Effect of Reference Price

Toyota Prius, since its introduction, has been the the only real option for hybrid cars. Despite offerings from Ford and Honda, Toyota won the battle for mind share and wallet share. Customers were willing to wait and pay a price premium (that is significantly more than gas only sedans) for Prius.

When gas prices reached record highs, it gave economic rationalization to Prius owners when they got 50 miles per gallon of gas. The gas prices have since come down but even in their highs they only served as rationalization for a purchase that appealed to their emotions about being green.

We do not have scientific study done that will give us the exact price premium people paid for Prius because of their need to be seen green. But we can safely claim that whatever price premium there was, Prius claimed it all because there were no alternatives and hence no reference price.

Since last week that has changed. Honda has introduced a new model of Insight that is priced $4000 lower than Prius. Another option to be seen green and eco-friendly but at a lower cost. Insight gives 41 miles per gallon vs Prius’ 50 which is not economically large enough to justify the $4000 premium at even when gas price reaches $4.5 a gallon.

Now Toyota was reportedly reducing the price of its 2009 and 2010 models to match Insight’s price. That is the power of reference price. A marketer’s ability to capture the value added is always limited by the reference price. The question is, do you want the reference price to be set by others or want to actively drive it so you get to be the price leader?

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