2 An information processing review of the subjective value of 3 money ...

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Journal of Business Research xx (2006) xxx – xxx

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Priya Raghubir

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Haas School of Business, University of California at Berkeley, Berkeley, CA 94720-1900, USA

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Accepted 7 June 2006

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An information processing review of the subjective value of money and prices ☆

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Abstract

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This article draws on current and classical psychological theories of consumer behavior to review current findings in the psychology and economics literature on the subjective value of money, using an information processing framework. Consumers subjectively value both prices and money. That is, consumers value an identical economic value as a price or as a sum of money differently depending on their individual characteristics, price presentation characteristics, monetary form characteristics, and the consumer context due to subjectivity in their: Perception (biases in assessing the subjective value of money and prices); Inferences (whether consumers use price information to make other judgments); affect (the feelings and emotions associated with spending and saving); memory (errors and biases in recall of money and prices); and information integration (the manner in which consumers integrate costs and benefits to make decisions of whether, when, how much, and what to spend on). © 2006 Published by Elsevier Inc. Keywords: Value of money; Consumer context; Price presentation; Information processing

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Contents

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Perception. . . . . . . . . . . . . . . . . . . . . . . . . . 1.1. Reference points . . . . . . . . . . . . . . . . . . . 1.1.1. How consumers form reference points . . . 1.1.2. Implications of having a reference point . . 1.1.3. Asymmetric effects of gains and losses . . 1.1.4. Prospect theory . . . . . . . . . . . . . . . 1.1.5. Implications of prospect theory for pricing. 1.1.6. How to construct reference points . . . . . 1.1.7. Unintended reference points . . . . . . . . 1.2. Effort-accuracy biases . . . . . . . . . . . . . . . . 2. Inferences . . . . . . . . . . . . . . . . . . . . . . . . . . 3. Affect . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4. Memory. . . . . . . . . . . . . . . . . . . . . . . . . . . 5. Information integration . . . . . . . . . . . . . . . . . . . References . . . . . . . . . . . . . . . . . . . . . . . . . . . .

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☆ The author appreciates the comments and suggestions of Ban Mittal on a book chapter that serves as a foundation for this article. E-mail address: [email protected].

Consumers subjectively value both prices and money. That is, consumers value an identical economic value as a price or as a sum of money differently depending on their individual characteristics, price presentation characteristics, monetary form characteristics, and the consumer context.

0148-2963/$ - see front matter © 2006 Published by Elsevier Inc. doi:10.1016/j.jbusres.2006.09.013 Please cite this article as: Priya Raghubir, An information processing review of the subjective value of money and prices , Journal of Business Research (2006), doi:10.1016/j.jbusres.2006.09.013

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1. Perception: Biases in assessing the subjective value of money and prices 2. Inferences: Whether consumers use price information to make other judgments. 3. Affect: The feelings and emotions associated with spending and saving 4. Memory: Biases in recall of money and prices 5. Information Integration: The manner in which consumers integrate costs and benefits to make decisions of whether, when, how much, and what to spend on.

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1. Perception

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1.1. Reference points

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People evaluate money and prices not as absolutes but relative to reference points (Kahneman and Tversky, 1979).

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1.1.1. How consumers form reference points Reference prices can be based on comparative judgments with other products or stores (Urbany et al., 1988), past prices of the same product on a different occasion (Mayhew and Winer, 1992; Winer, 1986), advertised contextual prices along with the actual price being charged (Liefeld and Heslop, 1985), price expectations based on prior product and promotion experiences (Jacobson and Obermiller, 1990; Kalwani and Yim, 1992) and perceptions of what is a fair and acceptable price based on prices of other similar products as well as beliefs regarding the product's cost structure (Lichtenstein et al., 1988).

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1.1.2. Implications of having a reference point Once consumers form a reference point, consumers evaluate a monetary transaction against that reference. When a price is lower than one's reference point (due to its being on sale, or lower than another store's price, or because another competitor's price is higher, or than the price others paid), then people feel that they have “gained” relative to their reference point. This makes them more likely to positively evaluate that price and act on it. On the other hand, if the reference point makes a price or income appear to be a “loss” because the income is lower than others receive, or the price is higher than the past price, or the price is higher than the comparable price charged by a competitor, then they may unfavorably evaluate the price.

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1.1.3. Asymmetric effects of gains and losses When a price is perceived as a gain, people are more likely to think that the price is better, feel better about paying the price, and are more likely to act towards purchasing a product at the

price. On the other hand, when a price is perceived as a loss, then people are not only less likely to act, but the size of the effect is even greater. To explain, if a “gain” of $5 will make a consumer who buys 25 units of a product, buy 10 more of a product, the same $5 if perceived as a loss will make the same consumer reduce his purchase quantity by more than 10 units. Said differently, people feel the pain associated with a price increase more sharply than they feel the joy associated with a price decrease. They react more strongly to a negative change than they do to a positive change. In other words, they punish to a greater extent than they reward a company for giving them a loss rather than giving them a gain.

