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PAPER: Mind Your Pricing Cues | Harvard Business Review

If you aren’t sure, you’re not alone: For most of the items they buy, consumers don’t have an accurate sense of what the price should be. Consider the findings of a study led by Florida International University professor Peter R. Dickson and University of Florida professor Alan G. Sawyer in which researchers with clipboards stood in supermarket aisles pretending to be stock takers. Just as a shopper would place an item in a cart, a researcher would ask him or her the price. Less than half the customers gave an accurate answer. Most underestimated the price of the product, and more than 20% did not even venture a guess; they simply had no idea of the true price.

This will hardly come as a surprise to fans of The Price Is Right. This game show, a mainstay of CBS’s daytime programming since 1972, features contestants in a variety of situations in which they must guess the price of packaged goods, appliances, cars, and other retail products. The inaccuracy of the guesses is legendary, with contestants often choosing prices that are off by more than 50%. It turns out this is reality TV at its most real. Consumers’ knowledge of the market is so far from perfect that it hardly deserves to be called knowledge at all.

One would expect this information gap to be a major stumbling block for customers. A woman trying to decide whether to buy a blouse, for example, has several options: Buy the blouse, find a less expensive blouse elsewhere on the racks, visit a competing store to compare prices, or delay the purchase in the hopes that the blouse will be discounted. An informed buying decision requires more than just taking note of a price tag. Customers also need to know the prices of other items, the prices in other stores, and what prices might be in the future.

Yet people happily buy blouses every day. Is this because they don’t care what kind of deal they’re getting? Have they given up all hope of comparison shopping? No. Remarkably, it’s because they rely on the retailer to tell them if they’re getting a good price. In subtle and not-so-subtle ways, retailers send signals to customers, telling them whether a given price is relatively high or low.

In this article, we’ll review the most common pricing cues retailers use, and we’ll reveal some surprising facts about how—and how well—those cues work. All the cues we will discuss—things like sale signs and prices ending in 9—are common marketing techniques. If used appropriately, they can be effective tools for building trust with customers and convincing them to buy your products and services. Used inappropriately, however, these pricing cues may breach customers’ trust, reduce brand equity, and give rise to lawsuits.

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Pricing Guarantees
So far, we’ve focused on pricing cues that consumers rely on—and that are reliable. Far less clear is the reliability of another cue, known as price matching. It’s a tactic used widely in retail markets, where stores that sell, for example, electronics, hardware, and groceries promise to meet or beat any competitor’s price.

Tweeter, a New England retailer of consumer electronics, takes the promise one step further: It self-enforces its price-matching policy. If a competitor advertises a lower price, Tweeter refunds the difference to any customers who paid a higher price at Tweeter in the previous 30 days. Tweeter implements the policy itself, so customers don’t have to compare the competitors’ prices. If a competitor advertises a lower price for a piece of audio equipment, for example, Tweeter determines which customers are entitled to a refund and sends them a check in the mail.

Do customers find these price-matching policies reassuring? There is considerable evidence that they do. For example, in a study conducted by University of Maryland marketing professors Sanjay Jain and Joydeep Srivastava, customers were presented with descriptions of a variety of stores. The researchers found that when price-matching guarantees were part of the description, customers were more confident that the store’s prices were lower than its competitors’.

But is that trust justified? Do companies with price-matching policies really charge lower prices? The evidence is mixed, and, in some cases, the reverse may be true. After a large-scale study of prices at five North Carolina supermarkets, University of Houston professor James Hess and University of California at Davis professor Eitan Gerstner concluded that the effects of price-matching policies are twofold. First, they reduce the level of price dispersion in the market, so that all retailers tend to have similar prices on items that are common across stores. Second, they appear to lead to higher prices overall. Indeed, some pricing experts argue that price-matching policies are not really targeted at customers; rather, they represent an explicit warning to competitors: “If you cut your prices, we will, too.” Even more threatening is a policy that promises to beat the price difference: “If you cut your prices, we will undercut you.” This logic has led some industry observers to interpret price-matching policies as devices to reduce competition.

Closely related to price-matching policies are the most-favored-nation policies used in business-to-business relationships, under which suppliers promise customers that they will not sell to any other customers at a lower price. These policies are attractive to business customers because they can relax knowing that they are getting the best price. These policies have also been associated with higher prices. A most-favored-nation policy effectively says to your competitors: “I am committing not to cut my prices, because if I did, I would have to rebate the discount to all of my former customers.”

Price-matching guarantees are effective when consumers have poor knowledge of the prices of many products in a retailer’s mix. But these guarantees are certainly not for every store. For instance, they don’t make sense if your prices tend to be higher than your competitors’. The British supermarket chain Tesco learned this when a small competitor, Essential Sports, discounted Nike socks to 10p a pair, undercutting Tesco by £7.90. Tesco had promised to refund twice the difference and had to refund so much money to customers that one man walked away with 12 new pairs of socks plus more than £90 in his wallet.

To avoid such exposure, some retailers impose restrictions that make the price-matching guarantee difficult to enforce. Don’t try it: Customers, again, are not so easily fooled. If the terms of the deal are too onerous, they will recognize that the guarantee lacks substance. Their reaction will be the same if it proves impossible to compare prices across competing stores. (Clearly, the strategy makes no sense for retailers selling private-label or otherwise exclusive brands.) How much of the merchandise needs to be directly comparable for consumers to get a favorable impression of the company? Surprisingly little. When Tweeter introduced its highly effective automatic price-matching policy, only 6% of its transactions were actually eligible for refunds.

Interestingly, some manufacturers are making it harder for consumers to enforce price-matching policies by introducing small differences in the items they supply to different retailers. Such use of branded variants is common in the home-electronics market, where many manufacturers use different model numbers for products shipped to different retailers. The same is true in the mattress market—it is often difficult to find an identical mattress at competing retailers. If customers come to recognize and anticipate these strategies, price-matching policies will become less effective.

Antitrust concerns have been raised with regard to price-matching policies and most-favored-nation clauses. In one pending case, coffin retailer Direct Casket is suing funeral homes in New York for allegedly conspiring to implement price-matching policies. The defendants in this case have adopted a standard defense, arguing that price-matching policies are evidence of vigorous competition rather than an attempt to thwart it. An older, but perhaps even more notorious, example involved price-matching policies introduced by General Electric and Westinghouse in 1963 in the market for electric generators. The practice lasted for many years, but ultimately the U.S. Justice Department, in the early 1980s, concluded that the policies restrained price competition and were a breach of the Sherman Antitrust Act. GE and Westinghouse submitted to a consent decree under which they agreed to abandon the business practice.

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Mind Your Pricing Cues.