Reference Point

Reference Point

In prospect theory, value is felt as a change from a reference point rather than as an absolute state. Move the reference point and the same outcome becomes a gain or a loss without anything real changing. Most pricing psychology is reference-point manipulation, and anchoring is the case where the reference point is a number presented to you.

What it is

Daniel Kahneman and Amos Tversky set it out in 1979 as one of the tenets of prospect theory. People do not evaluate outcomes against their total wealth, which is what standard economics assumed; they evaluate them against a starting point, and the starting point is supplied by whatever the situation makes salient.

The everyday demonstration is the discount. A grill reduced from three hundred and fifty to two hundred and fifty attracts more buyers than the same grill at two hundred and forty reduced from two hundred and fifty. People pay ten dollars more for the larger discount, because the reference point rather than the price is what the pleasure is measured against. Richard Thaler's work on mental accounting supplies the machinery for that, in which the satisfaction of the deal exists separately from the value of the thing bought.

In effect

The struck-through price on a tag exists to install a reference point. So does the recommended retail price, the was-price in a sale, the first offer in a negotiation and the highest tier on a pricing page. In each case the seller is not describing the product, they are setting the point from which the buyer will feel the difference.

This is also why a price rise and a withdrawn discount feel different to a customer while costing them the same amount. One is a loss measured from the current reference point; the other is a smaller gain. The arithmetic is identical and the experience is not.

What it does not say

It does not say the reference point is arbitrary or infinitely movable. People carry expectations from past prices, competitor prices and their sense of what something costs to make, and Lisa Bolton, Luk Warlop and Joseph Alba found that consumers tend to believe selling prices are substantially higher than fair prices, with attempts to correct that belief only modestly effective.

It does not license the claim that any manipulation of the reference point will work. The evidence that a number moves a purchase is strongest when the number reads as a plausible price, which is the condition established for anchoring by Sugden, Zheng and Zizzo.

Sources

  1. Kahneman, D., & Tversky, A. (1979). Prospect theory: An analysis of decision under risk. Econometrica, 47(2), 263-291.
  2. Thaler, R. H. (1980). Toward a positive theory of consumer choice. Journal of Economic Behavior and Organization, 1(1), 39-60. doi:10.1016/0167-2681(80)90051-7
  3. Bolton, L. E., Warlop, L., & Alba, J. W. (2003). Consumer perceptions of price (un)fairness. Journal of Consumer Research, 29(4), 474-491. doi:10.1086/346244
  4. Sugden, R., Zheng, J., & Zizzo, D. J. (2013). doi:10.1016/j.joep.2013.06.008
  5. The grill and clock-radio scenarios that circulate in popular marketing books are adapted from Thaler's mental accounting work, which this publication records on the [[Mental Accounting]] note.
  6. Where this came from
  7. One book in this library carries this concept. A concept resting on a single popular retelling is roughly twice as likely to be contested, mixed or unverified as one two or more books carry, so treat it as unchecked until it has been taken to a primary source.