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1.1.4. Prospect theory The overall schematic of this model is expressed in the “prospect theory value function” (Kahneman and Tversky, 1979) which shows that:

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1. Value is assigned with respect to a reference point, rather than an absolute zero. 2. In the area of gains people experience a diminishing marginal value for gains, which means that as the amount they gain increase, the value they derive increases, but does so at a reducing rate. This leads to the value function tapering off. 3. In the area of losses people experience disutility subject to a reference loss. While this loss also increases at a reducing rate, the value function is steeper in the area of losses than in the area of gains. This implies that people respond more strongly to a loss than to a gain.

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1.1.5. Implications of prospect theory for pricing Some of the key implications for pricing illustrating the manner in which people assign value to income or prices were summarized by Thaler (1985). They are:

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1. SEGREGATE AN INCREASE IN GAINS: rather than offering a single lump sum gain offer the same amount in two or more separate rewards. this is because of the concave diminishing marginal utility of the gain function. the value the consumer will assign to two separate rewards, a and b, is higher than the value they will assign to the rewards c = a + b, because the value function at the point c has started showing diminishing returns (i.e., concavity), while the value function at the points a and b both operate in a steeper region of the value function, where greater value is assigned for the same gain. an example of this in price promotions would be to offer multiple discounts, totaling the same value, rather than a single discount. a set of free gifts provided by many cosmetic companies, rather than a single gift that is of equivalent value, is an example of how segregating gains may lead to greater overall happiness than lumping them all together as one. companies could offer multiple small discounts rather than an equivalent single large discount. for example, while arithmetically a 20% discount is greater than a 10% discount, followed by a second 10% discount (as the second 10% discount is off a discounted price already), consumers may

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Since Monroe (1973) discusses the subjectivity of prices, a number of researchers have uncovered the antecedents and consequences of the subjectivity in price perception. This review brings together some of the key findings in the last three decades as they pertain to the subjectivity of prices, in specific, and money, in general, using an information processing framework, discussing the subjectivity in assessment due to:

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Please cite this article as: Priya Raghubir, An information processing review of the subjective value of money and prices , Journal of Business Research (2006), doi:10.1016/j.jbusres.2006.09.013


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1.1.7. Unintended reference points Frequently, consumers may form a reference price due to the actions of one or more manufacturers/retailers that is detrimental to the sales of their product. One of the most common forms of these unintended reference points is that consumers use sale prices to form a reference against what they expect to pay (Krishna, 1991). This price expectation leads them to unfavorably evaluate a full price when the sale is retracted and leads to a reduction in sales, as consumers experience a “loss” when they see a regular price, against their reference of a sale price. Given this unintended consequence of offering sales, some of the conventional wisdom in marketing suggests that having infrequent sales, or offering them at irregular intervals reduce the likelihood that a reference price based on sale price will be formed. Alternatively, or in addition, the marketer can make comparisons difficult. One of the oldest theories of pricing is that people assess a price change relative to the absolute price of the product, and that the difference has to be large enough to be noticeable. Smaller changes are less likely to be noticed by the average consumer. Weber's Law states that the rate of change divided by the original is a constant K. Given this, unintended reference points can be prevented from forming by changing the unit that is being compared from one occasion to another through changes in what the product contains (e.g., including different features, or additional products and samples as part of the package), changes in the size of the product, and product packaging (e.g., pizzas in single servings may come as a

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price–quality continuum, they can construct this brand set in a manner to make one of their brands more attractive to consumers. two well known examples from the behavioral decision theory literature (e.g., simonson, 1989) illustrate: a. The Attraction Effect: When a brand's share relative to another brand's share is higher in the presence of a third option that is closer to one of the existing options (in terms of the price–quality tradeoff), this belongs to the genre of the attraction effect. For example, if an airline offers two airline-hotel packages to Las Vegas from Oakland, one for 3 nights (priced at $299, called A) and one for 2 nights (priced at $199, called B), both at a reasonable quality hotel, then the addition of a third option at 2 nights in a worse hotel also priced at $199 (called C), would increase the share of the B plan relative to the A plan, as consumers can easily see that option B dominates over option C, and this will make them more likely to choose B. b. The Compromise Effect: Consider a brand that is high quality and high priced (say business class airfares), and a second brand that is relatively lower priced and of relatively lower quality (say economy class). If an airline company wishes to increase the sales of the business class seats, then the inclusion of a higher quality, but higher price brand (say a first class seat), will make the business class fare appear to be more attractive in the presence of the first class fare than in its absence. This is because the business class fare is now seen as the compromise option. Extremeness aversion is one the reasons that consumers prefer middle or compromise options.

