Toward Understanding of the Dual Entitlement Principle in Consumer Fair Price Judgments

ABSTRACT - Prior research on the consumer price fairness judgments mostly concentrates on the Dual Entitlement principle as a dominant rule for evaluation of the fairness of price changes introduced by firms. However, current literature provides a very limited theoretical explanation for this principle. Building our reasons on equity and motivational theories we tested how the choice of a fairness principle is influenced by several situational factors. Using experimental approach we found that individuals apply the Dual Entitlement principle when they have no information about a firm’s profit margins or when they identify themselves with the seller. In other cases subjects followed an equity-based fairness rule. The findings suggest that the Dual Entitlement principle is far from universal and open broad opportunities for future research in price fairness judgments domain.

Citation:

Alexey Novoseltsev and Luk Warlop (2002) ,"Toward Understanding of the Dual Entitlement Principle in Consumer Fair Price Judgments", in AP - Asia Pacific Advances in Consumer Research Volume 5, eds. Ramizwick and Tu Ping, Valdosta, GA : Association for Consumer Research, Pages: 180-185.

Asia Pacific Advances in Consumer Research Volume 5, 2002      Pages 180-185

TOWARD UNDERSTANDING OF THE DUAL ENTITLEMENT PRINCIPLE IN CONSUMER FAIR PRICE JUDGMENTS

Alexey Novoseltsev, Catholic University of Leuven, Belgium

Luk Warlop, Catholic University of Leuven, Belgium

ABSTRACT -

Prior research on the consumer price fairness judgments mostly concentrates on the Dual Entitlement principle as a dominant rule for evaluation of the fairness of price changes introduced by firms. However, current literature provides a very limited theoretical explanation for this principle. Building our reasons on equity and motivational theories we tested how the choice of a fairness principle is influenced by several situational factors. Using experimental approach we found that individuals apply the Dual Entitlement principle when they have no information about a firm’s profit margins or when they identify themselves with the seller. In other cases subjects followed an equity-based fairness rule. The findings suggest that the Dual Entitlement principle is far from universal and open broad opportunities for future research in price fairness judgments domain.

INTRODUCTION

Marketers have always been concerned about the reactions of consumers to the price changes they implement (see Monroe, 1990; Nagle and Holden, 1995). In recent years, consumer researchers have paid increasing attention to consumer fair price judgments in their relations to price changes. Many studies have found that unfair pricing policies may provoke consumer boycotts (Goldman, 1994), civil actions (Kaufmann, et al., 1991), retaliatory consumer behavior (Frey and Pommerehe 1993; Kachelmeier, Limberg, and Schadewald, 1991; Piron and Fernandez 1995), and eventually lead to lower sales (Grover, 1994).

Moreover, there is some evidence that companies in real-life price decision situations do take consumer price fairness judgments into consideration. For instance, Olmstead and Rhode (1985) documented decisions by individual gasoline sellers not to increase price even in the absence of any immediate threat to future custom or threat of regulation. Similarly, Blinder (1991) noted that 61% of marketing executives considered the fairness constraint to be one of the most important reasons why sellers would not raise prices.

THE PRINCIPLE OF DUAL ENTITLEMENT

Kahneman, Knetsch, and Thaler (1986a,b) (KKT) in two influential papers proposed "dual entitlement" (DE) as the dominant norm of price fairness. They stated that buyers and sellers recognize each other’s entitlement according to the terms of some reference transactionBbuyers to a reference price, sellers to a reference profit. Consumers use reference price as an anchor point to evaluate own gains and losses, and they use their knowledge about the firm’s reference profit to evaluate the gains and losses of the transaction counterpart. According to the DE principle, a price increase, which violates the buyer’s entitlement to the reference price, will be considered acceptable only if it perceived to be necessary to protect the seller’s reference profit. This implies that a price increase that increases the seller’s profit beyond its reference entitlement will be deemed unfair. According to the DE principle, it is considered fair if the company completely compensates its cost increase. It is also consistent with fairness norms not to pass cost decreases to the customer, since in this case the seller’s profit increases without violating the buyer’s reference price entitlement.

