Special Session Summary Consumer Understanding of Prices and Profits

Citation:

John W. Pracejus (2003) ,"Special Session Summary Consumer Understanding of Prices and Profits", in NA - Advances in Consumer Research Volume 30, eds. Punam Anand Keller and Dennis W. Rook, Valdosta, GA : Association for Consumer Research, Pages: 201-203.

Advances in Consumer Research Volume 30, 2003     Pages 201-203

SPECIAL SESSION SUMMARY

CONSUMER UNDERSTANDING OF PRICES AND PROFITS

John W. Pracejus, University of Alberta

OVERVIEW

Consumer knowledge of how business works is certainly an important substantive issue. While it has, for some time, received attention in terms of advertising (i.e. persuasion knowledge), only now are we beginning to ask questions about consumers understanding of prices and profits. What are consumers’ implicit theories about how prices are derived, why they change and how they are related to each other (across brands and within sub-brands). Do consumers really understand commonly used concepts like gross, net, overhead, and profit? These questions have important implications for consumer decision making. The fundamental issue explored in the session was, therefore, the rapidly emerging area of consumer knowledge (or lack thereof) and it’s importance for the field of consumer research. Specifically, it explored issues related to how consumer knowledge of prices and profits impacts important estimations, perceptions of fairness, and general understanding of "how the world works" in terms of ones consumption activities.

While the three papers are clearly substantively related, they each focused on a slightly different aspect of consumer knowledge of prices and profits. The first paper focused on issues of consumer confusion between price and profit. The second paper explored consumer lay theories about why prices are what they are. The third paper considered how giving consumers price information about one brand can impact their ability to accurately estimate the price of other products in the category. The three papers were also closely related methodologically, in that they all relied on assessment of the estimation methods employed by consumers.

 

CONSUMER KNOWLEDGE ABOUT PRICES AND PROFITS: THE POTENTIAL FOR DECEPTION IN CAUSE RELATED MARKETING CAMPAIGNS

G. Douglas Olsen, University of Alberta

John W. Pracejus, University of Alberta

Norman R. Brown, University of Alberta

Cause related marketing is the practice whereby a company donates money to a charity each time a consumer makes a purchase (Varandarajan and Menon 1988). While past research has shown that the amount of the CRM donation impacts consumer choices (Strahilevitz and Meyers 1998, Pracejus and Olsen in press), whether consumers understand how much is really being donated has not yet been investigated. Donation amounts are often stated as a percentage of profit. In these cases consumer knowledge about the profits are essential to their understanding of how much benefit the charity will receive as a result of their purchase.

Most notably, if they mistakenly replace profit with price, their estimate will be many times the actual donation. In other cases, no numerical information is presented to consumers at all. Phrases like "a portion of proceeds will be donated" require consumers to infer what a reasonable donation might be. Here again, consumer knowledge of profit will serve as an important factor in their assessment of how much benefit their purchase will provide. In order to assess these issues, we first surveyed CRM campaigns on the world wide web, so as to understand the types and prevalence of various donation description formats. We then examined, in a series of experimental studies, how consumers respond to each of these formats. Finally, where we found evidence of systematic estimation bias, we tested several potential legal remedies.

In study one, our search of CRM web sites, we find that 9.3% of the formats are estimable (e.g. x% of the profits will be donated) 10.7% are calculable (e.g. x% of the price will be donated) and the overwhelming majority (80%) are abstract (e.g. a portion of the proceeds will be donated). Given the prevalence of abstract formats, we next investigated consumer estimates based upon different abstract formats. In study two, 424 participants view one of 16 versions of ad copy for a CRM campaign (a 2x2x2x2, between-subjects design). The independent variables were: portion vs. substantial portion; net proceeds vs. gross proceeds; the purchase price of the product ($49.99 vs. $499.99); and the estimation method (percent estimate vs. dollar estimate). Results show higher estimates for "a substantial portion" (mean=$20.97, 9.8% of price), relative to simply "a portion" (mean=$11.44, 4.79% of price). The Purchase Price also affected estimation, with an average of $4.36 (8.7% of price) being estimated for the $49.98 product, and $28.97 for the $499.98 product (5.8% of price), indicating that higher priced items result in lower donation estimates, as a percentage of price. No other effects were significant.

Study 3, assesses consumer responses to estimable and calculable formats, and compares these assessments to estimates based on abstract formats. An additional 148 participants were randomly assigned to the cells of a one-way, five level design, manipulating the wording of the CRM offer. The phrases were "a portion of proceeds"; "a substantial portion of proceeds"; 5% of profits; 5% of the retail price; and a control condition with no CRM. Results show that the presence of a CRM offer results in perceptions that the company donates more to the community (F_1,146=8.01, p<0.01), is less risky (F_1,146=5.95, p<0.05), is more prestigious (F_1,146=4.37, p<0.05) and is more trustworthy (F_1,146=3.57, p<0.10).