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144 value the two 10% discounts more favorably, making them 145 happier at a lower cost to the company. 146 2. INTEGRATE AN INCREASE IN A LOSS: another implica147 tion of the s-shaped prospect theory value function is to not 148 price things separately, but bundle them together as part of an 149 integrated price (yadav, 1994; yadav and monroe, 1994). this is 150 for the same reason as one should segregate losses, i.e., the 151 value function is concave in the region of losses, so a price of 152 $100 “hurts” less than prices of $75 and $25 for two separate 153 items that both operate on the steeper part of the value function. 154 this argument that consumers notice each aspect of price. in 155 some cases, such as shipping and handling charges, consumers 156 may not incorporate ancillary charges into their judgments of 157 final price. in such cases, partitioning prices is recommended 158 (morwitz et al., 1998). 159 3. INTEGRATE A DECREASE IN A GAIN: as the value 160 function is steeper in the loss region than in the gain region, 161 gains and losses have asymmetric effects. if a transaction 162 requires both a gain and a loss, but the gain is high relative to 163 the loss (e.g., increase in wages with an accompanying tax on 164 that increase), then the consumer will receive greater utility 165 from a netted gain, rather than receiving the entire gain and 166 then having to pay out the loss afterwards separately. 167 4. SEGREGATE A SMALL REDUCTION IN A LOSS 168 (SILVER LINING): a final implication of the value function 169 is that separating a gain when a large loss accompanies the gain 170 (e.g., cash back with a consumer durable purchase), is better 171 than netting the gain out from the cost. this is because the 172 benefit of receiving the gain is greater than the reduction in the 173 disutility of a smaller price.

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1. MANUFACTURER SUGGESTED RETAIL PRICE OR MSRPs: the msrp allows the consumer to assess the price against the higher msrp, and even if they do not fully believe the extent of the price difference, they are still likely to evaluate the price as better in comparison to the msrp (lichtenstein and bearden, 1989). 2. PAST PRICES: frequently, sale signs advertise “was $____, now $_____,” to highlight the savings that a consumer is getting compared to the previous price that they would have paid for a product or service. this format allows consumers to assess their extent of savings directly and, even when the discount is not fully believed deal valuation still improves (blair and landon, 1981). 3. OTHER'S PRICES: another commonly used method, particularly with private labels and store brands is the ubiquitous “compare and save” sales tag that highlights the prices of national brands relative to the store brand and allows for the store brand price to be evaluated more favorably (della bitta et al., 1981). 4. PRICES OF OTHER BRANDS IN THE PRODUCT LINE: when a company has a range of brands that differ along the

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174 1.1.6. How to construct reference points 175 Some of the common ways in which manufacturers and 176 retailers use reference points to make existing prices appear to 177 be more attractive to consumers are:


ARTICLE IN PRESS triangular slice, those in an individual pie may come as a circle, and those in a large party pack may be served as a square, making size and price comparisons more difficult). The reference price idea suggests that consumers make relative judgments more often than they make absolute ones on the basis of what utility they wish for from a product/service and what that is worth to them in terms of prices. Marketers can help consumers make their decisions easier by providing price and quality references to aid value assessment.

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If one accepts that consumers incur a cost of thinking, and only engage in this cost if they expect benefits commensurate to, or greater than the costs, then mental shortcuts to compute prices and value could lead to systematic biases in decision making (Johnson and Payne, 1985; March, 1978). Classical research in psychology and economics shows that people use cognitive shortcuts, or heuristics, to make judgments (see Gilovich et al., 2002 for a review of cognitive heuristics used to make judgments). Three of these heuristics have been well studied. They are described below with respect to various biases they could lead to in the assessment of money and prices. Recent research in marketing has documented systematic biases in the manner in which consumers assess value, based on the form of the money they are used to think in, the form of money they are carrying and the manner of communication of prices. Some of these biases are described below:

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a cue to judge how many such instances exist in the population. Said differently, a salient or vivid piece of information is more likely to be used in a judgment than a pallid one. Examples include: a. LEFT TO RIGHT PROCESSING: consumers process prices from left to right despite years of school training to process numbers from right to left while adding and subtracting, leading to the well known effect of 99 cent pricing (schindler and kirby, 1997; stiving and winer, 1997; thomas and morwitz, 2005). given that people process numbers from left to right, they are likely to ignore the numbers on the right (typically the cents in low value purchases), and focus on the left most numeral to assess price. this implies that a price of $3.99 is perceived to be cheaper than a price of $4.00 compared to a $4.00 price versus a $4.01 price. this also suggests that discounts should be offered across the whole number. for example, if a product of $425 is to be discounted, discounting the price to $399 will be more effective than discounting the price to $400. by the same token, offering a discount of $10 will be more effective than offering a discount of $9.99. b. DEPTH OF DISCOUNTS VERSUS FREQUENCY OF DISCOUNTS: at a given cross-section of time, consumers perceive a store to be cheaper when they are presented with relatively many lower price products rather than a few deeply discounted ones (alba et al., 1994). alba et al. presented consumers with a list of prices in two stores with one store enjoying a frequency price advantage, (i.e., relatively many products cheaper, each by a small amount, compared to the competitor) and the other store enjoying a magnitude price advantage (i.e., a few products that were substantially lower in price compared to the competitor, which can be conceptually analogous to a condition where each price cut is individually easier to recall). they found that the frequency-pricing strategy led to perceptions of a lower priced store as compared to the magnitude pricing strategy. however, alba et al. (1999) show that, over time, a few deep deals relate to a cheaper product and a greater impact on sales than were frequent shallow deals (see also krishna and johar, 1996). 3. The anchor and adjustment heuristic. The anchor and adjustment heuristic postulates that consumers anchor on a starting piece of evidence (say a salient number), and then adjust this number (on the basis of other inputs) to make judgments of value. The bias occurs due to the inappropriate choice of anchor, or the inadequate level of adjustment. a. MONEY ILLUSION. one of the commonest examples of this is termed the money illusion where people use nominal values to make judgments and inadequately adjust for factors such as inflation rates (shafir et al., 1997). b. FACE VALUE EFFECTS IN FOREIGN CURRENCIES: raghubir and srivastava (2002) applied the money illusion to the domain of foreign currencies where people have to adjust the nominal face value of a foreign currency by the exchange rate of the currency. they report that when in a country where the exchange rate is a multiple of the home

