MBAM 651 Pricing

McGraw-Hill/Irwin

© 2003 The McGraw-Hill Companies, Inc., All Rights Reserved.

MBAM 651 Pricing

By Dr Freddy Lee

Pepperdine University

Week 2

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Chapter 5

Behavioral Foundations For Pricing Management

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Perception

• Buyers’ perceptions of value represent a mental tradeoff between the quality or benefits they perceive in the product relative to the sacrifice they perceive by paying the price:Perceived Value = perceived benefits (gain)

perceived sacrifice (give)Where perceived benefits are a function of perceived

quality, perceived quality is positively related to price, and perceived sacrifice is positively related to price

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Relationship of Price, Perceived Value, and Willingness to Buy

Willingness to buy

Perceived value

Perceived monetary sacrifice

Perceived quality

Actual Price

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Multidimensional Role Of Price on Buyers’ Perceptions

• Psychological price phenomena are the “irrational” effects of price on behavior– Customary prices

• All price alternatives are excluded except for a single price

– Price lines• Controls the price of an entire inventory of a

particular item

– Odd prices• Refers to a price ending in an odd number, or to a

price just under a round number

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Comparative Numerical Judgments

• Distance EffectDistance EffectTime to compare numbers is an inverse function of

their numerical distance. 8 vs. 6 8 vs. 2

• Magnitude EffectMagnitude EffectFor equal numerical distance, it is easier to discriminate

small numbers. 1 vs. 2 8 vs. 9

Special status of numeral 5• 1 to 4 “small” 6 to 9 “large”

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• Size Congruency EffectSize Congruency EffectResponse time is shorter when the “larger”

numeral is displayed in larger font size.Response time is shorter when the “smaller”

numeral is displayed in smaller font size.

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• The Odd EffectThe Odd EffectEven digits are processed faster and/or more

accurately than odd digits.People can judge smaller vs. larger faster than

odd vs. even.In odd-even judgments, the powers of 2

(2, 4, 8) were judged faster than 0 and 6.For odd numbers, 3, 5, 7 were judged faster than

1 and 9.

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• Remembering NumbersRemembering NumbersWhen not instructed to recall four-digit

numbers digit by digit: Remembered according to magnitude encoding, i.e.,

thousands recalled best, then hundreds, tens, and ones.

When instructed to recall four-digit numbers digitally: Remembered interior numbers less well than end

numbers.

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Proportion of Digits Recalled by Serial Position

Serial Position

1 2 3 40

0.1

0.2

0.3

0.4

0.5

0.6Prices

Phone Numbers

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Remembering vs. Knowing

• Remembering requires the conscious recollection of having encountered a piece of information– Remembering judgments demonstrate explicit

memory

• Knowing involves a sense of familiarity towards a previously encountered item– Knowing judgments demonstrate implicit

memory

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Conscious vs. Nonconscious Price Information Processing

• When price information is being processed consciously:– Buyers pay attention to the price, make judgments

regarding the value of the product relative to some other products that are either present in the external environment or retrieved from memory, and finally make a purchase decision

– Actual price information, a magnitude representation of the price, and their evaluative judgment maybe be transferred from working memory into long term memory, and they would be more likely to recall the price of the product at a later time

– Also possible that the actual price information may not be transferred into long term memory

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Conscious vs. Nonconscious Price Information Processing

• When price information is being processed nonconsciously:– The buyer is more likely to demonstrate a lack of “price

awareness” and not be able to recall the price of the product at a subsequent time

– The processing of price information may be more appropriately assessed by using an implicit memory task, such as ranking of the different products in terms of their relative expensiveness

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Chapter 6

Pricing Practices That Endanger Profits

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Adaptation-level Theory

• Anchoring effect– Every new price encountered by an individual

tends to move the adaptation-level price in its own direction

• Contrast effect– New prices far above or below the original

adaptation level may change the individual’s perception of other prices in the series

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Assimilation-contrast Theory

• Assimilation effect occurs when judgments of these previously perceived low prices in the category do not change when a new price is encountered– This occurs because the new price is perceived as similar to

the reference prices

• Contrast effect occurs when the new price displaces the reference price range sufficiently far and the original low prices will be perceived as lower than previously– This occurs because the new prices are perceived as

different from the reference price, but as still belonging to the same price category

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Prospect Theory and Transaction Utility

• Prospect theory shows that an evaluation of an outcome is strongly influenced by a standard of comparison, reference point, or “zero” point– Determines whether outcomes are gains or

losses– Stimuli equidistant from the reference point are

perceived to be closer to the reference point if they are larger than if they are smaller

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Product-Line Pricing

The lowest and highest prices in the product line are more noticeable than those between, and thus, anchor buyers’ judgments

The perception of a sale price may depend on the position of the price in the price range

Price is less dominant in purchase decisions if the price range is narrowed by shifting the end prices toward the middle of the range, or if there is little variation in prices

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Order of Presenting Prices

• Buyers who are exposed initially to high prices will perceive subsequent lower prices as less expensive than they would if they were initially exposed to low prices

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Introductory Pricing Strategies and Tactics

• Sellers introduce new products with short-term “introductory low-price promotions”

– Facilitates market penetration

– Produces lower long-run sales volume than if the product is introduced at its regular price

– The introductory low price serves as a reference price for evaluating a perceived price increase when the price is raised to its normal price

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Relative Price is More Important than Absolute Price

Buyers, in general, are more sensitive to perceived price increases, than to perceived price decreases.

