Reference Dependence and Price Negotiations The Role of Advertised Reference Prices

Abstract

Retailers routinely present a posted or sale price together with a higher advertised reference price, in an effort to evoke a perception of the discount the consumer is receiving. If prices can be negotiated though, what impact does this initial perceived discount (IPD) have on the ultimate discount, demand, and revenue? With data from consumers of a large durable goods retailer, in a natural decision-making environment, this study provides evidence that a greater IPD is associated with smaller negotiated discounts. Then, a lab experiment involving negotiation and purchase decisions for multiple products, with randomly assigned values of the IPD, establishes that a $1 increase in IPD lowers the negotiated discount by 5.7 cents. Furthermore, 55% of this decrease can be attributed to reduction in the participants' likelihood to initiate a negotiation. Under bargaining, almost one-third of the increase in revenue from a higher IPD stems from an increase in the negotiated price, which is unlike fixed pricing, in which setting an increase in IPD affects revenue only through changes in demand. Finally, the optimal advertised reference prices a seller would post under bargaining and fixed pricing are similar, but the benefit from posting this price is significantly higher under bargaining. These findings in turn have implications for researchers, retailers, consumers and policy makers.