumer’s
reference point is the status quo—the state of affairs before the purchase—and the item’s price is the
loss that must be incurred in order to obtain the product.

When a price is perceived as a single loss, the seller can use the implications of the Weber–Fechner
Law to estimate how a price change may affect the pain of paying. In general, the Weber– Fechner
Law suggests that the size of a price change in percent terms will be an important factor in
determining the change in the buyer’s pain of paying and thus in determining the buyer’s response to
the price change.

This implication of the Weber–Fechner Law becomes particularly interesting when it is recognized
that consumers often consider the products of many sellers as one “item.”

A set of related purchases that consumers consider as one purchase could be referred to as a
purchase aggregate. Although consumers often spontaneously think in terms of purchase
aggregates, the tendency to do so can also be influenced by a seller.

2. Perception of a Price as Two Losses

When a product’s price exceeds a consumer’s IRP, the consumer is likely to perceive the price as two
losses. When the consumer recognizes that the product’s price is not equal to her IRP, her reference
point might shift from her pre-purchase state to her IRP. The extent to which the product’s price
exceeds this new reference point would then be perceived as a second loss, which could be termed
the perceived surcharge. Such a reference point shift will not always occur, but when a product’s
price is higher than consumers’ IRPs, it will occur at least sometimes and result in at least some
perception of the product’s price as consisting of two losses.

 For the seller to avoid the negative evaluations of a price that is perceived as two losses, the
key is to monitor the IRPs of consumers. If a product’s price is below the IRP of most
consumers, then there is some room for an increase.
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of Business and MARKETING MANAGEMENT
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 Similarly, when consumers’ IRP for a product is a wide range of prices, the product’s price can
be increased up to the high end of that range without the negative effects of consumers
perceiving that they are being asked to pay a surcharge.

In situations where there is high consumer awareness of a product’s price, any price increase is
bound to be noticed and lead to the negative effects of a perceived surcharge. To deal with this
limitation, sellers often find that there will be smaller sales losses from reducing the size of the
product or the number of items in the product’s package than from increasing the price. This practice
is known as downsizing.

Because downsizing does involve a change in the per-unit price level, is it not, strictly speaking, an
example of framing. However, it is a closely related technique in that it relies on consumers’
disinclination to adjust their IRPs when a package size decreases. Downsizing strategies have often
been used for frequently- purchased consumer packaged goods such as facial tissues, paper towels,
coffee, candy bars, ice cream, canned tuna, orange juice, and disposable diapers.

3. Perception of a Price as a Loss and a Gain

When a product’s price is less than a consumer’s IRP, the consumer is likely to perceive the product’s
price as a loss and a gain.

When the consumer recognizes that the product’s price is not equal to her IRP, her reference point
might shift from her pre-purchase state to her IRP. The extent to which this new reference point (i.e.,
her IRP) exceeds the product’s price would then be perceived as a gain, which could be termed the
perceived discount.

 For a seller, the more positive consumer feelings engendered by the loss-and-gain perception
of a price make it worthwhile to encourage this perception. The key to doing this is the
management of the consumers’ IRPs. For example, when a product’s price is decreased under
conditions of low consumer price awareness, consumers may not recognize that a price
decrease has occurred. To create awareness of the price decrease— and thus maximize the
likelihood that the price is perceived as a loss and a gain—the seller should communicate the
product’s former price. Retail ads often carry headlines such as “Was $200.00—Now Only
$129.99!” In these ads, the higher price shown is known as an external reference price. Its
purpose is to suggest to the consumer the appropriate IRP. To the extent that the suggestion
succeeds, consumer IRPs will be higher than the product’s selling price, and the likelihood of a
loss-and-gain perception of the price will be maximized.
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of Business and MARKETING MANAGEMENT
Technology PRICING STRATEGY

4. Perception of a Price as a Gain Forgone

Under certain conditions, it is even possible for a price to not be perceived as a loss at all. One way
for a seller to frame a product’s price as a gain forgone is to create a salient link in the consumer’s
mind between the product’s price and something considered being a recent monetary gain. Some
retailers attempt to create such a link by running ads around the time that many consumers receive
income tax refunds. “Enjoy your tax refunds” is the kind of message that might encourage consumers
to perceive the price of a discretionary purchase in the less painful form of a gain forgone.

EFFECTS OF FAIRNESS JUDGMENTS ON THE VALUE OF A LOSS

Prospect theory explicitly describes how the value of a loss varies with its size, but it also leaves open
the possibility that factors other than size can affect the value of a loss. One such factor is fairness—
the degree to which the loss is judged to be in conformance to the rules of acceptable human
behavior.

Important to fairness is the concept of equity—the sense that both participants in an exchange
receive benefits that are, if not equal, at least appropriate to what each participant contributes to the
exchange. Consumers recognize that they receive benefits from a purchased product and thus
consider it fair for the seller to make a modest profit for providing the product. If consumers see the
seller’s profit as excessive, as would likely be the case with a $300 concert ticket, they would judge
the product’s price to be unfair. On the other hand, if the seller were seen as making very little profit,
say because of a policy of contributing most profits to charity, the product’s price would be considered
“more than fair” (i.e., better than average on fairness).

