Disclosing ‘true normal price’ recommended to protect consumers from deceptive pricing

Fifty years ago, the Federal Trade Commission (FTC) stopped enforcing deceptive pricing regulations, assuming that competition would keep retailers honest. Since then, competition has increased significantly — yet the practice of posting false, inflated comparison prices alongside sale prices has continued unchecked. Think of an advertisement from a furniture store that touts a $599 sale price for a couch as an $800 savings from a promoted regular price of $1,399. The problem is that the store may have never offered the couch for sale at the higher price.

This practice, called “fictitious pricing,” is ubiquitous in the retail trade. One recent investigation tracked the prices of 25 major retailers and found that “most stores’ sale prices … are bogus discounts” because the listed regular price is seldom, if ever, the price charged for the products. “Competition and the Regulation of Fictitious Pricing” is forthcoming in the Journal of Marketing from Joe Urbany, professor of marketing at the University of Notre Dame’s Mendoza College of Business, along with Rick Staelin from Duke University and Donald Ngwe, a senior researcher at Microsoft. The paper critically evaluates two assumptions underlying the FTC’s decision to halt deceptive pricing prosecution. The first is that inflated reference prices are largely ignored by consumers, who focus primarily on the sale prices, leading to price competition that pushes selling prices lower and renders reference prices harmless. However, dozens of empirical studies in marketing and psychology reveal that advertised reference prices — even those exaggerated to unrealistic levels — have significant impact on consumer decision-making. This is explained by the natural value that consumers place on getting a good deal, labeled “transaction utility” by Richard Thaler in his Nobel Prize-winning body of work. In contrast to the FTC’s second assumption that competition drives out economic incentives to cheat, a number of recent economic models show the opposite. Competition in fact increases the chance that a firm will offer noisy information in an attempt to shield itself by looking different to customers. As a result, deception is found to be more profitable as competition increases. These are fundamental forces that encourage the use of fictitious pricing. They also explain why state-level regulatory efforts and even a growing number of class action lawsuits have done little to discourage the practice. “There are limits to enforcement by litigation,” Urbany said. “It allows only a relatively small number of meaningful actions in a given time period, leading to limited visibility and impact on widespread practice.” The authors propose instead a disclosure solution in the form of requiring firms that use comparison prices in their sales promotion to additionally post the item’s true normal price (TNP). The TNP is the most frequently offered price for that product in a given period. For example, let’s say a price-promoting furniture retailer actually offers the sofa for sale at $1,399 for the first two weeks in a quarter (making zero sales), and then advertises the sofa on sale at $599, promoting $800 in savings for the other 10 weeks. Under the TNP disclosure proposal, the retailer would need to post $599 as its true normal price for the product in any subsequent sales promotions that included statement of a “regular price.” Through a controlled experiment with 900 participants, the authors found that providing TNP information largely eliminates the effect of an advertised regular price, which otherwise significantly raises the chance a consumer will buy. To gauge the likely response of firms to the TNP disclosure concept, the authors also interviewed a dozen senior retail executives, each with extensive experience in pricing. “Our interviews revealed that some practitioners are very supportive of efforts to rein in what is perceived to be an ‘out-of-control’ promotional environment,” Urbany said. “At the same time, they and others offered more sobering insights about the realities of likely resistance to intervention.” The paper concludes with conjectures about how TNP provision would motivate greater honesty in pricing, likely having an impact on average market prices, promotion frequencies and firm profits. Important research directions are highlighted.