Understanding Reference Prices
What are Reference Prices in Marketing?
In marketing, a reference price is defined as any price information accessed or used by consumer to assist them to compare and evaluate the value offered by a product at a particular price point.
The word “reference” means that the consumer is referring to existing internal knowledge, or to available external information, or a combination of both, to help assess the price of a product.
As we know, consumers are seeking perceived value whenever they make a purchase. Value is obtained by the consumer when the benefits of the product exceed the costs of acquiring the product.
Therefore, it is important for marketing success that consumers perceive that the price is appropriate, fair, and consistent with prior relevant prices, and consistent with similar competitor offerings.
The Two Types of Reference Prices in Marketing
There are two main types of reference prices that are relevant to marketers, namely:
- internal reference prices, and
- external reference prices
Internal reference prices (IRP) are held in the memory of consumers and are based upon their accumulated shopping and purchasing experience and their prior exposure to external reference prices.
The word “internal” is used as the reference price is inside the consumer’s memory and perception. This means that this reference price range is individual and unique to this specific consumer.
While consumers may have similar reference price ranges for certain product categories, in most cases they are unlikely to be identical. This allows for the possibility of segmenting consumer markets utilizing their understanding and perception of price points, which is a form of behavioral segmentation.
The second type are external reference prices (ERP). These are prices available in the marketing environment and would include:
- price tags,
- discount signage,
- media and internet reviews and comparisons,
- as well as information from family and friends.
The word “external” is used because it is outside of the consumer’s memory and is generally accessible by all consumers.
This does not mean that all consumers will frame expected prices the same way from their review of external reference price information. This is because individual consumers will review a different selection of price-based information. And this information would also be modified (or reinforced) by the consumer’s existing price perceptions.
Read More: The Two Types of Reference Prices
Internal and External Reference Prices are Interrelated
Although there are two types of reference prices, this does not mean that they operate independently. In reality, they are highly interrelated and will impact each other.
How External Reference Prices Impact Internal Reference Prices
For example, all external reference price information – from marketing materials, media, and word-of-mouth – is then assessed against the consumer’s internal reference price understanding. Depending upon external reference price information, the consumer will either reinforce or modify their existing internal reference price expectations.
This means that the consumer’s continual exposure to price points of various products will strengthen or change their view of pricing in different categories.
If a consumer has an internal reference price perception for an average price of a main meal at a quality restaurant to be in the vicinity of $20-$50, then any price exposures that are consistent with that perception will assist in strengthening and maintaining their internal reference price view.
However, if they see a sign for a restaurant advertising main meals for $80 each, they are likely to reject that information as being unreliable or lacking in consumer value. In this case, the consumer’s internal reference price will not change.
However, if they frequently go to restaurants where the higher quality meals are priced around $60, and their likelihood of modifying their internal reference price range is high and would probably now extend to $20-$60. This is because the change in their price perception has been reinforced multiple times and is not a significant shift from their current thinking.
How Internal Reference Prices Impact External Reference Prices
As discussed above, the consumer modifies and interprets the external price information based upon its consistency with their existing price perceptions = their internal reference price information.
If a consumer is quite experienced in a product category and is a regular purchaser, then they have an attitude and belief that their price understanding is quite accurate. In this case, it will be difficult to modify the consumer’s internal reference price perception in the short term.
However, if a consumer is inexperienced in the product category, or the product is a new-to-the-world product, then the consumer will place a higher emphasis and reliability on external price information, and is less likely to modify that based upon their own price perceptions.
Read more: Internal versus External Reference Prices
When Do Consumers Use Internal or External Reference Price Information?
Internal reference price information is more likely to be utilized by consumers in the following purchase situations:
- for low purchase involvement decisions
- for products that they buy on a regular basis
- for relatively low-priced products
- for products that they have been exposed to significant price-based advertising over time
- when repeat or habit buying regular products
- the consumer is time poor and does not have time to shop around
And external reference price information is typically sought out by consumers when:
- undertaking high involvement purchases
- buying products that they have not bought before, or rarely buy
- for any brand-new products
- when they are switching to a higher or lower quality brand
- purchasing products on discount
- purchasing products via a salesperson
- purchasing high value products
- purchasing long-term or durable products
Note: Most Consumers will Utilize Both Approaches
The above list does not suggest that consumers will use either internal OR external reference price information. For the first list, internal reference prices, this may be utilized independently, especially for regular product purchases.
However, external reference prices generally used in combination with the consumer’s internal reference price perceptions. The only time that external reference prices are used exclusively is where the consumer has virtually no purchase experience or knowledge in that product category.
Where Do Consumers Get External Reference Price Information From?
Consumers are typically exposed to price information on a regular basis, especially when shopping in-store and online. This will form the basis of their internal reference price perception.
However, as discussed above, for certain purchases and situations the consumer will seek out external reference price information – or will simply be exposed to it in the process of their shopping experience.
