Applying the peak-end rule to reference prices

Purpose - The objective of this paper is to propose and empirically test a potential mechanism for how consumers form reference prices. The proposed peak-end rule of reference price formation says that reference prices are formed as a weighted average of the highest observed price and the most recent price. Design/methodology/approach - The authors argue why the peak-end rule observed in satisfaction contexts may also apply to the process by which consumers form reference prices. They then test the proposed peak-end rule using IRI scanner panel data for decaffeinated coffee. Findings - Fit and predictive validity of a choice model improves when a reference price term based on the peak-end rule is added. While the most recent price has a greater impact on reference price, the effect of the highest observed peak price is also significant, managerially and statistically. Research limitations/implications - The study provides evidence for a novel and behaviorally plausible reference price formation process. Practical implications - Temporarily charging a high price has a longer-lasting effect on reference price than would be suggested by other reference price models, which typically involve a quickly decaying lag effect. Temporarily charging a very high price to restore the reference price may therefore be a useful pricing tactic. Originality/value - While the peak-end rule is amply supported as a mechanism by which consumers form global satisfaction judgements, its application to reference price formation is novel, and has some potentially useful implications.