proactive pricer sets price to be consistent with customers'

The Thought Leadership Series
Kent Monroe

Price and perceived value

Understanding how your customers form value perceptions

A successful proactive pricer sets price to be consistent with customers´
perceived value. To understand how customers form value perceptions, it is important to recognize the role of price. Because of the difficulty of evaluating the quality of products before and even after the product has been acquired, how customers form their perceptions of a product becomes an important consideration when setting prices. Kent B. Monroe is J.M. Jones Distinguished Professor of Marketing Emeritus, University of Illinois, and Distinguished Visiting Scholar at the University of Richmond and Drexel University in Philadelphia. He has pioneered research on the information value of price, and has authored the leading text Pricing: Making Profitable Decisions. A leading consultant on pricing, marketing strategy and market research to corporations, governments and the United Nations, he has conducted training programs for business, non-profits and universities in North & South America, Europe, Asia and Africa. In 2002, Monroe received the American Marketing Association´s Marketing Pioneer Award for lifetime contributions to the development of pricing theory in the marketing discipline, and in 2005, he was the recipient of the AMA´s Distinguished Marketing Educator Award. He talks here with James Nelson on how customers think about price when forming their perceptions of value.

Would you explain the importance of value perception within the context of product
pricing?
Perception basically involves a process of categorization. We tend to place new experiences into
existing familiar classifications. When buyers are confronted by a price different from what they
believe they have previously paid, they must decide whether the difference between the old and
new prices is significant to them. If the price difference is perceived to be insignificant, they may
classify the two prices as similar and act as they have in the past. In a similar manner, when
comparing two alternative products, if the prices of the alternatives are perceived as similar,
even though they are not identical, some buyers may perceive the prices as equivalent, and
choose on bases other than price. On the other hand, if the price differences are perceived as
significant, buyers may classify the products as different, and make their choices on the basis of
price.
During this perceptual process buyers make heavy use of information cues or clues. Some of
these cues are price cues and influence buyers' judgments of whether the price differences are
significant. For example, buyers may use prices as indicators of product or service quality.
What is a good example of the roll price plays in the assessment of product quality?
Would you buy a package of 25 aspirin that costs only 25 cents? Would you be happy to find
this bargain, or would you be suspicious about whether the product is inferior to other brands
priced at 12 for 89 cents? In fact, most consumers would be cautious about paying such a low
relative price. The price of a product tells us not only how much we must give up (sacrifice) to
acquire the product, but because of our imperfect information about how the product may
satisfy us, the price helps us assess quality and how much we gain if we acquire the product.
Since buyers generally are not able to assess product quality perfectly (i.e. the ability of the
product to satisfy them), the perceived quality becomes important. Under certain conditions, the
perceived quality in a product is positively related to price. Perceptions of value are directly
related to buyers' preferences or choices: the larger a buyer's perception of value, the more
likely they are to express a willingness to buy or a preference for the product. Perceived value
represents a trade-off between buyers' perceptions of quality and sacrifice and is positive when
perceptions of quality are greater than the perceptions of sacrifice.

Where does the concept of price thresholds come into play?
From psychology we learn that small, equally perceptible changes in a response correspond to
proportional changes in the stimulus. For example, if a product's price being raised from 10 to
12 dollars is sufficient to deter you from buying the product, then another product originally
priced at 20 dollars would have to be repriced at 24 dollars before you would become similarly
disinterested. This general idea provides a basis for discussing the behavioral issues underlying
two pricing errors: Not distinguishing between perceived value and price, and not distinguishing
between absolute price and relative price.