Some of the sources where they will access price information – either intentionally or through their actions as a consumer and shopper – would include:
- in-store signage
- in-store price tags and prices on products
- discount signs showing normal and discounted prices
- coupons offering discounts or special deals
- online advertising showing prices
- traditional media advertising, such as TV and press
- media and online articles
- information from bloggers and influencers
- comparative websites
- product review sites
- special offers received by the consumer, typically via email or text
- shopfront or shop window advertising and signage
- discussions and comments from word-of-mouth sources
- information from salespeople
- potentially podcasts and videos
- online forums and discussion groups
- social media advertising and posts
- potentially brochures and flyers
The degree of believability and credibility of this external price information will vary. For example, a consumer may be less believing of a salesperson who indicates that this is that “great price”, yet be very convinced by the same comments on a comparative website or from an influencer that they follow.
As discussed above, consumers will be exposed to some of this information through their day-to-day lives and their shopping experiences – such as in-store signage – but at other times they will deliberately seek out this information – such as product review and comparative websites.
Any price information obtained deliberately as a form of research by the consumer is more likely to have greater believability and credibility and therefore influence on their expected price range perception.
Connection to the Consumer Buying Decision Process
As we can see from the above lists of when consumers are more likely to use internal or external reference prices, there is a connection between accessing this information and the buying decision process that we find in consumer behavior textbooks and in most marketing textbooks as well.
As a reminder, the structure of five phases of the decision process for consumer purchases are:
- Problem or need recognition = triggering the purchase pathway
- Information search = gathering information, either internally or externally
- Evaluation of alternatives = making a decision choice based upon the information
- Purchase and consumption = undertaking the purchase task and then consuming the product
- Post purchase behavior = any actions or thinking after the consumption = deriving a level of customer satisfaction
You will note above, next to “information search”, that the consumer will gather information either internally or externally. While this applies to the product features and benefits, it also includes price information. And this is where reference prices come into play.
Therefore, one way of recalling the difference between internal and external reference prices is to think about the consumer buying process model outlined above.
In this model, internal information is accessed through the consumer’s perception and memory and is based upon prior experiences and knowledge in the marketplace.
And where the consumer deems this level of knowledge and sufficient to make a suitable purchase choice, they will actively seek out external information (through marketing media, online information, influencers, salespeople, word-of-mouth, and so on) in order to gather enough information to feel confident in their choice.
As you may know from your study of this model, it varies on whether the purchase decision is a high or low involvement one. If it is a low involvement purchase decision, then the consumer makes the decision very quickly and typically relies upon internal information only.
Most products that we purchase through a supermarket would fall into the low involvement purchase category. This is why consumers can potentially make 50+ purchase decisions in a supermarket within half an hour or so.
However, for higher involvement purchases – which are typically more important to the consumer – additional information is usually sought, including suitable price points – which is our external reference prices.
And this is why a consumer may spend potentially months in a high involvement purchase decision, such as buying a new car.
As you can see the speed decision-making between high and low involvement purchases is substantially different. This is because in one situation (low involvement) the consumer utilizes internal information, whereas for high involvement purchases they need to gather and assess that information.
Why are Reference Prices Important?
Reference prices form part of the psychology of pricing. Reference prices are used by the consumer to frame their expectations of price ranges and value. As we know, the consumer needs to perceive value in a product purchase prior to completing the transaction.
If they perceive they will receive positive value – that benefits exceed the costs – then they are far more likely to purchase the product. However, if they perceive that the purchase would result in negative value – that the costs exceed the potential benefits, and they are unlikely to purchase it.
While product costs also include time, effort, the purchase process, shopping around, information gathering, and so on – generally most consumers primarily consider the price of the product in their purchase decision making.
Therefore, it is critical for price points of products to be consistent with the price that consumers expect to pay – which is from a combination of internal and external reference price information.
Obviously, consumers will have different reference price information depending upon the quality of the brand, the product features, the choice of retailers, any additional services or augmentation – but the combination of benefits still need to exceed the perceived costs = price in most cases.
If we are priced outside of the consumer’s expectations – either too high or too low – then the consumer will eliminate the product as a suitable choice and purchase an alternative competitive or substitute product.
No doubt, you have picked up a product in a store and not known the price and then asked a shop assistant what the price for the product is. In this case, if the price is within your expected price range you will buy it – but if it falls outside your expected range then you put the product back on the shelf and not buy it.
While it is clear why a consumer would not buy a product that is priced well beyond their price expectations – because the product does not deliver net positive value at that price (the costs exceed the benefits) – but why would a consumer not buy a product priced below the expected price range.
This would happen because most consumers connect price and quality. Therefore, if they were buying a new computer desk and they expected to pay between $100 and $300, they would reject a $20 desk as being suitable. This would happen because they would perceive that the $20 desk was simply low quality, and they would just be wasting their money if they were to buy it.
