One of the factors retailers must consider while determining their pricing strategy is customers’ internal reference price or the price that they expect based on previous shopping experiences. Customers’ IRP for the same product differs across formats because of differences in the price-image of formats. Therefore, retailers should focus on lower prices and value for money in low-price image formats, and on value-addition through service and wider assortments in high-price image formats.
An important concept in pricing and sales promotion research is the internal reference price. It is well established that price has a disproportionately high influence when shoppers are making purchase decisions. It thus becomes imperative for retailers to carefully arrive at their pricing strategy. Pricing, in turn, is impacted by the customer’s perception of price levels. However, across multiple retail formats, it is not known how this perception of price affects behaviour. Therefore, a study looked at internal reference price across two retail formats—discount stores and supermarkets—to determine if and how price perception affects purchase choice.
Internal reference price (IRP) implies a price expectation based on previous shopping experiences. That is, the average price expectation that a customer develops based on the memory of prices encountered during previous shopping trips. For example, if a customer buying detergent of a particular brand always finds the price to be between ₹ 130 and ₹ 140 per kilo, then their IRP for that detergent is ₹ 135 per kilo.
The study found that customers respond to prices differently based on the store format. Their IRP for the same product is lower when shopping at a discount store than when shopping at a supermarket. For example, their IRP for a 5 kg bag of flour could be ₹ 175 for a discount store, but ₹ 200 for a supermarket.
This difference in IRP is in response to the different price images of the two formats. Customers have a low-price image of discount stores and a high-price image of supermarkets. They adjust their price expectations for the same product based on these price images. So, they might find the same product at the same price to be a good buy at a supermarket but too expensive at a discount store. Some retailers play with this perception by having staple purchases like wheat flour at low prices to signal a low-price image for the store. However, they may jack up prices on other items to make up for the lower margins on the staples.
IRP affects purchase choices based on whether customers tend to be loss-averse or gain-seeking while shopping. In this context, consumers perceive a loss if actual price is higher than IRP, and if actual price is lower than IRP, they perceive a gain. Customers are loss-averse if their purchase choices are affected more by perceived loss, and gain-seeking if their purchase choices are affected more by perceived gain. In discount stores, customers are loss-averse, while in supermarkets, they are gain-seeking. Given their different IRPs for the two formats, the same price for a product could be seen as causing a loss in a discount store (which would discourage them from buying the product) but a gain in a supermarket (which would encourage them to buy the product).
This study has implications for pricing strategy for retailers, especially those planning to have, or having, multiple formats. It is critical to consider price image when setting prices for various products. The most important factors for customers to buy from low-price image formats are low prices and value for money. On the other hand, in higher-price image formats, customers look for wider assortments and better service levels, and are willing to pay a higher price for the same products. Retailers need to adjust their pricing strategy for various formats based on customer behaviour and combine pricing with other factors like discounts, assortment, and service (depending on format) to maximise sales.