Price is an indicator of the economic value created by the company. Thus, price is used as an important product information source and quality indicator by many consumers, especially when there is uncertainty in the purchasing process. consumer behaviorists, psychologists, and behavioral economists have studied the process in some depth, and have found that purchase decisions tend to be made principally on the value elements introduced by the marketer. This is a very different view from the classical economists’ pricing philosophy.
Value can be simply expressed as a function of the benefits expected to be gained by every dollar spent on the product:
Every consumer eventually tries to maximize their benefits while trying to pay less. One way to increase value in the eyes of consumers is by influencing their perception of the product’s potential benefits. This is mainly achieved by media advertisements and other promotion tools. Most of these perceived benefits are intangible ones that come with the brand and its associations. However, the marketer needs to know which value elements associated with the product/brand make consumers feel confident about buying it.
sometimes, consumers see value in the product quality or use product as a social class indicator. They may buy an expensive product just because they believe that the higher the price, the better the product quality. Their value understanding, in some situations, might have nothing to do with the product’s market price; consumers’ perception of value and benefits go beyond sheer economic value. Such perceptional value elements are generally created with the help of other marketing-mix elements such as media advertisements and promotion.
The best-known perceptional consumer value association is price and product quality. Many consumers think that the product’s price is a strong indicator of its quality. This effect is especially noticeable with speciality products such as wine and clothing. For example, in a Stanford University experiment, the same wine was tagged with different prices and served to ordinary consumers. Consumers were asked to decide which wine was better quality. Most thought that the wine with the higher price tag was better quality even though all the wines were the same.3
The link can be stronger for some specific products, but less valid for other products as explained by Corstjens and Corstjens’ (1995:144) “value corridor” conceptualization. My own classification is inspired by their graph but differs from it slightly (see Fig. 4.7).
Every company wants to be above the value corridor (highlighted with red arrow in Fig. 4.7) and perceived to be offering good quality. Even a good-quality product can be perceived as poor quality if the price does not reflect its true quality in the eyes of consumers. At the bottom of the corridor, there are private labels which are low-quality and low-priced products produced by retailers rather than manufacturers. Because private labels have less brand power and their success are highly dependent on distribution and in-store merchandising support, they are more likely to be preferred by price-sensitive consumers and perhaps those loyal to a particular store. Hence there are manufacturers who produce cheap products in the corridor because of their relatively lower brand power in the markets. Mimic brands, which follow the major national brands by copying their philosophy but cannot be perceived as leading and original, come next. Finally, well-known national brands offer the highest prices because of their strong brand power in the markets. These brands are recognized by all and are seen as the highest quality. The value corridor ultimately sets the expectations based on the price-quality relationship.4 If consumers read higher prices as a sign of higher quality, then the company can set its price higher than expected to maximize its profits. Similarly, a company that does not have exceptional product quality can even set its price at the same level as products perceived to be high quality to signal that its product is of the
Fig. 4.7 Value corridor-price and quality relationship
Source: Corstjens et al. (1995) Author’s note: I have changed the original figure and added red highlighted features in the figure by inspiring from C&C (1995) book!
same quality so deserves to be valued at the same level. This is called “prestige pricing” and it helps a company to maximize its profits if it sets its price at the same level as that of high-quality products.
A similar strategy is used for products in the same product line. The marketer can rank prices for products in the same product line (see Fig. 4.8). This strategy is designed to give consumers a clue as to the quality of products in the same product line. The pricing can indicate which product has better and additional features compared to other products in the same product line. For example, if you want to buy a car you look at the standard product’s base price without any additional features. Ifyou want to add more horse power or want the sport version, you probably pay more than for the regular standard product. Thus, the various versions of the same product in the product line can be placed in a logical price order. Price lining can eventually reduce the potential confusion for consumers and sales personnel created by various value elements. Furthermore, each price level can indicate different market segments and the products’ price elasticity. Thus, price lining can ultimately help the company to better organize its operations
Fig. 4.8 Price lining
(such as stock levels and inventory) to reach operational efficiency and reduce many purchase risks as perceived by consumers.
For new products, pricing strategy can be difficult. The company can start by setting the price high to test potential demand. This is a common strategy for both new-to-world products and /or existing products with new features. The company first skims the best demand in the market, then lowers the price along the demand curve as shown by the red lines in Fig. 4.9.
This is a similar pricing mentality (sliding down the demand curve until the right price range is found) to the one used by economists to determine price equilibrium with changes in supply. In other words, price skimming is always a good strategy when the demand for the product is higher than the supply. This can be a good pricing strategy especially when the company has a valuable brand with strong patents which will limit the possibilities of competitors entering the market. From a marketing point of view, this is also a better strategy for recovering major product development expenses in the early stages of the product life cycle. But the question is: how much lower should the price get? The lower the price,
Fig. 4.9 Price skimming and penetration pricing
the lower the quality could be perceived. This, in turn, damages the perception of the product’s quality and its brand image in markets, as illustrated with green lines in Fig. 4.9. In the long run, that potential image erosion caused by a sudden price reduction can cost a company more in advertising to change perceptions of the product’s quality.
Alternatively, the company can enter the market at the lowest possible price and increase its price gradually when the demand starts picking up, as shown by the blue lines in Fig. 4.9. This initial low price can help the company achieve a larger market share. This is a very good strategy if the company is focusing on mass markets and if the demand curve is elastic. A low initial price can also deter potential competitors from entering the market as they assume that the company is operating on very low profit margins, as shown by the bold lines in Fig. 4.9.
Another very influential perceptional pricing strategy is aimed at impacting consumers’ sensory perceptions. This is known as “sensory pricing”. The best-known variation of this strategy is ending prices with 9, 99, or 95. People tend to read the first number and conclude that the price is actually somewhere around that number. For example, they read $1.99 as around one dollar but in fact it is about two dollars. The one cent price discount can increase the sale considerably by increasing the consumer’s willingness to buy. If the company prices its products/services with zero at the end, such as $2.00, or $30.00, that can also send consumers a message that the products are of high quality. A Cornell University study found that when prices were given just as numbers without dollar signs, consumers tend to spend more.5 The logic is that when consumers see a number on its own, subliminally they may not associate it with money, making them more willing to spend that amount. A final psychological pricing strategy is to set the number of products/services purchased at a certain price level. If a company restricts the purchase amount at a specific price level (e.g., two per customer), the consumer thinks that the product is in high demand and is encouraged to buy it, in some cases perhaps in greater quantity than planned.6 I remember buying a Lego set for my son just because I saw that per-customer information attached to the product and worried that I might be missing a hot deal in Lego world!
All these sensory and psychological pricing techniques can increase a company’s sales numbers, but from an ethical point of view they can be controversial strategies as many consumers are not aware of why they are making these selections.