Why are Reference Prices Important?

The Importance of Reference Prices

Reference prices are an important concept in marketing. Reference prices are the expected and acceptable price range that a consumer will pay for a particular product and/or brand.

If a product is priced well above or well below the expected price range, then the consumer is unlikely to see value in the product and is unlikely to purchase it. Instead, the consumer will purchase a more suitably priced competitive or substitute product.

Therefore, it is critical that products are priced within the consumer’s reference price range in order to generate sales and profitability for the firm.

Why will consumers NOT buy a product priced below their reference price range?

When we use the term “reference price”, we are indicating the price range that a consumer expects to pay for that product and that brand.

The word “reference” means that the consumer is referring to some piece of knowledge or information when setting the boundaries of their reference price, or expected price, range. Consumers will have both an upper and lower limit on their expected price range.

So why will consumers NOT buy a product that is priced too low?

As we know from marketing and consumer behavior, most consumers equate price points with product quality. A higher priced product is generally considered superior in quality to a similar product with a lower price point. This is especially true for products that consumers do not purchase regularly and do not have a good understanding of the range of prices or the product features and attributes.

Therefore, a product priced BELOW the expected price range would be considered by consumers to be of reduced quality and an inferior product. As a result of this perception of the product, based upon price, the consumer will NOT purchase the product.

Let’s Use an Example

For example, let’s assume a consumer wanted to purchase a new coffee machine for their home. Let’s assume that their expected price range for a suitable machine (for their needs) would be in the range of $200-$400. This means that they would rule out (not consider) a $50 coffee machine.

This is because they would perceive this low-price competitor as being low-quality or unreliable or simply unsuitable for their needs.

The Danger of Pricing Products Too Low

The danger here (see coffee machine example above) for marketers, is not only do they lose that immediate sale, but it also has the potential to damage the brand. If a consumer sees that a brand is priced below their reference price range, they will connect that brand in their mind to low-quality products. This will damage and limit any positioning efforts as well.

As a result, this will mean that the product and brand will be placed in the inept brand set by the consumer – which will also mean that the consumer considers that brand to the unsuitable for their needs even into the future. This will result in the brand never being purchased by the consumer.

That is why it is necessary to take care when pricing products too low. While it is acceptable to have short term discounts as part of a sales promotion campaign, long term pricing that is below most consumers’ reference price range will damage the brand and obviously will undercut profitability substantially.

Why consumers will NOT buy a product priced above their reference price range?

When consumers make any purchase decision, they are primarily concerned about maximizing value from the transaction. Most consumers will look for the best value purchase.

As we know from our study of marketing, perceived value is the comparison by the consumer of the benefits they receive versus the cost of acquiring the product.

Once a product exceeds the reference price range, then the consumer is unlikely to perceive that value will be acquired through the purchase. This is because the cost of the product will exceed their expected benefits.

The Goldilocks Price Point Range

You may know the story of Goldilocks and the Three Bears, and how astronomers are looking for potential planets that sit in the Goldilocks zone relative to a star. This is the geographic distance from the star that will allow water to be liquid and therefore potentially sustain life on that planet.

The same concept can be applied to expected price ranges for consumers. Price too low and the consumer will perceive the product to be inferior quality and a poor value choice as a result.

And price too high and the consumer will no longer see value as they perceive the product’s cost exceeds the benefits.

Obviously depending upon the product category, price ranges (the Goldilocks’ price zone) can be quite broad – such as with motor vehicles – or can be quite narrow, such as a loaf of bread, which may have a reference price range of only a few dollars.

Goldilocks pricing zone 1

Reference prices vary by market segments

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.

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.

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