The most intriguing aspect of the DE principle is its claim that the seller’s profit entitlement takes precedence over the buyer’s price entitlement whenever both are threatened. This implies that it is consistent with community norms of fairness for cost increases to be passed on to consumers in the form of higher prices, in order to protect the seller’s reference profit. Moreover, the DE principle effectively implies that the supplier is allowed to increase its profits when there are costs reductions. In other words, "it is fair for prices and profits to only ever increase, because it is consistent with this norm of fairness for sellers to pass on costs increases and not cost decreases" (Kalapurakal et al. 1991, p.789).

So far the literature provides no theory which explains the phenomena of the DE principle. However, there have been several empirical works attempting to elaborate the original findings of KKT. Some research has found support for the role of reference profit in perception of fairness (Kachelmeier et al. 1991; Campbell 1999). Those findings report that price changes are consistently considered unfair when subjects attributed the price increase to a firm’s attempt to take advantage of sudden demand increase (Kalapurakal et al. 1991; Kachelmeier et al. 1991; Piron and Fernandez 1995). More recently, Campbell (1999) demonstrated that the inferred motive of the price change as well as inferred relative profit also provides causal explanation of perceived price unfairness. In addition she found that the firm’s reputation can influence the inferred motive, thereby altering perceptions of price unfairness. Finally, Kalapurakal et al. (Kalapurakal et al. 1991; Dickson and Kalapurakal 1994) have found that some other rules based on a more symmetric treatment of cost increases and decreases were perceived more fair than rules based on DE principle. They proposed that the DE principle may not necessarily reflect community norms of fairness. Rather, it can be an outcome of information asymmetry between supplier and consumer. They suggested that buyers may not have information about a firm’s pricing practices in other situations and particularly about a consistency in the seller’s behavior with respect to price increases and decreases. They suggest that since fairness evaluations appear sensitive to situational factors and information available, there may be no simple robust principles that govern norms of what is fair or unfair pricing behavior. Such contextual factors include, amongst other things, the judge’s self-interest in the transaction, knowledge about a suppler’s initial costs and profit margins and information about a supplier’s past pricing and competitive behavior.

In this research we propose two alternative explanations for the DE principle. In the next sections we provide theoretical background based on equity and motivation theory and report results of two studies which test our hypotheses.

EQUITY THEORY

The notion of fairness is almost synonymous with equity in that it explicitly implies a form of distributive justice (Jasso, 1990). Equity theory is a social comparison theory in which individuals evaluate the ratio of the investments they make to a particular exchange to the profits they derive from it, relative to the investments and profits allocated to their exchange partners. Equity theory posits that for an equitable exchange relationship to exist the parties involved have to obtain equal ratios of perceived profits, or gains, to perceived investments, or losses (Adams, 1965).

Application of equity theory to exchange suggests that equity judgments in pricing are determined by a comparison of the ratio of the consumer’s invested inputs to received outcomes relative to that of the seller (Oliver and Swan, 1989). The entitlements of buyer and seller in the transaction may be determined by an assessment of the relative contribution of each in terms of input-output ratios. Unfairness arises when there is over- or under-benefit for one party at the expense of the other.

FIGURE 1

THEORETICAL PATTERNS OF PRICE FAIRNESS JUDGEMENTS

The formulation of equity theory assumes some degree of consumer knowledge about the firm’s outputs which in most cases are the company’s profits (Oliver and Swan, 1989). Indeed, in order to be able to judge how equitable is the transaction, consumers should have an idea about firm’s profit margins. However, the existing evidence suggests that buyers have very inaccurate perceptions of firm’s profits (Browne, 1973). In many cases, consumers are not even able to remember the price levels correctly (Dickson and Sawyer, 1990), not speaking about more complex things such as the seller profits.

However, the original survey questions of KKT do not provide any information about company’s profit margins. Here is an example of their scenario:

Question 1: Suppose that, due to a transportation mix-up, there is a local shortage of lettuce and the wholesale price has increased. A local grocer has bought the usual quantity of lettuce at a price that is 30 cents per head higher than normal. The grocer raises the price of lettuce to customers by 30 cents per head.

Following this question, the respondents were asked to judge how fair this price change was.

We propose a hypothesis that when individuals have information about the seller’s historical profit margins, their price fairness judgments will be driven by equity concerns. When they do not have this information they will base their judgments on DE norms.

