Sales of used light vehicles in the United States came to around 38.6 million units in 2022, according to Statista, with most of those buying decisions ultimately based on price. But what happens when the asking price deviates from the price consumers expect from their personal research, which is increasingly done online?
That’s the dynamic explored in research by Guofang Huang, an assistant professor of management in the marketing area at Purdue University’s Mitchell E. Daniels, Jr. School of Business. The paper, “Estimating expectations-based reference-price effects in the used-car retail market,” was coauthored with Haiyan Liu from the University of South Florida and published in Quantitative Marketing and Economics.
Unlike the standard price effect, which is solely determined by the actual price consumers face, the reference-price effect depends on the deviation of the actual price from consumers’ price expectation. The paper uses a large dataset of daily used-car listings from Cars.com, a leading automobile classified website with an estimated 14.5 million unique visitors in 2016, to identify car buyers' price expectations. Empirically estimating the reference-price effects has been challenging due to researchers’ lack of information on consumers’ price expectations. The paper’s novel idea is to overcome the challenge by identifying a key mass point in consumers’ price expectation for a car as its online list price on the previous day.
Most car buyers today use the internet to search for information on cars. The IHS Automotive Buying Influence Study found that 71% of all car buyers used the internet in their car buying process in 2011, spending about 11 hours online and 6.5 hours offline. “As an influential source of information for car buyers, third-party automobile classified websites have made it much easier for car shoppers to search for information on the cars available at local dealerships,” Huang says. “Through these websites, consumers can view detailed information on cars in local dealers’ inventory, including vehicles’ list prices, and thus form price expectations before they actually visit the dealerships.”
“Our analysis finds that, due to the reference-price effects, an increase in a car's actual price from its previous day’s list price lowers its daily sale probability significantly more than what can be accounted for by the standard price effect,” Huang says. “The magnitude of the reference-price effects is comparable to that of the standard price effect. And importantly, the reference-price effects are significantly stronger for cars with more exposures to prior consumer search.” This is key because information on the relative magnitude of the reference-price effects is necessary for managers and policy makers to appreciate the relevance and importance of these effects on actual pricing strategies and policies.
These findings further suggest that dealers should set higher initial prices for used cars and consider smaller price increases but larger price cuts when responding to inventory fluctuations. Similar changes are likely also appropriate for retailers of other durable goods.
“Car buyers are particularly influenced by price deviations because cars are infrequent purchases and represent a significant financial commitment,” Huang says. “As retailers increase their presence and advertising online, there will be more consumer awareness of prior list prices and stronger reference-price effects. This will lead to more price stickiness in the upward direction and more price flexibility in the downward direction.”
The study’s empirical research strategy is likely applicable in other markets and situations. “It is becoming routine for consumers to research online before making decisions, from purchasing durable goods to choosing restaurants to patronize to shopping at offline stores,” Huang says. “ The expectations that they develop while researching online, be it about prices or service quality, will shape their reference points and the choices they make. Our research shows that the effects of these expectation-based reference points are substantial and need to be taken into account when firms develop their pricing strategies.”
Media Contact: Guofang Huang, huan1259@purdue.edu