This difference in sensitivity is most apt to occur when the price change originates from the vicinity of the market average.

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Chapter 7

Price and Customers’ Perceptions of Value

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Price and Perceived Value

• The context of the place of purchase affects the purchase decision– Buying beer at a fancy hotel vs. a small, run-

down grocery store

• The availability of information affects the purchase decision– More weight on information that is most readily

available, or easily recalled from memory

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• The anchoring affect has a direct impact on pricing– The order of price presentation, the low or high

prices in a product line, and the original price of a product

• People tend to choose an alternative they associate with some past success or refuse to choose an alternative they associate with a previous failure

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Price-Perceived Quality Relationship

• Buyers use cues to determine the product or service quality– Extrinsic cues are product-related attributes but

they are not part of the product• Price, brand name, packaging

– Intrinsic cues are are product-related attributes but they cannot be changed without altering the physical properties of the product

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Actual Price

Willingness to buy Perceived

value

Perceived monetary sacrifice

Perceived quality

Perceived brand name

Perceived store name

Perceived warranty

Perceived country of

origin

Perceived price

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Price-Perceived Quality Relationship

• The strength of the use of price or other external cues, such as brand or store name, as indicators of product quality, depends on the relative perceived differences between different cues and on the degree to which buyers know about the product and actual price-quality relationships

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The Effect of Time Pressure on Buyers’ Perceptions of Value

• When buyers are attempting to process all available information, they place greater weight on price as an indicator of sacrifice

• When buyers process information using heuristics, they place greater weight on price as an indicator of product quality

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Decomposing Perceived Product Value

• The overall perceived value of a product being considered for purchase is its:– 1. Acquisition value – the expected benefit to

be gained from acquiring the product less the net displeasure of paying for it

– 2. Transaction value – the perceived merits or fairness of the offer or deal

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Decomposing Perceived Product Value

• The perceived benefit of the product is equivalent to the utility inherent in the maximum price the buyer is willing to pay for the product

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Ways To Frame Offers

1. Provide a price reduction with no comparison to previous price (or other external reference price)No “deal perception”Therefore, no transaction value and only

acquisition value based on the regular price - perceived quality and price perceived sacrifice relationships

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Ways To Frame Offers

2. Price reduction with comparison to previous or other external reference price (e.g., regular price $xx.xx, sale price $yy.yy).TV based on perceived price difference, i.e., Regular

price - sale price. AV based on regular price - perceived quality

relation.Therefore, TV enhances overall perceived

(acquisition) value.

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Tensile Price Claims

For example, the seller may advertise:

• A range of potential savings– “Save 30-70% off”

• A minimum amount of price reduction– “Prices reduced 30% or more”

• A maximum amount of savings– “Save up to 70%”

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Chapter 8

Customer Value Analysis

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Perceived Acquisition Value

• Perceived = perceived benefits or quality

acquisition value perceived total sacrifice

• Perceived total sacrifice to the buyer is equal to purchase price + start-up costs + post-purchase costs

• Perceived benefits or quality is equal to some combination of physical attributes, service attributes, and technical support available, as well as the purchase price and other indicators of quality

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Components of Perceived Acquisition Value

1. Sacrifice

2. Equity

3. Aesthetics

4. Relative use

5. Perceived transaction value

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Chapter 9

Research Methods for Pricing Decisions

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Basic Questions

• 1. What are the benefits of the offering as perceived by customers?

• 2. Do customers associate quality with price?• 3. Can buyers determine quality prior to

purchase?• 4. What is the relative size of each market

segment?• 5. What is the maximum amount that customers

will pay?

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Surveys

• Basic objective is to elicit facts and opinions from respondents relating either to a predication of the quantity they would be willing to buy at various prices or to their intent to buy in the near future

• Pros:– Easy to conduct

– One of the least costly research methods

• Con:– Unreliable responses

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Experimentation

• Basic objective is to isolate and control various market factors that may affect market demand and then to observe buyers’ reactions to changes in one or more of these factors

• Cons:– Often conducted in not a natural shopping environment

– Lack of control over factors in natural shopping environment

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Panels

• Household participating in the panel record their purchases by brand and price in a daily diary or their purchases are recorded when they are scanned at a store’s checkout counter

• Pros:– Observations accumulate quickly to establish an

adequate data base to develop and test models

• Cons:– Not representative of the general population– Possibility of errors in recording

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Price Level Sensitivity:Absolute Thresholds

• Direct question approachDirect question approach:• 1. What is the minimum price you would be

willing to pay?• 2. What is the maximum price you would be

willing to pay?• Simple and easy, but may suggest to respondents

that there is a price that is too low or a price that is too high.

• Each respondent only responds for two prices.• Extension: use a price scale.

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Price Limits: Direct Question

0

20

40

60

80

100

$0.00 $10.00 $20.00 $30.00

Price

Perc

ent

Accept. Low Accept. Accept. High

MBAM 651 Pricing

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