Read more: Why are Reference Prices Important?
The Goldilocks Pricing Zone
As discussed above, consumers form an expected price range based upon a combination of either internal and/or external reference price information. And consumers are seeking products that fit within their upper and lower price expectations and they will reject products as suitable if they are priced too high or too low.
This suggests that there is an ideal pricing zone or range for each product category. This is like the story of Goldilocks who did not want her porridge too hot too cold, but just right. The same applies for consumers, they do not want price to be too high or too low, but just right.
This is demonstrated in the following diagram. As you can see, this gives marketers a product range to price their products within. Keep in mind that this range generally reasonably broad, and is modified by brand quality and product features and any augmentation.
Therefore, it is not as restrictive as it sounds, that as marketers we need to ensure that we need to price within the Goldilocks pricing zone, while also taking into account profit margins, competitiveness, product positioning, and underlying costs, and various other pricing considerations.
Read more: A Model of Reference Prices
How are Internal Reference Prices Formed?
Over time, consumers become more experienced both in life and in their shopping behavior. In terms of regular purchases, they will form strong views of acceptable price ranges, and they will be continually exposed to price-based marketing materials and word-of-mouth and media information.
Therefore, their internal reference price perception will be created by a combination of:
- the price they paid for a similar product on their most recent purchase
- the range of prices they pay for similar products over time
- the range of prices and discounts they pay for similar products over time
- their estimation of the average price in that product category
- their recall of any price-based advertising
- their recall of sales promotions and discounts and special deals
- their memory of any price-based research that they undertook
- any memorable advertising highlighting price, even from the past
- their perception of the overall value of the product to them
- their perception of “fair pricing”
- strong recommendations from word-of-mouth sources on pricing ranges
- their observation of price tags in-store and online
- their review of purchase receipts
- potentially a review of their bank account purchases
As we know, not all consumers are the same, and the above pricing information sources will be observed and interpreted differently by different consumers. Some consumers are less price conscious, while others are very budget conscious and put more emphasis on price points.
This means that two different consumers, although exposed to similar external price information, may end up with substantially different internal reference price ranges. This may provide an opportunity for a segmentation and target marketing approach in some markets.
And in product categories where the consumer is very experienced (that is, a regular consumer of that product category) then their reference price range would be relatively well defined with clear upper and lower limits of price acceptability.
However, for product categories where they are inexperienced (rarely/never buy the product category) then their reference price would be much larger and less defined.
For example, let’s assume a consumer has never had their house renovated – so their upper and lower limits of pricing acceptability would be much broader, as compared to somebody who has had been through multiple house renovations.
Can Internal Reference Prices Be Modified?
While consumers will generally have good information and knowledge about the price range of most products that they purchase on a regular basis and will even have some knowledge of the prices of products that they buy infrequently, this is not to mean that internal reference prices are fixed and cannot be changed.
Indeed, there is a significant interaction between internal and external reference prices. Obviously, internal reference prices are primarily built upon external price information.
Over time, consumers purchase products in-store and online and see the price of various products and brands. And consumers also are exposed to price-based advertising and sales promotions, as well as potential discussions on social media and with family and friends.
This means that it is possible to modify internal reference prices over time, based upon new and revised external price information. This will partly depend upon the consumer’s experience and frequency of product purchases in that category.
If it is a product that they purchase frequently and even shop around between competitors, then their internal price range will be quite fixed. This is contrast to a product that they purchase infrequently, where the internal price range is quite variable and more influenced by external information.
This is a form of a consumer attitude. As we know, consumer attitudes can be strong or weak. Strongly held attitudes are more difficult to change and the consumer is more likely to defend their attitude, whereas weakly held attitudes are more likely to be subject to revision by the consumer.
How Marketers Can Use Reference Prices
Marketers can utilize reference prices in their marketing activities, and they can even modify consumers’ internal reference price range over time.
One common way that marketers utilize reference prices is through sales promotions, especially discounts. With a discount offer, the brand will typically show the normal price and the discount price on the same signage, perhaps along with a percentage saving.
The intent of this sales promotion tactic is that consumers will compare the discounted price against their reference price range and be persuaded that the revised price offers such great value that the consumer should purchase it.
As we know, sales promotions are short-term promotional tactics designed to increase sales and generally all discount offers show normal versus discount price in order to reinforce the tremendous value of the deal to consumers.
For example, if they have an item of clothing on sale for $50 and the signage says normally $99, then the consumer will automatically believe that the true value of the item is higher and that $50 is great value.
However, marketers need to be aware of the lower limit of price acceptability. If we use the same example, if the sign says normally $99 and the item of clothing is on sale for only $5, then the consumer will perceive that the discount is too great and that the clothing is probably a very low-quality item.
