Overpredicting and Underprofiting in Pricing Decisions

This research examines sellers’ price-setting behavior and discovers a naturally occurring mismatch between sellers and buyers: Sellers who make a price decision often consider alternative prices and engage in the joint evaluation mode, whereas buyers who make a purchase decision see only the finally set price and are in the single evaluation mode. This mismatch in evaluation modes leads sellers to overpredict buyers’ price sensitivity and underprice their products. However, these effects apply only to products unfamiliar to buyers and without salient reference prices and can be alleviated if sellers are encouraged to mimic single evaluation when making pricing decisions. These propositions are empirically tested and verified. Copyright © 2011 John Wiley & Sons, Ltd. Suppose that a seller introduces a new product to the market — for example, a new board game, and seeks to set a price so that he or she can maximize his or her profit. Suppose also that the seller has his or her exclusive channel to sell the product, and the product can only be sold at the price he or she sets. Will the price the seller sets be profit maximizing? If not, will it be too high or too low? Whereas there is a large behavioral literature on how consumers make purchase decisions, less is known about how sellers make price decisions (see Liu & Soman, 2009 for a review). In this research, we examine how sellers set prices and explore when the prices they set fail to maximize profit. In what follows, we first propose that sellers and buyers are naturally in different evaluation modes. Second, we demonstrate that the difference in evaluation modes can lead sellers to underprice their product and compromise their revenue or their profit. Third, we show that this underpricing effect occurs only for new and unfamiliar products and not for familiar products. Of these three sets of findings, the first one (different evaluation modes between sellers and buyers) is, to the best of our knowledge, a new discovery; the other two findings (the underpricing effect and the familiarity effect) are based on yet extended from the attribute evaluability and the projection-bias literatures.