Sangman Han, Sunil Gupta, and Donald R. Lehmann

Of all the tools available to marketers, none is more powerful than price. Price has a significant influence on consumers' purchase behavior and consequently on firm sales and profits. It is therefore not surprising that price promotion has become an increasingly large fraction of the marketing budget and an almost ubiquitous aspect of consumer choice. In fact, consumers may be both conditioned to expect deals and desensitized to small ones. As a consequence, changes from a base or reference price are likely to have an impact only when the price change is above a threshold.

The purpose of this article is to explore the existence and magnitude of price thresholds and the factors that influence these thresholds. We allow price thresholds to be probabilistic and be influenced by company, competitor and consumer factors. These thresholds capture consumer insensitivity to small changes in price, or the zone of price indifference. We also allow the thresholds to be asymmetric for price decreases (or gains) and price increases (or losses).

The proposed model and three competing models were estimated on scanner panel data for coffee purchases. The proposed model fits the data better than competing models. Our results show that contrary to prospect theory the impact of price increases and decreases are approximately equal once the threshold is reached. Therefore the findings that losses loom larger than gains may be due to differences in the size of thresholds. We also find that own-price volatility increases the threshold for loss. In other words, with greater uncertainty in prices due to, say, frequent price promotions, consumers tolerate larger deviations (losses) from their reference prices. However, own-price volatility decreases consumers' threshold for gain, thereby making them more sensitive to small deviations (gains) in prices from their reference prices. These results suggest that frequent discounting may increase consumers' price sensitivity in the long run.

Our results also show that discounting by competing brands does not have a significant effect on the threshold for gain, but it significantly decreases the threshold for loss. In other words, while consumers feel a significant loss or disappointment toward a target brand if competing brands offer substantial discounts, they do not perceive any gain toward a target brand if competing brands are not discounting.

The asymmetric results for own-price volatility and competitive brands discounting are interesting. These results suggest that consumers are more sensitive to the loss (with respect to reference price of a brand) when competing brands are offering larger discounts. At the same time, consumers appear to be more sensitive to gain as the price volatility of the target brand increases. Put together, these findings suggest a dual role of price promotions increase sensitivity to gain for own brand, and also increase sensitivity to loss for competing brands. If all brands have a similar effect, this can lead to increasing price promotion, a phenomenon that we observe in the market place.

In addition to providing a better understanding of consumer purchase process, our model offers useful guidelines to managers for segmentation and assessing the power of their brands. Thresholds for gains and losses provide a measure of the price gap (between reference price and shelf price) that is needed to impact consumer choice. One way to segment consumers is based on their thresholds. Consumers with large thresholds arc less price sensitive than consumers with relatively small thresholds. Similarly a comparison of threshold sizes for different brands provides an interesting measure of relative power or effectiveness of the price promotions of different brands. Brands with a small threshold for gain need offer only a small discount to realize significant effects on consumer choice behavior. In other words, these brands have high leverage. Similarly, brands with a large threshold for losses have latitude in raising prices or high resistance.

In sum, we proposed and illustrated a simple model that includes probabilistic thresholds for gains and losses with respect to reference price of a brand. This model fits the data better than the existing models, provides better understanding of consumer purchase behavior, and offers useful insights for brand managers.