Dynamic pricing and reference price effects

Abstract

Dynamic pricing enables online retailers to dynamically adjust prices in response to demand and supply conditions. However, dynamically changing prices may also affect how consumers assess current retail prices compared to their internal reference prices. This paper develops propositions for the influence of dynamic pricing on the internal reference price effect based on a reduced demand model, and tests these propositions with a field experiment and an online lab experiment. Both experiments systematically manipulate two dimensions of dynamic price variation (amplitude and frequency). We find that customers react strongly to price increases but not to price reductions. However, higher amplitude, as well as the higher frequency of price changes, attenuate the internal reference price effects in the field experiment. The online lab experiment provides additional insights in a more controlled setting measuring the internal reference price and additional covariates. Therefore, dynamic pricing can provide an additional benefit for retailers by attenuating potentially detrimental reference price effects on demand.