Reference Pricing in Marketing: A Comprehensive Report
What Is It?
Reference Pricing is a psychological pricing strategy where a company presents a product's current price alongside a higher price, known as the **reference price**. This higher price acts as a benchmark, or anchor, that consumers use to evaluate the attractiveness of the actual selling price. The core goal is to influence the consumer's perception of value, making the current price appear to be a significant bargain or a great deal.
The reference price can be either **external** or **internal**. An External Reference Price (ERP) is explicitly provided by the seller, such as "Original Price: $199.99" or "MSRP: $250." An Internal Reference Price (IRP) is the price a consumer recalls from memory, based on past purchases, market knowledge, or the price of similar products. Marketers strategically use ERPs to manipulate the IRP and create a favorable perception of the current offer.
A classic example is seen across major retailers like Amazon, which frequently displays a "List Price" crossed out next to the lower "Our Price," immediately establishing a high external reference point. Similarly, software companies often display a high "monthly" price but offer a lower "annual" price, using the higher monthly rate as the reference to make the annual commitment seem like a substantial saving.
How It Works
| Mechanism/Theory | Explanation |
|---|---|
| **Anchoring Effect** | The high reference price acts as a cognitive anchor, disproportionately influencing the consumer's perception of the product's true value. All subsequent prices are judged relative to this initial, high anchor, making the current price seem lower than it otherwise would. |
| **Prospect Theory / Loss Aversion** | Consumers evaluate the current price relative to the reference price. The difference is framed as a "gain" or "saving," which is highly motivating. According to Prospect Theory, the pleasure of a gain (saving money) is a powerful driver of purchase behavior. |
| **Perceived Value and Quality** | A high reference price often signals high quality to the consumer (the price-quality heuristic). By setting a high reference price, the marketer suggests the product is high-quality, and the current lower price is a temporary deal, not a reflection of lower intrinsic value. |
| **Transaction Utility Theory** | Consumers derive utility not just from the product itself (acquisition utility) but also from the perceived quality of the deal (transaction utility). A large positive difference between the reference price and the actual price creates high transaction utility, increasing the likelihood of purchase. |
Quote from a Popular Marketer
"Lowering your price is the refuge of the marketer who has run out of ideas."
10 Tips on How to Use It in Marketing
- Display the External Reference Price (ERP) Clearly: Always show the higher, original price (e.g., "Was $150") crossed out next to the current, lower price. This is the most direct application of the principle and immediately establishes the anchor.
- Employ a Decoy Effect with a Premium Option: Introduce a significantly more expensive, premium option that is not intended to sell well. This high-priced "decoy" serves as a reference point, making the target product's price seem reasonable and a better value by comparison.
- Anchor with Bundled Value: When selling a bundle of products or services, first state the total price of all items purchased separately, then present the lower, bundled price. The sum of the individual prices becomes the high reference price.
- Highlight Future Price Increases: Use urgency-creating language like "Introductory Offer," "Price Goes Up Next Month," or "Limited-Time Pricing." This anchors the current price as a temporary low reference point, incentivizing immediate action.
- Leverage Competitor Pricing as an ERP: If your price is lower than a major competitor's, use their price as an external reference point. For example, "Competitor X sells this for $299, our price is $199."
- Establish a High Internal Reference Price (IRP): For new products, launch them at a high price to establish a high IRP in the consumer's mind. Later, a permanent, slightly lower price will be perceived as a great deal, even without an explicit discount.
- Break Down Costs into Smaller Units: For expensive products (e.g., a $1,200 annual subscription), break the cost down into a smaller, more manageable unit (e.g., "Just $3.29 per day"). The large annual price is the anchor, and the small daily price makes the commitment feel negligible.
- Use Price-Per-Unit Comparisons: For commodity goods, use a higher-priced, smaller unit as the reference. For example, show the price of a 10-pack of batteries, then offer a 100-pack at a much lower price per battery, using the smaller pack's unit price as the anchor.
- Offer a "Good, Better, Best" Tiered Structure: The highest-priced "Best" option acts as a powerful anchor, making the middle "Better" option appear to be the most sensible and best-value choice. This is a classic application of the decoy effect within reference pricing.
- Use Psychological Pricing Cues (e.g., Charm Pricing): While not strictly reference pricing, combining a high reference price with a current price ending in '9' (e.g., "Was $100, Now $79") enhances the effect. The reference price establishes the value, and the charm price triggers the perception of a better deal.
References
- **Kahneman, D., & Tversky, A. (1979).** *Prospect Theory: An Analysis of Decision under Risk.* Econometrica, 47(2), 263–291. (For Loss Aversion and Framing)
- **Thaler, R. H. (1985).** *Mental Accounting and Consumer Choice.* Marketing Science, 4(3), 199–214. (For Transaction Utility Theory)
- **Tversky, A., & Kahneman, D. (1974).** *Judgment under Uncertainty: Heuristics and Biases.* Science, 185(4157), 1124–1131. (For Anchoring Effect)
- **Biswas, A., & Blair, E. A. (1991).** *Contextual Effects of Reference Prices in Retail Advertisements.* Journal of Marketing, 55(3), 1–12. (For Internal vs. External Reference Prices)