Estimates of the amount being donated were found to differ among the formats. As in study 2, "substantial portion" resulted in higher estimates than "portion" (t₅₌2.38, p<0.05). The most interesting finding of this study however, is that there was no significant difference in estimation between the "5% of price" and the "5% of profit" condition! Given that 5% of profits is, by definition, lower than 5% of sales price, it is very surprising to find that no estimation difference is observed between these conditions (t₆₀₌0.81, n.s.).

To test the robustness of this finding, in study four we attempted to replicate it using some participants who had formal training in accounting, and all participants make their estimates immediately, rather than after a 2 minute delay as had been done in study three. Here, 142 additional participants took part. Once again, we find no significant difference between estimates in the price and profit groups (F_1,137=1.40, n.s.). Accounting Knowledge (F_1,137=0.98, n.s.) and the interaction between these variables (F_1,138=0.19, n.s.) also had no impact.

Clearly therefore, even with high accounting knowledge, most people mistakenly calculate a percentage of price rather than profit. It is quite possible that this could meet a legal definition of deceptiveness. One very non-intrusive legal remedy, is to require advertisers to define the term "profit" in the ad. A slightly more intrusive remedy is to force disclosure of profit level, either as either as a percent of price, or in absolute dollars. We test these three potential remedies (definition only, profit disclosure as percent, profit disclosure as dollar value) against a control condition where no remedy is present.

Mean donation estimate differed among the four conditions (F_3,133=20.278, p<0.001). The estimate in the base condition (mean=$7.83) was significantly higher than the definition condition (mean=$5.77, t₇₀=3.34, p<0.001), the profit=$60 condition (mean=$4.32, t₆₇=6.05, p<0.001), and the profit=40% condition (M=$3.52, t₆₈=11.23, p<0.001). All three remedies also result in a substantial reduction in the number of people who mistakenly calculate a percent of price when they are told a percent of profit will be donated.

Therefore, the five studies demonstrate that there are systematic effects of format on donation estimation, and that poor consumer knowledge about the distinction between price and profit results in overestimation of CRM donations. Simple, legally defensible remedies, however, can significantly improve estimation performance.

 

EXPLORATIONS IN PRICE (UN)FAIRNESS

Lisa E. Bolton, University of Pennsylvania

Luk Warlop, KU Leuven

Joseph W. Alba, University of Florida

Fine restaurants gouge consumers, as evidenced by wine prices that are multiples of the going retail prices. Music on the Internet should be freely shared because the recording industry is rapacious in its pricing. Gasoline prices are exorbitant because they are determined more by industry collusion than market forces. Pharmaceutical prices should be regulated due to the obscenely high profits made on prescription drugs and the relatively low prices paid in other countries for the same products. Such beliefs are not narrowly held, yet their accuracy is an issue of great consequence because the profitability of firms may be constrained by justifiable fear of consumer backlash to perceived exploitation (Blinder 1991; Kahneman, Knetch, and Thaler 1986a; Piron and Fernandez 1995) and consumer price consciousness and satisfaction with competing vendors may be shaped by perceptions of price fairness (Sinha and Batra 1999).

Despite the apparent importance of perceived price fairness, research on the topic has been sparse. Relevant research that does exist has largely been inspired by the principle of dual entitlement (Kahneman, Knetch, and Thaler 1986b), which argues that fairness perceptions are governed by the belief that firms are entitled to a reference profit and customers are entitled to a reference price. In the scenarios used to study the principle of dual entitlement, reference transactions mostly involve recent past prices that are accompanied by an explanation (e.g., costs, demand) given for the price change. Such scenarios focus on a dynamic pricing environment and examine consumer responses to changes in pricing across transactions.

The goal of the present research is to explore a variety of factors that contribute to consumer perceptions of price fairness. We build on the provocative findings of Kahneman et al. (1986b) regarding the principle of dual entitlement but depart from their approach in four ways: (1) We broaden our treatment of reference points to include past prices, comparison prices, and vendor costs. (2) This broader treatment permits us to examine static as well as dynamic environments. For example, how do people judge price fairness in the absence of a price change? (3) We examine profits as well as prices and attempt to obtain greater access to consumer understanding of profitability. (4) In contrast to prior research that has emphasized the vendor’s motivation for altering the status quo (e.g., Bies, Tripp, and Neale 1993; Campbell 1999; Martins and Monroe 1994), the present research focuses on cognitive determinants of fairness by investigating consumer understanding of markets, the environment, and the vendor’s constraints. Specifically, we focus on three cognitive reference points that should affect fairness perceptions: past prices, comparison prices, and the firm’s costs.

