How to manage price thresholds: customers discount your discounts

Price is the ultimate marketing mix weapon a manager can wield: it directly affects profits and touches both consumer thoughts and feelings. Pricing psychology is especially interesting – my very first marketing term paper back in 1991 discussed reference prices, and many of my early publications expanded our understanding of price effects and when they operate. Especially disturbing was the result by (fellow UCLA) profs Sunil Gupta and Lee Cooper that customers ‘discount the discounts’, i.e. they perceive large discounts (eg 50% off) as less and act accordingly, thus losing brands money. In my Marketing Science paper with Shuba Srinivasan and Philip-Hans Franses, we examine when price thresholds matter for your bottom line, and show asymmetry for price increases versus decreases on three levels: the threshold size, the sign and the magnitude of price effect on your sales.

What a pleasant surprise to see Europanel cover our paper with graphics such as the above over the past 2 weeks! The starting point is the elasticity of your sales to price: by how much % do your sales change if you change your price? The typical answer is -2.5: if you decrease price by 10%, sales go up by 25%. However, this may only play in your business-as-usual zone close to what the consumer expects to pay for your brand, i.e. the reference price’ If you price beyond the ‘constant elasticity’ zone (in Europanel’s above graph), will you get higher or lower elasticity after a threshold is reached? Where are these thresholds and do they differ for price increases versus decreases in your category?

We find that thresholds matter for most (76% of) brands, and that some are driven by internal or historical reference prices (consumers remember prices from their last brand purchase), while some are driven by external or competitive reference prices (consumers observe current prices of competing brands). In our sample of fast moving consumer goods, it was the internal/historical reference price that mattered most often. Compared to this historical reference price, we often see that consumers ‘discount the discounts’: they respond relatively less when the price is far away from their reference point, as illustrated for this large cookie brand:

In contrast, competitive price thresholds mattered more for smaller brands. Moreover, we see consumers reacting stronger to big price changes, especially price increases. Consumers thus have a latitude of acceptance around your competitors’ prices, but you’d better not exceed the threshold, as illustrated for this small cookie brand:

Another great way to show the results is the below graph by Europanel:

(1) a small price drop suffices for high share brands and for expensive brands: when you are well known and/or are expensive, your price promotion does not need to be large to give consumers a reason to buy;

(2) a large price drop is needed to get consumer attention and purchases when prices have been volatile – changing often for your category or for your brand;

(3) a small price increase already hurts your sales a lot if prices are volatile, likely because consumers expect a price drop is coming soon, so they can afford to wait;

(4) a large price increase, in contrast, is needed to get consumers out of their latitude of acceptance for high share and expensive brands:

What is our pricing advice? For price decreases, provide a large enough discount to overcome inertia, especially for expensive brands. In contrast, beware of too high discounts for store brands, as they show more saturation effects (discounting of discount).

For price increases, stay below the threshold and slowly increase with competition. This is especially important for store brands and categories with little price volatility and price spread among competitors. In contrast, national brands in concentrated and inexpensive categories get punished less for large price increases.

I am also happy this research saw several applications and extensions in different categories. First, consumers in the travel industry are more sensitive to external (vs internal) reference price due to their higher information accessibility and perceived diagnosticity.

Second, food demand is more responsive to price increases than to price decreases, and price changes improve dietary quality of low-SES household food purchases most, especially for sweet snacks, desserts, and fats/oils.

Finally, investors react to price increase announcements by bidding up the firm’s stock price, especially when it is larger and attributed to high demand.

Interested in more research on pricing? Check out the freely available papers at http://marketingandmetrics.com/category/price/ or my previous blog on price wars

Leave your comment here

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s