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281 1. The representativeness heuristic: The representativeness 282 heuristic suggests that the degree to which A is representa283 tive of B will define the judgment of the extent to which A is 284 believed to originate from B. For example, in the domain of 285 money, more familiar forms of money may be valued higher 286 than less familiar forms (Raghubir and Srivastava, 2002). 287 This could lead to: 288 a. BIASES IN THE FORM OF MONEY: 289 i. Specifically, gift certificates or gift cards are valued 290 lower than their cash equivalents (Raghubir and 291 Srivastava, 2006a). 292 ii. People pay more using credit cards than they do paying 293 cash, as credit card payments are less painful (Prelec 294 and Simester, 2001). 295 b. BIASES IN DENOMINATION: 296 i. Consumers are less likely to spend larger versus smaller 297 denominations of an equivalent amount of money 298 (Raghubir and Srivastava, 2006b). 299 ii. Paper notes that are representative of higher denomi300 nations are valued more than metal coins (Mishra et al., 301 2006). 302 c. BIASES IN SHAPE, SIZE, COLOR AND MATERIAL: 303 larger coins have more value than smaller coins, especially 304 by young children (bruce et al., 1983; kirkland and flanagan, 305 1979), suggesting that monetary forms that are more colorful 306 and less serious may be more likely to be spent. 307 2. The availability heuristic: The availability heuristic suggests 308 that the ease with which something comes to mind is used as


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To summarize, the perceptual sources of errors in judgment are due to: (1) Consumers using effort–accuracy tradeoffs to make judgments and (2) Consumers making relative judgments on the basis of a reference that can be contextually determined to judge value.

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e. Uncertainty. People are less certain about prices subsequent to a currency transition (Ranyard et al., 2003 in Ireland, and Kühberger and Keul, 2003 in Austria). This leads to less accurate estimation of prices (Marques and Dehaene, 2004, in Portugal and Austria). In fact, the “Weber fraction,” (standard deviation of estimated prices/mean of expected prices), which reflects accuracy of price estimates, was higher for Euros than for French Francs, Portuguese Escudos and the Irish Punt, (Dehaene and Marques, 2002). Antilla (2004) find that the internal reference prices and the width of price latitudes changed in Finland after the introduction of the Euro. f. Changes in Market Structure. The Euro introduction has changed the way consumers make price–quality tradeoffs. Diller and Ivens (2000) found that when prices were described in Euros, consumers bought more expensive products, allowing premium brands to increase their market share.