Given that consumer knowledge of explicit and unambiguous retail price information can be low and may be declining (Estelami, Lehmann, and Holden 2001), it seems reasonable to expect poor appreciation of closely guarded cost and profit information. Although knowledge of profits and costs has not been extensively investigated, consumers are not highly satisfied with the price-profit relationship they perceive to exist among large firms (Business Week, 2000). Thus, our guiding hypothesis is that consumer understanding of prices, costs, and profits does not exist at high levels across the population; moreover, we propose that such knowledge levels contribute to consumer perceptions of price unfairness.

The set of experiments that investigate this proposition are organized around three reference points that should affect fairness perceptions: past prices, comparison prices, and the firm’s costs. We characterize these reference points as looking back (at past prices), looking across (at comparison prices), and looking inward (to costs). Evidence from 12+ completed experiments is summarized below (details omitted for brevity’s sake):

When "looking back" and assessing prices over time, consumers systematically underestimated the effects of inflation. Potential corrective strategies (i.e., providing explicit inflation rates, current prices, or historical data) were insufficient to correct for underestimation. Indeed, the salience of recent price data appeared to exacerbate perceptions of unfairness arising from underestimation of inflation.

When "looking across" and comparing prices, consumers infer price unfairness. When comparing store prices, consumers tend to attribute differences to profit rather than costs. Even after controlling for profit levels, consumers take into account how profits are made when comparing prices. Corrective efforts that explain price differences as a consequence of marketing strategy may be insufficient to improve fairness perceptions. In fact, certain marketing strategies (e.g., margin versus volume strategies) may be judged unfair even when beyond the store’s control. From a consumers’ perspective, price differences appear fair(est) only if they can be attributed to quality differences.

However, when consumers "look inward" and assess costs, other cost categories besides cost of goods sold are likely to be ignored. Cueing other costs (e.g., more cost categories, more details about costs, and less obvious costs) may provide only limited relief to the vendor. Profit estimates appear to be sticky and high, and some costs (e.g., promotional costs) can stimulate feelings of unfairness.

The importance of understanding the reference points used by consumers to judge price fairness should be self-evident not only to marketers who develop pricing strategy but also to consumer researchers interested in purchase satisfaction and consumer welfare.

 

THE STRUCTURE OF CONSUMER KNOWLEDGE FOR AUTOMOBILE PRICES: ESTIMATING AND UPDATING

Kyle B. Murray, University of Alberta

Norman R. Brown, University of Alberta

The marketing literature provides strong empirical support for the theory that consumers use an internal reference price (IRP) as a standard against which observed prices are compared (Kalyanaram and Winer 1995). Specifically, a price is judged positively when the IRP is above the observed price and negatively when the observed price is greater than the IRP. As the internal reference price for a product increases relative to the observed price for that product, the demand curve for that product shifts outward and the probability of purchase increases (Putler 1992). In total, the evidence from pricing research, argues persuasively for the fundamental role of internal reference prices in consumer judgement and decision making. Unfortunately, although the importance of IRPs has been well established, the process by which internal reference prices are formed and updated remains unclear.

This paper argues for a new perspective in investigations of internal reference prices. We contend that while IRPs have historically been experimentally operationalized as price estimates, researchers in marketing have failed to explicitly study internal reference prices as estimates. Instead, attention has been focused on issues of perception (Niedrich, Sharman and Wedell, 2001). We believe that focusing on internal reference prices as estimates provides a more coherent and grounded methodological and theoretical framework, which will ultimately prove to be a more fruitful approach to understanding the formation of IRPs. Building on the foundation provided by the literature in cognitive psychology on quantitative estimation (Brown and Siegler 1993), this paper investigates how consumers form and update internal reference price knowledge. We report the results of two experiments that examine consumers’ internal reference prices for automobiles.

Our theory is relatively simple. In the absence of specific price knowledge, consumers will form an internal reference price by estimating a price for the product in question. Their estimate will be based on inferences drawn from their knowledge of other information, such as an automobile’s brand name and product class membership, which in turn provides the consumer with the metric and mapping knowledge required to generate reasonable price estimates for specific products. It is our expectation that the categorical knowledge that is most accessible for automobiles is the product class and the brand name. We are not suggesting that consumers store specific brand and product class price information, but we do expect that they have strong brand ranking skills and general product class knowledge. Therefore, we expect that consumers’ IRPs will be consistently grouped by product class, and that within each product class the brands will be consistently grouped into distinct price tiers.