Behavior patterns of fairness judgments

Before we continue with the theory of fairness judgments let us introduce a brief description of several possible patterns of consumer’s price fairness judgments.

When costs change, the consumers make decisions about a firm’s new fair price on the basis of their judgment about the profit the company is entitled to make. In other words, consumers make decisions about the supplier transfer rateBthe share of cost change the company should transfer to customers. For instance, when costs increase by 3 Euro, there are several options. First, the firm may be allowed to fully compensate its cost increase by setting a new price 3 Euro higher than the old one.

This situation implies a maximum (100%) transfer rate. In other words all cost increase is transferred to the customer. Second, for some reasons it may not be fair for the company to react to its cost increase at all and to increase the price. In this case the transferred amount will be minimal and equal to 0 Euro. Third, the company may be granted partial compensation of the cost increase, which leads to different values of transfer rates between 0% and 100%. The same situations may occur when costs go down. The fairness norms may require a company to decrease its price following the cost decrease (100% transfer rate); the company is allowed to keep all extra profits and keep the price at the old level (0% transfer rate); or transfer some benefits to consumers (transfer rate is between 0% and 100%).

The combination of both cost increase and decrease results in an overall set of price fairness principles which people may use when seller’s costs change (Figure 1). The first principle is symmetric and based on notions of equity (line (a)): suppliers ought to pass on the customer a share in both the burden of a cost increase and the pleasure of a cost decrease. This principle implies equal transfer rates, independent of whether the cost change is an increase or a decrease. At the extremes, this principle will translate in a 'buffering’ rule, when all cost changes are absorbed by the supplier (transfer rate is 0%), or in a cost-plus rule when all changes are transferred to the consumer (100% transfer rate). Several intermediate rules may be conceptualized, depending on the proportion of the cost change which is transferred, but they are all symmetric because the transfer rate is the same for cost increases and for cost decreases. On average, when this symmetric rule is applied neither a seller nor a customer gains profit or bears losses from the transaction. This is a pure equity rule where everybody gets what he or she deserves.

Two alternative principles may be asymmetric. According to the first asymmetric principle the supplier should absorb all cost increases, but transfer all cost decreases to the customers (line (b)). Consumers require the company to decrease the price when costs go down. At the same time consumers protect their interests and do not allow the company to increase the price in order to compensate its cost increase. This principle would be applied by a consumer who has no concern at all for the welfare of the supplier. As far as comparisons are possible, this would be the self-interested type of consumer assumed by standard economic theory.

FIGURE 2

RESULTS OF STUDY 1

The second asymmetric principle suggests that the supplier is permitted to increase price whenever it is justified by a cost increase but is allowed to keep a share of benefits when supplier costs decrease (line (c)). This principle resembles the DE pattern. On average, instead of sharing benefits and burdens customers allow the company to benefit from both situations of cost increase and decrease.

Transfer rates for cost increase and cost decrease situations are two characteristics which help to distinguish one principle from another. Two identical transfer rates describe the symmetrical price fairness judgment pattern. When the transfer rates are different it implies either a self-interest judgment pattern or a DE pattern.

It should be noticed that the presented framework is based on behavior patterns of individuals’ price fairness judgments. The slope of the lines helps to distinguish between different fairness principles people use in their judgments of fair prices: a positive slope reflects a DE motivation, a negative slope signifies a consumer self-interest motivation, and the horizontal line suggests an equity motivation.

STUDY 1

In this study we test whether the information about the seller’s historical profit margins changes the individual’s pattern of price fairness judgment. Ninety-five undergraduate students from a Dutch-speaking Belgian university participated in the study as part of a course requirement for an undergraduate business class. They were asked to participate in a short survey related to pricing policies of firms. The experiment was held at the start of a regular class lecture. The subjects were asked to carefully read a paragraph containing the experimental manipulations, and to answer the question about the new fair price the company should set. No other measures were taken. After five minutes all questionnaires were returned back to the administrator. Subjects were randomly assigned to the cells of 2x2 between subjects design, where the factors were (1) the direction of cost change (increase vs. decrease) and (2) presence or absence of information about the seller’s historical profit margin. The cost change was manipulated by presenting the information about changes in seller’s costs (either increase or decrease) by 10 Belgian Franks (about 25 US cents). The dependent variable was an absolute difference between a new fair price and the price prior to the cost change. An example of one scenario is presented in Appendix 1.

