How perceptions of fairness affect prices
The recent case of the Fortis hospital in Gurugram overcharging the parents of a girl who was unsuccessfully treated for dengue, raised serious concerns and outrage. The inquiry report revealed that the hospital had charged margins up to 900% on some non-scheduled drugs and as high as 1,700% on medical consumables. The Times of India reported on 16 December that Fortis charged Rs106 for a three-way stop cock bi-valve with a procurement price of Rs5.77 and Rs200 for a disposable syringe procured for Rs15.29, making margins of 1,737% and 1,208%, respectively.
Defending itself, Fortis stated that no price exceeded the maximum retail price and their billing practice was the same as that adopted by other hospitals. If this is the case, why was there much ado about the Fortis bills?
The sense of outrage expressed over these prices charged for individual items is far greater than the slight murmurs of discontent routinely voiced over the high cost of medical treatment in private hospitals. What, then, causes this sense of outrage? In which situations do we deem high prices acceptable and when do high prices seem unfair?
It is important to point out here that in the entire controversy over the Fortis bills, no objections seem to have been raised over the doctors’ charges or intensive care unit charges. It is the drugs and consumables which have attracted the ire of the public and the authorities. Let us try to understand why this is so.
In many cases, consumers opting for private hospitals as a matter of choice rather than necessity go with the expectation of high- quality standards and hygienic and pleasant ambience, as well as higher standards of service. They accept the high consultation fees of doctors and high charges for rooms which come equipped with every facility. Consumers perceive this value to be greater than that of other hospitals and are willing to pay the differential for the added value.
Even if, in some cases, the difference in actual value delivered is less than the price differential charged, they are willing to pay—as long as the price charged matches or is below their perceived value for the specific product/service.
Consumers thus deem it fair, broadly speaking, for hospitals to charge a high price and make a profit on the services provided by them. But when it comes to consumables, the expectation is that these will be charged at actuals and will not be a tool for profiteering.
Looking at pricing purely from an economic point of view, one would consider only the cost of goods sold and the objective value delivered to the consumer, or, at most, also the perceived value from the point of view of the consumer.
However, taking a purely economic approach does not capture the true picture of a consumer’s response to pricing. Willingness to pay is guided not only by actual or perceived utility derived from the product/service, but also by the perceived fairness of the transaction.
Consumers do not like being taken advantage of. While they evaluate the quantum of their own benefit, consumers are also sensitive to a firm’s cost of goods sold and will be reluctant to pay for products they perceive to be overpriced relative to cost.
Various studies have indicated that consumers accept that a firm is entitled to make profits. If a firm faces a cost increase, most consumers are likely to accept an increase in price charged by the firm, provided the higher costs pertain directly to the transaction.
A study on rented accommodation, Fairness As A Constraint On Profit Seeking, published by Daniel Kahneman, Jack Knetsch and Richard Thaler in The American Economic Review (1986), found that consumers perceived it as unfair if a landlord raised rentals to make up for the loss of another source of income. On the other hand, the majority of respondents found it acceptable for a higher rent to be charged for apartments in one of two otherwise identical buildings because that particular building had a costlier foundation according to the landlord.
So while consumers are willing to concede a firm’s quest for profit, any action that deliberately exploits the special dependence of the consumer is likely to be found offensive. In the case of the Fortis billing, it is not so much the absolute amount of money paid but the sense of exploitation which is the most damaging. To many patients going to such hospitals and paying high bills, the absolute value of Rs200 for a syringe is no cause for concern. However, the fact that the firm actually has a margin of over 1,000% makes it seem rampantly unfair, and so decreases willingness to accept the pricing.
Similarly, the testing of a Coke vending machine, which could raise the price of the Coke when outside temperature increased, led to a negative backlash from the press and public in 1999—taking advantage of the consumer’s thirst and discomfort in hot weather was perceived as exploitative.
The nature of the product or service also plays a role in determining the unfairness of a transaction. For luxury goods or entertainment services, the cost of goods sold may not play a significant role in influencing consumers’ perception of fairness, but, in the case of necessities, sensitivity to the sellers’ costs becomes very high.
Management theorists have pointed out that fair behaviour is one of the key factors leading to maximization of profits in the long run. If a customer suspects unfair treatment, she is not likely to stay with the firm. If there are no viable alternatives or all others behave similarly, firms may get away with unfair pricing in the short run, but in the long run they will have to pay.
Ruppal Walia Sharma is professor, marketing, and Delhi centre head, SPJIMR.