Important price sensitivity issues
Posted on 16 June 2014
How do I have to price my products? Take advantage of the following important price sensitivity issues which I think are important to take into consideration.
Price sensitivity deals with the consumer’s sensitivity to price changes and is important for strategic decisions. Price has a significant influence on the behavior of consumers and consequently on firm revenues and profits. In general, price sensitivity is analyzed by the slope of the demand curve or by the price elasticity of demand (Kaul & Wittink, 1995, p. 151). In my article we will use price elasticity, since it is not sensitive to the units of measurement and is often used in the field of microeconomics, and we will focus on describing the factors which influence price elasticity. It measures the percentage change in demanded quantity due to one percent price change ceteris paribus. When the price elasticity is larger than one, the demand will be price elastic. When the price elasticity is smaller than one the demand will be price inelastic. Basically, in the first case demand is sensitive to price changes and in the second case it is not.
Furthermore, the so-called price thresholds and reference price are important to take into account. “Consumers with low thresholds for price changes are more sensitive to price changes than consumers with high thresholds. The reference price is based on the past pricing activity of a product and is stored in the consumer’s memory. This reference price is used as a point of comparison for future purchases (Han, Gumpta & Lehmann, 2001, p. 436). When a consumer encounters a brand at a price lower than its reference price, it is perceived as a gain. On the contrary, a higher price than the reference price is perceived as a loss (Han, Gumpta & Lehmann, 2001, p. 437). Generally, consumers react more negatively to losses than they do positively to gains which is called Prospect Theory in Psychology and Marketing (Kalyanaram & Little, 1994, p. 410).
Several studies show that minor changes in price do not have any significant impact on consumer behavior. The consumer has to feel a gap between the reference price and the advertised price, which is called the zone of indifference around the reference price. Unless the price gap is large enough, consumers will not experience any positive or negative utility (in microeconomics: marginal utility).
According the 3C’s framework we can distinguish three factors that affect the aforementioned price thresholds. Competitive factors, the price level of product A significantly depends on the price level of product B which is a substitute of product A. Promotional discounts offered by competing brands are important to take into account as well. If a competing brand offers a larger discount, consumers will be likely to be less sensitive to the initial product. As mentioned before, the perceived gain on the large discount brand is larger than the perceived gain on the initial product. Therefore, competing brand discounting strongly influences consumers’ price sensitivity and their price threshold (Han, Gumpta & Lehmann, 2001, p. 443).
Secondly, company factors deal with the consumers’ perception about the product price based on its historical pattern. According to experiment of Mazumdar and Jun (1992), price volatility widens the gap between the threshold for loss and the reference price. However, this is not the case for the gap between the threshold for gain and the reference price. In general, price volatility increases the width of price acceptance (Han, Gumpta & Lehmann, 2001, p. 443).
Last but not least, consumer factors: each consumer has his/her own intrinsic sensitivity which can be consumer-specific (deal proneness), brand-specific and time-specific (discounting occasions). Therefore, thresholds vary by brands, consumers, and time (Han, Gumpta & Lehmann, 2001, p. 443).