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currency (like americans in canada), people underspend, whereas in a country where the exchange rate is a fraction of the home currency (like americans in england), they overspend. this is because the face values of the prices that they see are lower than the face values they are used to paying, and they inadequately adjust for exchange rates. c. EURO EFFECTS: the face value effect speaks to situations where currencies change, like in europe recently. in 1999 the general council of the european central bank set the conversion rates for the euro for 12 countries that went on the euro standard: belgium, germany, greece, spain, france, ireland, italy, luxembourg, the netherlands, austria, portugal and finland. in all of these countries, except ireland, the nominal prices of goods were lower in euros than they were in the prior local currency. by the end of february, 2002, all 12 countries had discontinued the use of the local currency. prices are overall more transparent due to the easier comparison of prices across countries with a single currency (mussweiler and strack, 2004). however, euro prices are perceived to be cheaper than the former, familiar currency when the nominal value of the familiar currency is larger than that of the euro (desmet, 2002), especially for certain demographics (lemaire and lecacheur, 2001), and at the initial time of introduction (mussweiler and englich, 2003). documented euro effects include: a. The accordion effect. The accordion effect captures that prices are perceived to be less different from each other when they are expressed in Euros versus the original European currency where the face value is a multiple of the Euro (€1 = FF 6.56; Gaston-Breton and Desmet, 1999). This allows national brands to charge higher price premiums over store brands (GastonBreton, 2003) as consumers are willing to pay more for additional features when the face value difference in the price appears small (Gamble et al., 2002, 2003). b. “Richness Effect” on Prices Willing to Pay. In Italy, Romani and Dalli (2002) found that the transition from the Lira to the Euro led to people feeling that they were richer, leading to their being willing to purchase more. In Germany, Jonas et al. (2002) found that consumers over estimated prices in Euros, and in Sweden, Gamble et al. (2003) found that students preferred to use a currency that had a smaller nominal value when paying for a product. c. Poorness Effect on Satisfaction with Wages. The mirror opposite of the richness effect is the poorness effect on satisfaction with one's income. Jonas et al. (2002) found that German workers were willing to travel shorter distances from home to work when salaries were paid in Euros versus the DM. In Sweden, workers preferred to receive their salary in a higher nominal value currency (Gamble et al., 2003). d. Euro-Inflation. Marini et al. (2004) find that since January 2002, the inflation rate in Italy was underestimated by as much as 6%, possibly due to “euroinflation.”

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Consumers need information to make judgments. However, in many instances, such as those for new customers or new products, they have to make decisions on the basis of incomplete information especially about an important product attribute, such as quality. In such cases, they look to see what information is available to them to help make such a decision. When two attributes are perceived to be correlated, such as price and quality, consumers can infer the quality (the unknown attribute) from the price (the known attribute). The attribute that is used is a “signal” for the attribute that is inferred (see Kirmani and Rao, 2000 for a review). A signal is easily observable. An example of a signal is “search attributes.” A search attribute's information is readily available in the shopping context. Examples include price, product specifications (such as the number of calories in a food container, or the size of a television monitor), brand name, country-of-origin, service aspects etc. These observable search attributes may signal unobservable attributes that consumers could only know if they tried the product (“experience attributes” such as durability, speed, clarity, taste), and sometimes would not even know for sure after trying the product but just take on faith (“credence attributes” such as health benefits). As experience and credence attributes are frequently a very important input in a consumer's purchase decision, marketers try and signal the values of these to the consumer using search attributes. Examples of “signals” include:

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a. Price: When consumers use prices as a cue for quality, they infer higher quality with higher prices (Olson, 1977). Higher

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promotions. For example, if a manufacturer has offered a deep discount of 50%, consumers would infer that they were covering production costs, and infer that margins were N50%. Judgments of fair price may be based on such cost and margin beliefs, and consumers may be unwilling to pay full price in the future. iii. Consumer inferences from promotions may undercut their economic value and backfire. For example, consumer will be less willing to pay full price for a product if they infer that the reason a manufacturer gave the product away for free in the past was because the product cost little to produce (Raghubir, 2004a, 2005). iv. Consumers may also use the value of the coupon to estimate the actual price of the product, and the higher the coupon, the higher the economic benefit, but also, the higher the price and possibly economic cost (Raghubir, 1998, 2004b). Therefore, high value coupons may backfire (lowering intentions), and lead to lower profits for the company. v. Sometimes, promotions can enhance a product's economic value due to positive promotional informational effects. For example, consumers infer low prices from an end-of-aisle display, making them more likely to purchase (Inman et al., 1990). vi. Placing a restriction on a deal such as “limited offer,” or “only available with purchase of $____” also improves sales. If the consumers believe that the manufacturer or retailer is restricting the amount that they can buy on deal because they believe that the deal will be a very popular one and they will loose money if too many people buy too much on deal, then consumers use the mere presence of a restriction to infer that a deal is a good one (Inman et al., 1997). vii. Restrictions of the type: “Maximum 2 per customer” also indirectly suggest to the consumer that they should purchase 2 units of the item rather than one (Wansink et al., 1998). This is another application of the “anchor and adjust” heuristic. b. QUALITY EXPECTATIONS: offering price promotions may also lead to unfavorable quality and brand evaluations (dodson et al., 1978; lichtenstein et al., 1989). for example, when a consumer believes that a deal was offered because a product would not otherwise sell at full price, they may judge the product to be low value for money. raghubir and corfman (1995, 1999) show this inference is most likely when other companies in the industry do not promote. when others promote, then consumers can attribute the promotion to competition among manufacturers and stores to try and attract customers to switch to their product, rather than product quality. such attributions (or the imputing of causes to events) can lead to consumers believing that a price promotion, even if it lowers prices only temporarily, is an indication of poor quality.