In experiment 1, subjects were asked to make price estimates for a total of 18 automobiles from 3 classes and 6 brands. As predicted, the data from the first experiment illustrate a consistent pattern of price estimates based on inferences from more general knowledge about the relationships among brands and between product categories.

The robust nature of this general knowledge structure is evident in the second experiment, as subjects are asked to make price estimates for 21 automobiles (7 brands and 3 classes). Following the seeding methodology developed in the quantitative estimation literature (Brown and Siegler 1993), subjects are asked to make two set of price estimates. The first set of estimates are completed in the same manner as in Experiment 1, and then subjects are exposed to an external reference price (for an automobile that was initially mis-estimated) while they make a second set of estimates for the same 21 vehicles. The results of this study provide strong evidence for a general knowledge structure that is built upon an understanding of the relationships among brands and between product categories. Specifically, we find that while subjects are willing to update their price estimates based on external reference price information, they do not adjust the general organization by product class and by price tier within brand. Even though the second set of estimates are often far less accurate as a result of their strict adherence to this structure.

These results provide preliminary support for the treatment of internal reference prices as another type of quantitative estimate. We find many of the key properties of real world estimation in our data. In addition, we find strong evidence for the central role of categorical knowledge in the estimation process, which in the case of automobiles is manifest in the brand name and the product class. Using this framework allows us to extend our understanding of the process of internal reference price formation, by focusing on the storage and retrieval of price information rather than on the perception of prices themselves.

SELECTED REFERENCES

Bies, Robert J., Thomas M. Tripp, and Margaret A. Neale (1993), "Procedural Fairness and Profit Seeking: The Perceived Legitimacy of Market Exploitation," Journal of Behavioral Decision Making, 6 (Dec), 243-256.

Blinder, Alan S. (1991), "Why Are Prices Sticky? Preliminary Results from an Interview Study," American Economic Review, 81 (May), 89-96.

Brown, Norman R. and Robert S. Siegler (1993), "Metrics and mappings: A framework for understanding real-world quantitative estimation", Psychological Review, 100, 511-534.

Campbell, Margaret C. (1999), "Perceptions of Price Unfairness," Journal of Marketing Research, 36 (May), 187-199.

Estelami, Hooman, Donald R. Lehmann, and Alfred C. Holden (2001), "Macro-Economic Determinants of Consumer Price Knowledge: A Meta-Analysis of Four Decades of Research," International Journal of Research in Marketing, 18 (December), 341-355.

Kahneman, Daniel, Jack L. Knetsch, and Richard H. Thaler (1986a), "Fairness and the Assumptions of Economics," Journal of Business, 59 (Oct), S285-S300.

Kahneman, Daniel, Jack L. Knetsch, and Richard H. Thaler (1986b), "Fairness as a Constraint on Profit Seeking: Entitlements in the Market," American Economic Review, 76 (September), 728-741.

Kalyanaram, Gurumurthy and Russel S. Winer (1995), "Empirical Generalizations From Reference Price Research." Marketing Science, 14, G161-G169.

Martins, Marielza and Kent B. Monroe (1994), "Perceived Price Fairness: A New Look at an Old Construct," in Advances in Consumer Research, Vol. 21, Chris T. Allen and Deborah Roedder John, eds., Provo, UT: Association for Consumer Research, 75-78.

Niedrich, Ronald W., Subhash Sharma, and Douglas H. Wedell (2001), "Reference Price and Price Perceptions: A Comparison of Alternative Models," Journal of Consumer Research, 28 [3], 339-398.

Piron, Robert and Luis Fernandez (1995), "Are Fairness Constraints on Profit-Seeking Important?" Journal of Economic Psychology, 16 (March), 73-96.

Pracejus, John W. and G. Douglas Olsen (in press)"The Role of Brand/Cause Fit in the Effectiveness of Cause-Related Marketing Campaigns" Journal of Business Research

Putler, Daniel S. (1992), "Incorporating Reference Price Effects into a Theory of Consumer Choice," Marketing Science, 11 [3], 287-309.

Sinha, Indrajit and Rajeev Batra (1999), "The Effect of Consumer Price Consciousness on Private Label Purchase," International Journal of Research in Marketing, 16 (September), 237-251.

Varandarajan, P. Rajan and Anil Menon, (1988) "Cause Related Marketing: a Coalignment of Marketing Strategy and Corporate Philanthropy", Journal of Marketing, 52,58-74

Strahilevitz, Michal and John G. Meyers, (1998) "Donations to Charity as Purchase Incentives: How Well They Work May Depend on What You Are Trying to Sell", Journal of Consumer Research, 24 (March), 434-446

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