You´ve written about absolute price thresholds and differential thresholds. Exactly
how do they differ?
The aspirin example implies consumers have lower and upper price thresholds of acceptable
prices for products or services. Furthermore, the existence of a lower price threshold implies some prices are unacceptable because they are considered to be too low, perhaps because buyers are suspicious of the product's quality. Rather than there being a single acceptable price for a product, buyers have some range of acceptable prices. Thus, people may refrain from purchasing a product not only when the price is considered to be too high, but also when the price is considered to be too low. To illustrate this issue consider the plight of a local "Generally, it is the perceived
accountant who opened a local tax accounting service. relative differences between
They quickly established a reputation of providing excellent prices that influence buyers'
service and enjoyed a competitive advantage over the use of price as an indicator of
nationally franchised tax consulting services. However, one
of the national organizations upgraded its basic service quality." 
package and offered additional service hours to meet the
needs of the local community with a price premium over the local organization. Since the higher
price for the service also signaled higher quality, customers perceived a net increase in value. To compete with this change, the local tax accounting service reduced its level of services covered in its basic price in order to maintain a monetary price lower than the national firm. However, customers soon perceived a reduction in the value of the local organization's service, and they shifted their patronage to the national organization. The important lesson to learn from this example is there are limits or absolute thresholds to the relationship between price and perceived quality and perceived value. The local tax consulting service failed to recognize this relationship between price and perceived value and reduced its price and perceived value below what customers were willing to pay. As to differential price thresholds, a buyer usually has alternative choices available for a purchase. However, even if the numerical prices for these alternatives are different, it cannot be assumed the prices are perceived to be different. The price setter must determine the effect of perceived price differences on buyers' choices. As I mentioned, the perception of a price change depends on the magnitude of the change. People have been shown to be more sensitive to price increases than decreases. Generally, it is the perceived relative differences between prices that influence buyers' use of price as an indicator of quality. In a similar way, relative price differences between competing brands, different offerings in a product line, or price levels at different points in time affect buyers' purchase decisions. A recent experience of a major snack food producer illustrates the error of not recognizing the difference between absolute price and relative price. At one time, the price of a specific size of this brand's potato chips was 1.39 while a comparable size of the local brand was 1.09. Over time, the price of the national brand increased several times until it was being retailed at 1.69. In like manner, the local brand's price also increased to 1.39. However, while the local brand was maintaining a 30-cent price differential, the national brand obtained a significant gain in market share. The problem was buyers perceived a 30-cent price difference relative to 1.69 as less than a 30-cent price difference relative to 1.39. This example illustrates the notion of differential price thresholds, or the degree of buyers' sensitivity to relative price differences.
What alternatives can companies use to adjust or change their prices, while still
maintaining their products´perceived value?
 Some time ago a shortage of cocoa beans resulted in a shortage of chocolate for candy
manufacturers. This shortage of chocolate also resulted in an increase in the price of chocolate. Prior to this shortage, a multipack of six candy bars was priced at 0.89 cents. One candy company changed price by increasing the quantity of money to be given up by the buyer and quoted its candy at 1.19 for six candy bars. Thus, one obvious way to change price is to: change the quantity of money or goods and services to be paid by the buyer.  However, another candy company changed the price of its multipack by decreasing the number of candy bars in a multipack to five and quoted its candy at 0.89 for five bars. A seller may change the quantity of goods and services by changing the number of items, or the quantity of goods and services may be changed by changing the weight (contents). For example, a box of cereal may be reduced from 16 oz. to 14 oz. for the same amount of money. Hence, another way to change price is to change the quantity of goods and services provided by the seller.  If the quantity ratio remains unchanged, but the quality has been decreased, then the price has increased because the buyer actually receives less. If quality is raised without changing the quantity ratio, then the price has decreased. Thus, a seller can change price by: changing the quality of goods and services provided.  Suppose a seller quotes a 5 percent discount for all quantity purchases of 100 units or more. If each unit sells for 4 dollars, then anyone who purchases 1 to 99 units pays 4 dollars per unit. However, if a customer buys 150 units, then the price is actually 3.80 per unit. Price can also be changed by offering premiums with purchases, such as trading stamps, toys, glasses, or frequent purchase rewards. In each case, if the quantity ratio remains constant, a premium serves to reduce the actual price paid, because the buyer receives additional goods or services. So, price can be changed by changing the premiums or discounts to be applied for quantity variations.  A practice in the retailing of furniture provides for a complete inventory to be stored at the retail store, thereby allowing the buyer to take immediate possession instead of waiting several months for delivery. These furniture stores generally have three different price tags on the furniture. If buyers wish to pay cash and take the item home, they pay a lower price than buyers who pay cash and have the store deliver it. Buyers who prefer an installment purchase and delivery pay the highest price. These different prices explicitly recognize the differences in selling costs and services, and the furniture store, in effect, transfers the delivery costs to the buyers. Therefore, price can be changed by: changing the time and place of transfer of ownership.  Being able to purchase a product and having 90 days to pay without interest is an actual reduction in price over paying at the time of purchase. Many retail revolving charge accounts provide for no interest charges if the balance is paid within 25 days. Since money has a time value, permitting customers to have the merchandise for a time without paying for it is a reduction in price. In addition, many business firms give discounts for cash payments made at the time of purchase or within a short period after purchase. For example, if payment is received by the tenth of the month, a 2 percent discount may be allowed. Often the actual price is changed if the place and time of payment are changed.  Some businesses do not accept checks, other firms operate on a cash-only basis, while others accept credit charges for regular customers. Some gasoline retailers quote a cash price that is lower than the credit price, demonstrating. another way of changing price is to change the acceptable form of payment.
You coined the term "proactive pricing." What does this involve and what are the
objectives?