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prices can lead to greater costs for the consumer, and reduce demand from an economic point of view, implying a downward sloping demand curve. However, from a psychological point of view, if high prices signal high quality, then, under certain conditions, the higher the price, the higher the demand — an upward sloping demand curve. Warranties and Guarantees: Another observable signal is warranty and guarantee information (Boulding and Kirmani, 1993; Purohit and Srivastava, 2001). If a manufacturer wants to signal that their car is good, but they do not have enough consumers who have tried the car for a long enough period to make that claim, and their brand is not very well-known or well-respected, then they could use warranty information to signal to the consumer that the car will drive well for a certain number of years. An example of this is the “10 year/ 100K mile” guarantee offer by Hyundai and Kia, both Korean manufacturers with a brand name that was not as strong as Toyota or Honda. Brand Name: The brand name is one of the strongest signals of product quality (Rao et al., 1999; Rao and Monroe, 1989). Consumers use brand name as a heuristic that informs them of the unobservable qualities of a product. The brand name must be consistent with the price of the product. For example, if a brand has an up-scale image (like MercedesBenz), then pricing its products low may lead to people questioning its quality, and reducing sales for the brand and others in the product line. Country-of-origin: Consumers hold stereotypes about a variety of countries (Hong and Wyer, 1989). For example, they may believe that a product made in Germany has good engineering, one in Italy has good styling, and one in China is produced at low cost. Given these stereotypes, consumers may use country of origin of a product to assess quality and costs. Price Promotions: Much like prices, price promotions also carry information (Raghubir et al., 2004). Commonly documented sources of information that a price promotion carries are: 1. Awareness: Many promotions serve an advertising function; the presence of the coupon or sale may draw a consumer's attention to a brand or store that they may otherwise not have noticed (Bawa and Shoemaker, 1989). This increases awareness and purchase intentions, even if the consumer does not buy the product on sale. 2. Expectations: Consumers form expectations based on their exposure to marketing stimuli, and then use this expectation as a reference against which they evaluate an actual offering of a product or service. Three commonly studied expectations around promotions: price, quality, and dealing patterns are discussed next. a. PRICE EXPECTATIONS: i. Consumers expect to see a product on sale if they have seen the product frequently promoted in the past (Kalwani and Yim, 1992; Krishna, 1991). This is an example of a price expectation that forms due to past promotions. ii. Consumers can also infer the cost structure and normal margins of a product from the presence of

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The informational effects of promotions can carry through to managers' profits through reducing purchase intentions, or the maximum price that consumers are willing to pay. They may harm the brand's image if they relate to poor quality perceptions. They may increase consumers' price-elasticity, and make them deal sensitive, such that they would only wait for a sale before buying a brand. This would erode manager's profitability and in the long run reduce the average cost of a product in the product category (Raghubir et al., 2004).

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613 3. Affect

A third route by which consumers form attitudes is the feelings and emotions relating with prices, spending and saving. Consumers do not act by cognition alone, but have human feelings and emotions that they use to judge prices and transactions and make decisions (Chandon et al., 2000). Some examples of how affect enters the economic decision include:

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c.

could win a big prize adds feelings of excitement to the purchase. Therefore, more exciting promotions generating more sales than regular “percentage off” or “Dollar off” promotions that merely reduce prices. Auctions are another area where excitement can play a large role. In an auction, the excitement fuelled by winning a bid may lead to people overpaying (in the sense of their economic utility for that deal). The fact of winning leads to extra utility. Feelings of self-worth: The same way that a price can signal quality of a product or service, the fact that a consumer can afford to purchase a product, may signal to them their own buying power, and this can make them feel good about themselves. Many advertisements leverage this feeling by saying that the consumer is “worth” the purchase. This gets consumers to think of what paying for a product means about how well they think of themselves, and encourages purchase as a method of demonstrating self-love. Feelings of smartness: Many consumers are value conscious and deal-prone, and derive value not only from having got the same product quality at a lower price, but also from the fact that they are able to wait till a product is on sale, that they got more for less due to their effort in searching for the best deal, and that they paid less than other people for the same product (Schindler, 1992). These feelings, referred to as “transaction utility,” are associated with the fact of the transaction, rather than the product's price-based value (Lichtenstein et al., 1990). Here, the manner in which a promotion, or a low price, or better terms that are negotiated for the same price work is through signaling to the consumer that they were smart and savvy enough to find a good deal and were not taken advantage of by a manufacturer or retailer. Feelings of guilt: In the domain of self-gifts, consumers may feel guilty about rewarding themselves with hedonic pleasures, and do not buy such products for themselves, but enjoy receiving them as gifts. Feelings of Regret: Regret is the feeling that comes when one imagines “what could have been” and compares this with actuality. A consumer could feel regret when imagining the price that they could have got for a product that they did not purchase when it was on deal (Simonson, 1992). The counterfactual question that a person would ask is: “How would I feel if I did not do this?” By emphasizing the possibility of future regret, manufacturers can get consumers to take action today. Feelings of Embarrassment: Frequently, consumers may wish not to maximize positive emotions, but to reduce negative ones, such as embarrassment, anxiety or uncertainty (Raghubir et al., 2004). Take the case of embarrassment. Despite the fact that coupons are well used, consumers may still feel embarrassed about using one at a check out counter which has a large line; or at a dinner for Valentine's day; or for a gift for a special person. This is because they do not want to look cheap to others. If coupon usage implies money-consciousness, consumers may wish to avoid using coupons.