If this was to occur, not only will the consumer the unlikely to purchase the product, but they also felt likely to distrust marketing communications from that brand. And this would have a substantial negative long-term impact on the brand’s success.
Marketers can use comparative advertising where they price their product directly against a competitor. This gives the consumer a direct external reference price comparison.
There are two potential strategies that the marketer could utilize in this case. The first would be to offer their product at a discount as compared to the competitor. This gives the consumer the impression that they are both similar in product quality – which is why they are being compared in the advertising – but one product is cheaper than the other.
Alternatively, the ad could show similar pricing, however the advertised brand/product is of lower quality than a superior well-known brand – again designed to communicate that the two products are relatively equal in quality and features.
While this may not necessarily generate substantial sales, it does help reposition the advertised product to be considered of higher quality than it actually is, which will help build long-term sales and new customers.
Obviously, the second approach may carry some brand reputation risk, particularly if the advertised product fails to meet customer expectations, which would result in customer dissatisfaction and limited repeat purchases.
The in-store or online tactic of displaying a moderately priced product next to a more expensive product. In this case, the consumer may see a more expensive item of clothing for $300, next to an item of clothing on sale for only $150.
In this case, the marketing intention is to persuade the consumer that $150 is great value, by referencing it directly to the $300 item next to it. This would mean that the store/website is not anticipating selling too many $300 products but is utilizing it to frame the consumer’s price expectations.
As a similar example, sometimes in restaurant menus they will have a very expensive item for reference and comparison. They may have three variations of steak – with the most expensive being $90. This makes the other two choices of $40 and $60 appear good value.
Like with the clothing example above, the restaurant is attempting to influence the consumer’s perception of prices and what represents “good value” by having it shown next to a higher price product.
It is possible that the consumer would not have considered purchasing a $60 steak before entering the restaurant, but they are potentially influenced to purchase it because it appears to be relatively good value compared to the $90 option.
So, as you can see, the restaurant customer has “referred” to another price point and that has influenced their overall perception of value.
Reference Price Ranges Will Vary by Market Segment
It is also important to remember that different consumers will have different reference price ranges. Some consumers are very budget-conscious and will have lower price points where they see value and are more willing to purchase lesser-known brands.
Whereas, other consumers may have higher expectations of quality, are more brand loyal, or a more likely to seek out higher quality brands as a matter of purchase reliability.
This means that two different consumers are likely to have different reference price ranges for the same product category. For example, one consumer may be willing to purchase a loaf of bread in the range of $1-2, whereas another consumer is seeking higher quality bread in the range of $3-5 per loaf.
This means that the consumer’s approach to purchasing and their reliance upon internal or external reference prices may offer a potential market segmentation approach. This would be classified as a form of behavioral segmentation, and it may be suitable for the development of a unique brand persona and their customer journey and experience.
Why Does It Matter Whether the Consumer Uses Internal or External Reference Prices?
As discussed above, when forming price expectations, the consumer is using a point of reference (either internally or externally) to frame the expected and acceptable price range for a product.
So why is it important marketer to understand whether the consumer is more reliant upon internal or external reference price information when making their purchase decisions?
The reason why this is important is that internal reference prices are more difficult for marketers to modify or manipulate. This is because internal reference prices have been constructed through multiple purchase decisions and market knowledge of the consumer.
In other words, because the consumer has usually bought the product category many times before, they have first-hand knowledge of the approximate price and in what price range that the product should fall.
This is the opposite to external reference prices where the marketer can influence the price point perception of a consumer.
For example, by offering a sales promotion where the discounted price is $50 and the signage indicates that the normal price is $100, then the consumer would be persuaded and influenced that $50 is a great price and represents good value.
However, this same level of influence is not possible for products where the consumer uses their internal reference price range for their decision-making.
For example, if a consumer regularly buys a can of soup for $2, then a sales promotion discount offering the same can of soup for $5 marked down from $10, this discount strategy is unlikely to be successful (and is likely to lead to dissatisfaction) as the consumer is aware that $5 is too much based upon their knowledge (their internal reference price).
In both examples above, the discount offered is 50% – but the product where the consumer is relying upon an external reference price would result in a successful sales promotion, as opposed to the purchase where they are aware of the prices and have established internal reference prices.
Considerations of Pricing When Using Reference Price Ranges
When pricing however, it is important to remember that not only are we trying to maximize sales through pricing at a suitable level within the consumer’s expected/reference price range, but we are trying to build a long-term customer base and maximize long-term profitability for the brand.
Therefore, reference prices and the expected price range is simply one input into our pricing decision. We need to be cognitive of:
- our positioning goals,
- our competitive pricing,
- the need to generate repeat customers, and
- our profitability and market share goals.
- The Role of Price in Marketing
- Internal factors influencing price
- Compensatory Decision Rules
- Non-Compensatory Decision Rules