How Reference Prices Shape Negotiation Outcomes

Have you ever walked into a store and noticed a product with two distinct prices—one struck out and another displayed as a discount? This practice, known as reference pricing, is a common tactic used by retailers to influence consumer perceptions and boost sales. But does this pricing tactic really influence a customer’s decision to buy?

Research suggests that a higher reference price makes the discounted price appear more attractive, thereby increasing the likelihood of purchase. But how does this initial perceived discount (IPD) influence consumers' decisions when prices can be negotiated? How does it affect the ultimate discount, demand, and overall revenue for the retailer?

Impact of reference prices on negotiated discounts 

In my study, Perceived Versus Negotiated Discounts: The Role of Advertised Reference Prices in Price Negotiations, published in the Journal of Marketing Research, I analysed data from a large durable goods manufacturer in the US where the retailer displays two different prices on all its products. The purpose was to understand the correlation between the prices consumers pay and the reference prices displayed to them.

The findings revealed a positive correlation between the reference price and the final price consumers paid. In simpler terms, when the reference price was higher, consumers tended to pay more, even when negotiations were possible. This happens because consumers, believing they are already getting a great deal, negotiate less aggressively. 

Why do consumers negotiate less? 

There’s a common assumption that as prices rise, the likelihood of purchase decreases. However, the data set only focused on customers who made purchases, so we couldn't assess how many people chose not to buy because they perceived the price as too high. To explore this further, I conducted a lab experiment where participants negotiated prices on various products, and I intentionally varied the reference prices across different groups. This allowed me to observe the causal effects of reference prices on both purchase likelihood and the negotiated prices.

The lab experiment mirrored the field data: as reference prices increased, so did the prices consumers paid. Specifically, for every $1 increase in the reference price, the negotiated discount dropped by 5.7 cents. Interestingly, 55% of this reduction was because of a lower likelihood of initiating a negotiation, while the rest was because consumers were not negotiating a big enough discount.

Even when consumers negotiated, they still ended up paying more. As reference prices rose, not only did fewer people negotiate, but those who did, paid a higher price compared to those negotiating at lower reference prices.

Simply put, when the initial perceived discount is larger, consumers are less likely to feel the need to haggle over the price.

The findings also highlighted a significant distinction between fixed pricing and bargaining situations. Under bargaining, about one-third of the revenue increase from a higher IPD comes from the rise in negotiated prices. This contrasts with fixed pricing, where a higher IPD only affects revenue through changes in demand.