Results

The results of the experiment are shown in Figure 2. The results show that there is a significant interaction effect between the direction of cost change and the absence or presence of profit margin information (F(1,91)=9.44; p<0.01). The planned comparisons show that when information about the seller’s historical profit margin is given, the pattern of fairness judgments is presented by a horizontal line (F(1,91)<1) assuming an equity motivation. This empirical finding confirms our hypothesis that when individuals posses information about seller’s outputs they follow an equity pattern in their price fairness judgments. Consumers consider it fair when the seller shares with them both benefits of costs decrease and burdens of costs decrease.

In contrast, when information about profit margin is not given, the fairness judgment pattern resembles the DE principle. The line slope is positive and significant (F(1,91)=14.97; p<0.001). As the results suggest, consumers allow the seller to completely compensate its cost increase, permitting, however, a partial price decrease when costs go down.

Discussion

The results of the Study 1 show that when information about the seller’s profit margins is present, individuals are motivated by norms of equity. They require the seller to share both benefits of cost decrease and burdens of cost increase. The findings also confirm our hypothesis that the DE principle of price fairness judgments is the principle which people follow when they have no direct information about the seller’s outcomes. In other words in this situation they base their judgments on some other norms of fairness which are different from equity norms. What are those norms? We will try to shed some light on this issue in the next part.

WHICH FAIRNESS NORM? A HELPING MOTIVE

The psychology of fairness emphasizes the influence on fairness judgments of the normative goals of a society (Leventhal, Karuza and Fry, 1980) and of individual acceptance of societal norms (Goolsby and Hunt, 1992). We propose that those norms may influence consumer price fairness judgments.

Detailed analysis of the original KKT research made us presume that consumer’s identification with the seller might be another possible reason why the DE principle was observed at the first place. If we have a look at the way the original survey scenarios were presented (see above), it seems that the individuals were prompted to evaluate a particular seller’s business problem (a cost change) from the seller’s perspective. For instance, in this scenario it is difficult to find a single word which could elicit equity concerns or make consumers think about their own interests. We propose that such framing of the problem may push consumers to concentrate on seller’s interests and eventually influence his or her price fairness judgments. We also propose that such an influence may be achieved via mechanisms of personal identification.

The current literature suggests that one of the most powerful situational predictors of an individual’s helping motives toward others is an identification of the individual with those others (Batson, 1996). In several studies both adults (Batson, et al., 1981) and children (Panofsky, 1976) who identified themselves with others, subsequently assisted these others more than individuals in no-identification control group. It has also been found that the helping motivation is particularly aroused when people perceive another person as similar to them (Piliavin et al. 1981). Support for the positive effects of such matching comes from the literature on sales force effectiveness (Crosby et al., 1990; Smith, 1998). The same findings have been explained in terms of group identity theory. Tajfel and Turner (1986) predicted that members of a group seek to establish a positive group identity by favoring their own group members over the members of other groups in their allocation of rewards. A number of studies in allocation games (Jost and Azzi, 1996) and social dilemmas (Foddy and Hogg, 1999) have confirmed this theoretical proposition. Furthermore, group identity research findings (Jetten et al., 1997) also demonstrate that people act more generously towards individuals and groups with whom they identify themselves. Seligman and Schwartz (1997) also found that the price actions of small firms run by individuals with whom subjects could identify were considered fairer than the same actions of the large companies.

We hypothesize that judges of price fairness will become more responsive to the welfare of the supplier if they identify themselves with the supplier. In other words, we propose that the individuals who identify themselves with the seller will tend follow the DE pattern in their price fairness judgments.

STUDY 2

The results of the first experiment have shown that individuals who posses some information about a seller’s profit margins are motivated by equity norms in their price fairness judgments. In this study we want to test whether identification with the seller might influence those norms.