The degree to which a consumer judges a price as fair will influence the consumer’s pain of paying
that price. A price is most painful when it is judged to be unfair, less painful when it is judged fair, and
less painful still when it is judged “more than fair.”

When Is a Price Increase Considered Fair?

When an item’s price exceeds a consumer’s IRP and the consumer experiences a perceived
surcharge (i.e., a second loss), the consumer’s feeling about that perceived surcharge would depend
on the business situation. If the price is one of long standing and the consumer is new to the market
for such items, then the consumer may well attribute the perception of a surcharge to his or her
ignorance and update his or her IRP. In such a situation, there may be consumer disappointment but
probably not a perception of unfairness.

On the other hand, if the price has recently been increased, and the consumer has enough price
knowledge to be aware of this, then price fairness may well be an issue. If the seller is seen as
increasing a product’s price in the absence of any increase in the seller’s costs, then consumers are
likely to feel that the perceived surcharge is unfair. Given the importance of the seller’s costs in the
consumer’s feelings about a price increase, it is in the seller’s interest to accompany a price increase
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with information about cost increases that could help account for the price increase. One approach to
this is to give some transparency to the price-setting process, such as is done in consumer loan
products whose interest rates are pegged to a standard financial measure such as the prime-lending
rate.

Another approach is to provide customers with a price rationale—an explicit price-change explanation
that—that highlights the seller’s increased costs. Such a statement could draw on media reports of
inflation or of price increases in basic product components such as raw materials, energy, or labor. A
price rationale for a price increase could also make use of the consumer’s price-origin beliefs. For
example, if consumers believe that higher-quality materials or a greater number of useful features
cause higher prices, then emphasizing such product changes would help make a price increase seem
more fair.

A consideration that is perhaps of underlying importance in price fairness judgments is the issue of
control. When consumers feel that they have no control as to whether or not they pay a price, they
are particularly likely to see a price increase as unfair. Thus, when consumers are faced with
persistent parallel pricing by all sellers of a product, consumer resentment of price increases is likely
to develop. Further, when a product is viewed as a necessity—for example, important for maintaining
life and health and with few alternatives—then the fairness of any price increase will often be
questioned.

Other Determinants of Fairness

In making price fairness judgments, consumers also look to what other customers are paying. When
they observe that other customers who they see as similar to themselves are paying lower prices for
the same product, they will tend to question the fairness of the situation. It is important for managers
to take this tendency into account when developing their organization’s price structure.

Because it is usually difficult for consumers to judge seller costs or be aware of prices that other
customers pay, their judgments of price fairness often rely on general impressions of the seller’s
motives. For example, oil companies and pharmaceutical manufacturers have acquired questionable
reputations over the years. For this reason, any increases in the prices of their products are
particularly likely to be judged as unfair and thus are likely to be especially painful to consumers. The
managers of such companies should keep in mind these consumer impressions when making pricing
decisions and, when implementing price increases, they would be wise to pay particular attention to
offering price rationales to justify the increases.
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of Business and MARKETING MANAGEMENT
Technology PRICING STRATEGY

FACTORS THAT CAN ENHANCE THE VALUE OF A GAIN

Since a price may be perceived as involving gains, such as perceived discounts, it is useful to
understand how the value of a gain can be affected by factors other than the size of the gain. Two
such factors, dangling and perceived responsibility, both act to increase the value of a perceived
discount.

Dangling

Retail advertising often works hard to draw the consumer’s attention to the offered discounts.
Headlines loudly proclaim the following:

“Save $$$ now!”“Don’t miss out on storewide savings!”“Save 40% or more on all camcorders in
stock!”

This type of promotion not only helps frame the retailer’s prices as discounts but also serves to
dangle these discounts in front of consumers. Dangling is the practice of putting a discount or other
offer into the consumer’s mind in a way that is vivid and immediate.

Perceived Responsibility

It has been observed that retail discounts are capable of causing some striking extremes of behavior.
Such consumer overreactions illustrate that perceived discounts can take on an emotional potency far
beyond that which would be expected given the amounts of money that are typically involved. One
reason for this is that consumers often consider themselves responsible for having obtained the
discount. Their sense is that they received the discount because they knew where to shop, where to
look, when to shop, what to buy, and so on. Research has shown that when consumers attribute
themselves as personally responsible for a discount, the pleasure they feel from this discount
increases.

Thus, we can see how perceived discounts may be capable of sparking feelings strong enough to
lead to shopper frenzy at blue-light specials and enduring enough to drive long-term product
satisfaction. More typically, these “smart-shopper feelings” can be expected to cause the consumer’s
response to a price decrease effectively framed as a pride-evoking discount to far exceed sales
response expectations based on routine price fluctuations.