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c. EXPECTATIONS OF PROMOTIONAL PATTERNS: consumers may also develop expectation of the frequency and regularity of a brand's promotion patterns, when it will promote and when it will not, depending on their experience with the past patterns of deals offered by companies (krishna, 1991; krishna and johar, 1996). if a brand unexpectedly offers a price promotion, this could lead consumers to increase their purchase likelihood (as they experience a “gain”), but if they expect to find a promotion and find the brand on full price, they experience a loss, and may be even less likely to purchase the product.

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620 a. Pain of paying: Parting with money is aversive (Prelec and 621 Loewenstein, 1998). Given this, the form in which a payment is 622 made can itself affect the extent to which the pain of parting 623 with money is felt (Prelec and Simester, 2001). For example, 624 paying by credit card is easier than paying by cash, as every 625 transaction does not seem to feel as painful. A consumer gets a 626 credit card bill at the end of the month. Similarly, gift certificates 627 are easier to spend than cash (Raghubir and Srivastava, 2006a). 628 Even within cash, larger denominations are valued more so than 629 smaller ones (Raghubir and Srivastava, 2006b). Therefore, 630 consumers may be more ready to part with five $1 bills, than 631 cash a $20 bill to pay for a product that costs $5 (Mishra et al., 632 2006). This is because smaller denominations appear to be 633 “change.” Not surprisingly, therefore, consumers value coins 634 less than notes, and treat them as “change,” rather than “real 635 money.” Given the differences in the pain of paying, payment 636 mechanisms that make a price seem trivial — e.g., “pennies a 637 day” rather than a large lump sum amount are perceived to be 638 less painful and more successful in generating sales as well as 639 post-purchase satisfaction (Gourville, 1998). 640 b. Excitement: In the domain of price promotions, a consumer 641 derives value through non-cognitive routes as well as cog642 nitive ones (Chandon et al., 2000). For example, taking part in 643 a sweepstake is exciting, even though its economic value may 644 be mere pennies. The possibility, however small, that a person

g.

Consumers use non-cognitive and cognitive inputs to make decisions. Their affect, or feelings about something, are a


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ARTICLE IN PRESS powerful route that enter their decision calculus. Incorporating aspects of psychological affect to understand how consumers behave in the marketplace can enrich traditional economic theories.

706 4. Memory

Perception, inferencing, and affect are all an input into decision making. These are stimulus-based, or contextual, in the sense that attitudes may be constructed at the time of purchase. However, consumers have access to another store of information which they could use instead of, or along with, the attitudes that they form. This is their memory. Memory has a lot of information that is differentially easy to retrieve. The existence of information in memory needs to be distinguished from the accessibility of such information (the ease with which information can be recalled). Some pieces of information are easier to recall than others. These are called “salient.” They are likely to be used when they are considered appropriate to a decision. This is called the “diagnosticity” of the source of information to make a decision. Each piece of information in memory is not equally accessible and not equally diagnostic. Illustrating this, the consumer behavior literature has shown:

5. Information integration

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The manner in which consumers integrate costs and benefits to make decisions of whether, when, how much, and what to spend on may also be prone to psychological effects. For example, what information people notice, what they choose to use, and how they use this information could be a function of how salient and useful the information is. Further, consumers take more effort to accurately integrate different sources of information to make a decision when the benefits of doing so are greater, and the costs associated with the effort are lower. For example, consumers may not find comparing the unit prices of different volume packages across brands worthwhile if the overall cost of the product is low, but may do so for home mortgage or large ticket purchases. The following aspects of information integration deserve special mention:

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Memory biases in how people recall information can also lead to departures from traditional economic theory.

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4. Biases in the recall of prices: Consumers are more likely to recall prices that are vivid — such as the less expensive prices that they searched for. Thus, promotional prices may be better recalled than regular prices (Krishna and Johar, 1996).

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a. Errors in Noticing Information: Morwitz et al. (1998) show that for certain consumers, and under a given set of conditions (e.g., the additions are small relative to the base price), small price additions to the base price of the product, such as shipping and handling charges, may not be noticed or incorporated into the final price judgment. They may be ignored, or only partially accounted for. This leads to partitioned prices being perceived to be a better deal than the total price. b. Errors in Sampling: Consumers may also resort to certain simplifying heuristics to sample certain price points from the entire array of prices available when a lot of information is present, which could lead to systematic biases in price perceptions (Das and Raghubir, 2006). c. Assimilation and Contrast effect in incorporating a new piece of information: Monroe (1971) introduces the “latitude of acceptable prices” to marketing, arguing that consumers believe that a range of prices are appropriate. If a price falls within this range (latitude), the price is incorporated into a judgment, but not if the price falls outside the latitude. Thus, an existing price schema dictates whether or not a new piece of information will be used to update the schema. d. Strategies to combine information: Compensatory and noncompensatory decision making: Traditional methods of attitude formation and decision making assume that consumers trade off a product's advantage on one dimension (e.g., good quality) against its disadvantage on another dimension (e.g., high price). This assumption is that the two attributes can compensate for each other (Shimp and Kavas, 1984). This is not always a fair assumption for consumers who have to make many decisions in a short period of time. Instead of going through a complicated mental arithmetic process of trading off attributes, they may instead simplify