Forty-five undergraduate students from a Dutch-speaking Belgian university participated in the study as part of a course requirement for an undergraduate business class. The experiment procedure was the same as in the Study 1. Subjects were randomly assigned to the cells of 2x2 between subjects design, where the factors were (1) the direction of cost change (increase vs. decrease) and (2) neutral situation vs. a situation where the subjects could identify themselves with the seller. In the high identity condition the seller was presented as a person with similar socio-demographical characteristics as the subjects. In the neutral condition no information about the seller was given. For a manipulation check we added a question "To what extend you identify yourself with the seller in this situation?" with a seven-point (1BNot at all; 7BVery much) answer scale. As in the Study 1, the cost change was manipulated by presenting the information about changes in seller’s costs (either increase or decrease) by 10 Belgian Franks (about 25 US cents). The dependent variable was again an absolute difference between a new fair price and the price prior to the cost change. An example on one scenario is presented in Appendix 2.

Results

The manipulation check demonstrated that our manipulation worked well (F(1,43)=5.03; p<0.05) with average scores 3.4 for high identification and 2.6 for neutral condition. The results are presented in Figure 3.

The results show a strong interaction effect between the direction of cost change and the level of identification with the seller (F(1,41)=5.22; p<0.05). When subjects do not identify themselves with the seller they keep following the equity principle in their judgments. The slope of the pattern line is not significantly different from zero (F(1,41)<1). This partially replicates the findings from the Study 1. When subjects identify themselves with the seller their pattern of judgments shifts toward the DE principle. The slope of the line is positive and significant (F(1,41)=8.43 ; p<0.01).

GENERAL DISCUSSION

In this study we report two studies designed to provide explanation for the DE principle. The results show that contrary to the existing evidence, the DE principle is far from universal. In the line of our hypotheses we found that individuals follow this principle when they do not have complete information about seller’s outcomes or they identify themselves with the seller. The findings imply a number of implications.

First, the results show that the customer perception of the seller’s outcomes is a very important variable in customer’s price fairness judgments. Similar to Oliver and Swan’s (1989), we found that the seller’s outcomes directly influence the consumer’s evaluation of transaction fairness. Our results suggest that it is beneficial for the seller to hide all information about its outputs from the customer. In this case driven by the DE norms the buyer will consider fair if the seller completely compensates its costs increase and shares only partially the benefits of costs decrease.

On top of this, our findings contribute to the existing knowledge of relationship marketing. The findings from the literature stress the long-term benefits of close customer-supplier relationship. We have shown that consumer identification with the seller can be beneficial for the firm even in the short-run. In this research we have studied the price fairness phenomena on the level of a single transaction. The results show that even one transaction can be beneficial for a firm if consumers identify themselves with this company. In these circumstances consumers consider it fair if the firm do not suffer from cost increase and benefit from cost decrease situations.

FIGURE 3

RESULTS OF STUDY 2

SUGGESTIONS FOR FUTURE RESEARCH

We have found that consumers change their price fairness judgments when they posses some knowledge about seller’s profit margins. However, apart from profits, the seller can have other outcomes from a transaction such as market share or customer satisfaction. The information about those outcomes can be more accessible for the consumer then the seller’s profit margins. It would be important to know how the consumer knowledge about these outcomes affects their perception of price fairness. So far there is no research which tackles these issues.

Another interesting area for research might be an investigation of a role of alternative motives in consumer price fairness judgments. For instance, Batson (1996) suggests that individual decisions can be driven by a number of different motives which may include altruism and self-interest. From managerial point of view, it would be very important to know how those motives influence the consumer price fairness judgments.

Appendix 1. An example of a scenario used in Study 1.

A local grocer usually buys bananas from a wholesaler at 80 BEF pe kilo. He sells the bananas to customers at 100 BEF per kilo, making 20 BEF profit for each kilo of bananas he sells.

Suppose that the wholesaler was required to increase its price. The local grocer has bought the usual quantity of bananas at a price that is 10 BEF per kilo higher than normal. What do you think would be a fair price per kilo he should charge to customers?

Appendix 2. An example of a scenario used in Study 2.

Peter Bogaert, 23 years old, is the owner of a grocery store in one Belgian town. He usually buys bananas from a wholesaler at 80 BEF per kilo. He sells the bananas to customers at 100 BEF per kilo, making 20 BEF profit for each kilo of bananas he sells.

Suppose that the wholesaler was required to increase its price. Peter Bogaert has bought the usual quantity of bananas at a price that is 10 BEF per kilo higher than normal. What do you think would be a fair price per kilo he should charge to customers?

To what extend you identify yourself with the seller (Peter Bogaert) in this situation?

(1-Not at all                  7-Very much)

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