Pricing and Fairness: Do Your Customers Assume You Are Gouging Them?
The recent cascade of corporate scandals -- WorldCom, Enron, Adelphia Communications, Global Crossing -- may have shaken many people's faith in corporate America. Yet it's easy to find others who will tell you they take rampant industry greed as a given. Some people are convinced, for example, that pharmaceutical companies make obscenely high profits on patent-protected drugs, that gasoline prices are exorbitant and determined more by industry collusion than market forces, that restaurants gouge patrons by selling wine at exorbitant prices.
The prevalence of such beliefs -- regardless of their validity -- led Wharton marketing professor Lisa Bolton and two fellow researchers to wonder if, in fact, U.S. consumers believe they get a fair shake from the businesses they regularly patronize, whether they are buying designer coats, frozen dinners, or DVD players. Moreover, how thorough is the average consumers' understanding of the American capitalist marketplace? The researchers -- Bolton, marketing professor Joseph Alba of the University of Florida, and business professor Luk Warlop of Katholieke Universiteit, Leuven -- describe the results of their experiments in a new paper, "Consumer Perceptions of Price (Un)Fairness." The paper is forthcoming in the Journal of Consumer Research. Bolton concludes that "there is a general perception that prices are unfair, and that companies -- not just retailers, but firms in general -- make a lot of profit." The study, she says, points to a gap between how customers think and how managers think, a gap which managers should acknowledge if they want to give customers a sense of being treated equitably.
In a series of 10 experiments, the authors presented 1,100 college students with various pricing scenarios. For example, respondents were asked to consider the past price of a polo shirt and to judge if the current higher price was fair. They also considered the price of a pint of ice cream at a grocery store and one at a convenience store. In other experiments, participants made judgments and assessed price fairness about clothing at a department store and a discount store. They were invited to guess at probable prices, cost of goods sold, other costs, and profits.
Besides assessing participants' thoughts and feelings about pricing, the researchers wanted to see if providing information about a store's costs or advantages might alter judgments of fair pricing. They presented different versions of the same question, for example including a phrase like, "You notice the department store has more selection and service and a pleasanter in-store environment." Some questions made reference to retail considerations such as labor, rent, maintenance, high-fashion inventory, administration, and promotion. Says Bolton, "We tried cueing various costs; we focused a lot on labor since it's such an obvious big one. We did one experiment where we looked at markdowns and rent -- less obvious costs -- to see if reminding people of other costs incurred by the firm would improve their perceptions of price fairness."
The findings suggested to the researchers that shoppers do tend to believe prices are unfair. Participants routinely assumed that companies gouge customers and reap large profits (estimated at around 30% across the survey). They tended to attribute store price differences to pure profit rather than to costs or business strategy choices. They systematically underestimated the effects of inflation -- even when provided with explicit inflation rates, current prices, and historical data -- and frequently ignored cost categories other than the cost of goods sold. High prices arising from high quality seemed fair, but high prices arising for other strategic reasons, such as margin strategy or inventory risk, were seen as less fair.
Bolton and her colleagues also found these perceptions very "sticky," i.e., hard to change. Even when they introduced cues into questions specially designed to remind or educate consumers about a store's costs or benefits, they could achieve only a "modest impact" on consumer's opinions.
To Bolton, the study results were rather unexpected. "We did go in with the idea that people might feel prices are unfair," she says, "but it was surprising how hard it was to correct those perceptions. And these are college students who might be expected to have a better understanding of the marketplace and price considerations -- such as inflation, costs, profits, and pricing -- than the general public."
To check their findings against a broader population sample, Bolton and her colleagues included an experiment in which 3,500 residents of Florida were surveyed by phone. Respondents answered a question about profits and fair prices for several familiar store types and products. The researchers found the responses similar to the college students', describing the respondents' intuition about pricing as "mostly bad." For example, consumers assumed that grocery store profits were around 27%. (According to the Food Marketing Institute in 2001, the average grocery store profit is about 1-2%.) The people surveyed also assumed that the markup for a clothing item at a department store approached 100% of cost (around $76 for a $40 item.) Their own proposed fair price was around $58. Notably, though, this price rose a bit, to nearly $63, when researchers supplied information about the store's labor and rent costs.
While providing information about a store's various costs did not greatly change pricing perceptions, it did change them a little, suggesting this might be an area for adventurous marketers to exploit. Bolton notes that firms come up with creative ideas to educate customers about their cost structure. "We've seen the drug companies try to do that by advertising their large research costs. Maybe there are [other approaches] -- emphasizing customer service costs in positive ways, for example -- that would help higher-price retailers compared to the discounters." However, such an approach would have to be done delicately. Bolton asserts that many executives would first have to conquer their "managerial bias." "A manager in the company is so familiar with the issues that contribute to pricing, that he or she can forget the man on the street isn't. What a manager thinks is a perfectly fair cost or pricing strategy, a consumer won't necessarily agree."
And some costs are probably best kept out of the spotlight altogether. To take the most obvious example, Bolton says, "educating consumers about the large bonuses paid to a firm's senior executives seems unlikely to improve consumer perceptions of price fairness." And emphasizing promotional costs seems unlikely to cut any ice with consumers either, as the researchers found through the study. This seems to make common sense. Imagine, says Bolton, if a company like Nike were to advertise that it bases its sneaker prices partly on a need to spend huge sums on promotion.
Another experiment conducted by the researchers throws into question some conventional wisdom about customer loyalty and relationship marketing. It involved how price fairness perceptions are affected when a consumer purchases multiple items or services over time. According to Bolton, the accepted belief is that companies can charge a higher price with long-time customers because they're less price sensitive. But the study showed that fairness ratings actually declined from a single transaction to multiple transactions. "What's fair when it's a one-shot purchase gets perceived as less fair when you're purchasing it multiple times. Perhaps over time it starts to emphasize to the customer how much money the company is making off them."
All materials copyright of the Wharton School of the University of Pennsylvania, © 2002.