The need for correct pricing decisions has become even more important as global competition
has become more intense. Technological progress has widened the alternative uses of buyers'
money and time and led to more substitute products and services. Organizations successful in
making profitable pricing decisions have taken what may be called a proactive pricing approach.
They have been able to raise or reduce prices without competitive retaliation. Through careful analysis and deliberate acquisition of pertinent information, they have become successful pricing strategists and tacticians. There are two essential prerequisites for be "Organizations successful in
successful proactive pricer. First, it is necessary to making profitable pricing
understand how pricing works. Because of the complexities decisions have taken what
of pricing in terms of its impact on suppliers, salespeople,
distribution, competitors and customers, companies m
ay be called a proactive
focusing primarily on their internal costs serious pricing errors. Secondly, it is essential for any
pricer to understand the pricing environment. It is important to know how customers perceive
prices and price changes. Often, price is used not only as an indicator of how much money the
buyer must give up, but also as an indicator of product or service quality. Equally, differences
between the prices of alternative choices also affect buyers' perceptions. The price setter must
know who makes the purchase decision for the products being priced and how this buyer
perceives price information.

Have any important points about price elasticity emerged from behavioral price
research?
Three come to mind, these being:
 Buyers, in general, are more sensitive to perceived price increases than to perceived price
decreases. In practical terms, this difference in relative price elasticity between price increases versus price decreases means it is easier to lose sales by increasing price than it is to gain sales by reducing price.  Sometimes a product may provide a unique benefit or have a unique attribute which buyers value. These unique benefits or attributes serve to make the product less price sensitive.  The frequency of past price changes can influence buyers' sensitivity to price changes. If prices have been changing relatively frequently, buyers may not have adjusted to the previous price change when a new change occurs. If buyers have not adjusted to the last price increase, then another price increase will be perceived as a larger increase than it actually is, making them more sensitive to the increase.

What basic guidelines should companies keep in mind in managing their products´
value perception?
They´ll be on the right track by remembering fundamentals including:
 The essence of pricing is determining potential buyers' perceptions of value for products
 Buyers' perceptions of value represent a comparison between the quality (or benefits) they perceive in the product relative to the cost of acquiring the product.  Prices should be set so as to reflect customers' perceptions of value.  Buyers determine whether a price is acceptable to pay by comparing it to a reference price.

Source: http://www.eede.gr/nletter/LS_88.pdf