Pure economic theory may recommend a price that would be perceived as unethical by customers. Using such a price could be very damaging to a company. As Amartya Sen said, “The purely economic man is indeed close to being a social moron.”
What Might be Considered Unethical?
Here is a list of pricing actions that might be considered unethical by your customers or society.
Inconsistent with Recent Transactions
Recent prices are a strong anchor and reference point for customers from which they judge fairness. That reference point may be so strong that it’s perceived as an entitlement. Changing prices is perceived as unethically changing the rules. This is especially true when a company starts charging for something that used to be free.
Charging Different Prices Unless There is a Cost Different
Some consider it unethical to charge different prices unless there is a cost difference. These people would not allow different prices to different customers who value a product differently. Even people who believe this may not apply it to some groups like senior discounts. Society tends to identify some groups as worthy of receiving better prices than the general public.
Companies can easily calculate costs, but customers’ perceptions of costs judge fairness. A company that charges different prices for a product may need to explain why different costs drive different prices. For example, a company’s operating costs are higher in some markets than others. The cost difference may be on the customer side. A company may give a customer a discount if that customer has higher transaction or conversion costs for the product.
Charging Different Prices Unless There is a Value Difference
Others say it’s unethical to charge different prices unless there is a value difference and the value the customer receives is greater than the price. You could think of this as value-based pricing with a cap. The cap is the customer’s perceived value.
That was the cap I used in my images on how to set prices with value-based pricing. Logic would say customers wouldn’t pay more than the value they received. For reasons I list below, some would say that a company can force customers to pay more than the value received. What’s tricky is that everyone values things differently, so companies have to make estimates of perceived value.
Disparities in Power
This may be in the form of coercion, whether explicit or implicit. After agreeing to buy a new car, some people may feel trapped in the car dealer’s finance and insurance office while they are subjected to multiple upsells of loans and insurance products.
The disparity in power may be from different levels of information. Sellers usually have more information about the product than the buyer. Some transactions (e.g., real estate) require lengthy disclosure by law. Other transactions don’t have legal requirements, but not disclosing them would be seen as unethical (e.g., lemon cars).
Another disparity arises from different levels of understanding of the economics of the transaction. Consumer loans have much more legally required disclosures than commercial loans.
In all these scenarios, companies must make efforts to avoid being perceived as taking profits at a vulnerable customer’s expense. Providing customers with education, especially about their rights, and reasonable return policies can increase both real and perceived fairness.
Takes Advantage of Essential Needs
Companies should not take advantage of people’s essential needs, especially during adversity. An example is price gouging for gas before a hurricane or during a gas shortage. Another example is high drug prices.
Especially in the gas example, the economic theory of supply and demand would say prices should greatly increase. That’s not going to fly with customers and in the press when vulnerable people are hurting.
A study asked participants if it would be acceptable or unfair for a hardware store to raise the price of a snow shovel from $15 to $20 after a large snowstorm. When they asked MBA students, 76% said this was acceptable. 24% said this was unfair. If their responses shocked you, you may be a regular (i.e., a non-MBA) person. 82% of regular people said this was unfair, and 18% said it was acceptable.
This is called theory-induced blindness. Finance, accounting, and business people are susceptible to this.
People agree companies need to make money to survive, but exceptionally high prices are suspect. These companies may be seen as taking advantage of people, especially those with the least income to pay high prices.
An industry that’s very vulnerable to this is the oil industry. People are very price-sensitive to gas prices. Companies in this industry may be making record profits while consumers are being crushed by high inflation. These companies have to tread lightly in their earnings press releases.
What’s “fair” versus “excessive” is very subjective. It may not be objective but rather varies with perceptions of the overall company. In this case, brand marketing helps avoid unfair pricing allegations.
Varying Levels of Access to Goods
Society judges that some goods should be available to all. These are often basic needs like food, clothing, and shelter. Available doesn’t mean free, but an option must be available for those of limited income.
Medical care is an area where concerns about this are very prevalent. For example, a person may have a condition for which their doctor recommends a procedure or medication. Unfortunately, the patient’s insurance doesn’t cover it, or the patient doesn’t have insurance. The patient can still receive the procedure or medication, but they will have to pay a very high price for it. A wealthy person can afford this, but many can’t.
Medical care is perceived by many to be a right, but there are wide ranges of what people have to pay. Those prices are beyond some patients’ ability to pay.
Here’s another short case study. I was the CFO of a health clinic system that had a sliding fee scale for patients without health insurance. The prices those patients paid were based on their income. Patients with lower incomes paid less for their treatment than those who had higher incomes and could probably pay more. Each patient paid a different amount based on their income, but all patients paid based on the same pricing policy.
Note that the sliding scale was a discount from the standard price, not a premium based on a low price. This is seen as more fair. I’ll talk more about this later.
Some may contend that sliding fee scales are unfair. They see the patients’ low income arising from choices made by the patient. Some people who work are unhappy that they pay taxes to pay for the medical care of those who don’t work. The fairness of the pricing is based on the perceived worthiness of the recipient for a discount.
For all the aspects of fairness that I’ve covered in this lesson, companies must decide the issues based on the perceptions and responses of their customers, employees, community, and other stakeholders.
Discounts and Surcharges
Discounts and rewards are almost always perceived as fairer than surcharges. Customers use the list price as a reference point. Pricing above this is perceived by the customer as a loss. Losses are perceived to be much more painful than similar-sized gains.
Reference points are very important. Assume you’re making $50,000 per year. I then bump up your base pay by $1,000. Six months later, I cut your base pay back down $1,000. Would the pay cut hurt more than the happiness you had from the raise?
Here’s another way to think about it. Imagine your job satisfaction the day before the raise versus the day after your pay cut. Would they be the same? Why not? You’re making $50,000 on both days.
A study was conducted on whether people thought certain pricing tactics were fair or unfair.
Here’s the first scenario: a shortage develops for a popular car model. A dealer has been selling them at the list price and now prices them $200 above the list price. Did people think this was fair? No. 29% said it was acceptable, and 71% said it was unfair.
Now, another scenario: a shortage develops for a popular car model. A dealer has been selling them at a discount of $200 and now prices them at the list price. What did people think of this? It wasn’t overwhelming, but a majority said this was acceptable. 58% said it was acceptable, and 42% said it was unfair. That’s a big improvement over scenario one.
Here’s the takeaway: Establish the highest price you intend to charge as the regular price, with any deviations as sales or discounts.
You can take discounting too far. Consistently offering the same discount can cause the discounted price to become the relevant reference price for customers. In that case, any decrease in the discount will then feel like a surcharge. Decreasing or eliminating the discount may also be perceived as unfair because it’s viewed as increasing the profit of the company at the customer’s expense. They interpret the old discount as one that provided a fair profit, but now the company is getting greedy.
For more info, check out these topics pages: