Relative Price

I was at Best Buy stores the other day and was looking at their cables. I was surprised to see HDMI cables being sold for $40-$80. Even a simple DVI to HDMI converter, which is useless without a cable, was priced at $30.  The same cables  from non-name brands are priced at fraction of the price online. In fact a quick search in the Internet shows stories since 2006 taking about  alleged “price gouging.

I do not believe price gouging exists in a free market where customers have options and are allowed to make their own choice.  But what explains the high price of these cables? It is the price  flat screen TVs.

The first reason is the relative price that is rooted in behavioral economics. To a consumer buying this TV (or having bought one), compared to the price the pay or TVs, the price of cables look cheap. Consumers tend to think of price they pay in terms of percentages and not absolutes. This is the relative price. For a crisper description see this.  $40 is a small percentage of $1000.

The second reason is the increase in reference price, which is the price a customer expects to pay based on their past experience. Having just paid $1000, customers are anchored to this price and are willing to pay $40-$80 on cables for these TVs.

Conveniently,  Best Buy only stocks cables $40 or more taking advantage of these factors at work. However, Amazon.com stocks cables of every possible price. In fact for the TVs Amazon says, “customers also bought $6 HDMI cables”. Here even though customers might be willing to pay high price for cables, the presence of cheaper options decreases  their reference price.

If you are a marketer, it is obvious what you should do with pricing. Price your complements as a percentage of the price of the primary component. Due to relative price and reference price effects, your customers will not mind paying high price for the complements.

If you are a buyer, be aware of relative price effects. The price you pay for accessories and complements should be looked at in isolation and not relative to the price of the primary component. In a consumer setup this can be handled by separating the two purchases in time. In a B2B set up, it can handled by having separate purchasing managers responsible for the primary component and secondary parts purchases.

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