United States consumers are exposed to the ubiquitous presence of permanent deals, whereby the seller posts the ‘original’, higher price and the less expensive, current sales price.
But the deal can be an illusion, says Professor Richard Staelin of Duke University’s Fuqua School of Business. In the paper, “Competition and the Regulation of Fictitious Pricing” published in the Journal of Marketing, Staelin and co-authors write that original prices are often “puffery.”
The researchers refer to the practice as “fictitious reference pricing.” They note the practice proliferated after the 1970s, when the US Federal Trade Commission (FTC) stopped enforcing its own rules, under the assumption that competition and rational consumers would monitor the market and weed out dishonest behavior. The researchers say the misleading pricing practice has now become the status quo.
“The sellers frame the purchase opportunity as a 'deal,' and this seems to provide the consumer an extra utility, a kind of joy for the realized savings,” Staelin said. “If the consumer had known that the reference price was not the true price, the individual may not have bought the product.”
In a 2018 paper, Staelin and co-authors showed competing firms have an incentive to perpetuate the practice of posting fictitious reference prices because it not only drives up their sales, but also reduces the chances that the firms actually get into a price competition driving down actual sales prices. Importantly, this tendency increases as the marketplace becomes more competitive, a finding that directly contradicts one of the FTC’s reasons for no longer enforcing its reference pricing rules.
“Under certain sets of assumptions—and without regulation—firms are incentivized to lie on the listed reference price whenever they put the item on sale,” Staelin said. “So the question is, if you give consumers additional relevant pricing information, will they make a different purchasing choice and will this in turn change firm behavior? And the answers are ‘yes’ and ‘yes.’”
Staelin says the solution is to require firms—if they want to claim the item is on sale—to display the True Natural Price (TNP), the actual price charged prior to the promotion.
Companies would still be free to post higher reference prices, Staelin says, but they would also be required to prominently display the item’s “most consistent price during the most recent business period.”
Staelin gives the example of an ad that shows a sofa on sale for $599, with an original price of $1399. With TNP, a disclaimer might read, “Legal disclosure: In the past six months, customers paid an average price of $621 for this item at this store.”
“TNP would be easily verifiable through company records,” Staelin notes. “If a consumer thinks the TNP is fictitious, he can sue and ask the company to prove it.”
The researchers tested the impact of the true price disclosure in an experiment with 900 participants, who were incentivized to respond honestly by the chance to either win the product or its cash equivalent. They showed them a high-quality tote bag that was on sale, in some cases displaying the TNP, and asked them to choose whether or not to buy it. The results showed that once TNP is disclosed, customers are no longer affected by the original price, and instead judge the size of the deal based on the true price.
The researchers also interviewed 12 senior executives of major retail corporations and asked their opinion about the proposed solution.
One group of executives liked the idea, Staelin said, out of concern for the reputational effects on the brand’s equity of being almost continually on sale.
“But another group rejected it. They said, ‘No way, this is how we make our money,’” Staelin said. “They're constantly giving deals to get people into the store, and the margins are getting thin. They don’t like it, but they are caught in what we call a prisoner's dilemma.”
Staelin concluded that contrary to the FTC’s assumptions, the market can’t regulate itself when it comes to misleading prices.
“So, we're left with one of three options, just ignore the violations now present in the marketplace, enforce the existing regulations or provide information that impacts consumer behavior,” Staelin said. “Our preferred solution is to provide consumers with our True Natural Price.”