Effect of consumer characteristics on optimal reference price

Abstract

When enticing consumers to purchase a particular brand, marketers occasionally use various promotional schemes, including price cuts. Acknowledging that consumers use a reference price (RP) in their purchasing decisions, marketers have ample opportunity to manipulate the RP in order to create a gain in the perceptions of consumers. This paper presents a conceptual framework and an analytical model for calculating the optimal RP that can be set by retailers in order to maximise their utility, given two consumer characteristics, ie the level of loyalty and sensitivity to quality variations and one structural variable — brand proliferation. The model is followed by an empirical study showing that: as loyalty level increases, the optimal RP increases; as competition increases, the optimal price decreases; and as the quality sensitivity increases, the optimal RP decreases. In practice, when the difference between the price and optimal RP is small and scarcely detectable by consumers, retailers may do better not to practise RP manipulation. In other words, retailers can practise this strategy only when competition is relatively low, consumer loyalty is rather high, and consumer quality sensitivity is rather low.