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723 1. Low levels of recall: An oft quoted finding is based on a field 724 study where researchers asked consumers how much they 725 had paid for a product they had just placed in their shopping 726 basket and found that less than half of the consumers could 727 recall the price, even when the brand had been chosen on the 728 basis of being low priced or on special (Dickson and Sawyer, 729 1990). Thus, price may not enter into the value equation in 730 the traditional manner that economists would argue. Instead, 731 consumers may be encoding a price as a “good” price, or a 732 “low” price, and using this information to make their 733 decision rather than the actual price of the product. Such a 734 manner of encoding implies that a consumer may purchase a 735 product on sale due to the fact of the sale, rather than the cost 736 savings of the sale. Understanding this can help managers 737 not offer an unnecessarily deep discount. 738 2. Biases in the recall of money: Consumers have recall biases of 739 how much money they have: The larger the denomination of a 740 monetary instrument, the more accurate they are, but as the 741 number of each note or coin increases, they underestimate the 742 amount that they are carrying (Raghubir and Capizzani, 2006). 743 3. Biases in the recall of spending: Recalling different 744 transactions and then aggregating them to identify how 745 much a person has spent is a difficult task. People can forget 746 not only the fact of the transaction, but its amount. They are 747 more likely to forget infrequent, distant, irregular or low 748 value transactions, compared to recent, frequent, regular or 749 high value ones; and also transactions associated with a 750 lower versus higher pain of paying. Each credit card 751 transaction is more difficult to recall as it is less painful 752 when it occurred than each cash transaction, leading to 753 people underestimating their credit card dues, and possibly 754 leading to their overspending on their credit cards in the 755 future (Srivastava and Raghubir, 2002).


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Other than reducing the costs of decision making by simplifying options (by “satisficing” rather than “optimizing”, Simon, 1955), consumers may also be prone to biases in their inappropriate choice of data to use. A common example of this is the fact that promotions that are framed “Buy one, get one free” are perceived to be better than those that are economically equivalent, such as “Two for the price of one” (Das, 1992). Companies use this while bundling products together, offering one for free with purchase of the other, rather than giving the joint price of the bundle purchase. Krishna et al. (2002) reviews other examples of how framing a promotion in different ways leads to differences in consumer's propensity to purchase. The way consumers think, act and feel in the marketplace is a function of economic factors as well as psychological factors that go beyond our traditional understanding of economics. By accepting that consumers perceptions may be based on reference points and the effort they put into a decision, the fact that consumers use known attributes to infer unknown attributes, that they use their feelings to make decision, and the fact that they do not use all the information at their disposal (either memory based, or available in their context), but a subset, which is then integrated in a manner that allows them to make a decision that is “good enough” rather than the best decision that they could make, one can get a better understanding of what drives consumer behavior and how marketers can best price and communicate the price of their products.

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their choices through the use of some of the following decision rules (see Gilovich et al., 2002 for a review): a. Choose what is the easiest to justify to others in case you make a wrong decision. b. Choose what you chose last time: the pervasive effect of habitual purchase. c. Choose a brand that is different from the one you chose last time: commonly referred to as variety seeking, this allows a consumer to explore different brands. d. Choose the brand that does best on the most important dimension: e.g., if you are shopping on price, choose the cheapest brand in the category. e. Reduce the set of items that should be considered into a “consideration set” and then do a more detailed evaluation of the items in the set. f. If items are non-comparable (e.g., vacation versus car), choose on the basis of which feels right. g. Reduce the set of brands by eliminating all those that do not perform at a minimum level on an important attribute: e.g., remove from consideration all brands that are priced at N $10.

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934 935 936 937 938 939 940 941 942 943 944 945 946 947 948 949 950 951 952 953 954 955 956 957 958 959 960 961 962 963 964 965 966 967 968 969 970 971 972 973 974 975 976 977 978 979 980 981 982 983 984 985 986 987 988 989 990 991 992 993 1052


DP

10


994 995 996 997 998 999 1000 1001 1002 1003 1004 1005 1006 1007 1008 1009 1010 1011 1012 1013 1014 1015 1016 1017 1018 1019 1020 1021 1022 1023 1024 1025 1026 1027 1028 1029 1030 1031 1032 1033 1034 1035 1036 1037 1038 1039 1040 1041 1042 1043 1044 1045 1046 1047 1048 1049 1050 1051