An Empirical Analysis of Price Discrimination Mechanisms and Retailer Profitability Author(s): Romana J. Khan and Dipak C.

Jain Reviewed work(s): Source: Journal of Marketing Research, Vol. 42, No. 4 (Nov., 2005), pp. 516-524 Published by: American Marketing Association Stable URL: http://www.jstor.org/stable/30162400 . Accessed: 03/02/2013 08:28
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ROMANAJ. KHAN and DIPAK C. JAIN*

Retailers typicallyengage in some formof price discrimination to In increase profitability.this article,the authors compare the impact on of disretailer mechanisms: quantity profitabilitytwo price discrimination and counts based on package size (second-degree price discrimination) or store-levelpricing micromarketing price discrimination). (third-degree Whereas the latterhas been well addressed in the marketing literature, there is limited discounts for empiricalresearch on the use of quantity sales data, the authorsestimatea Using store-level price discrimination. and structural demand model, accounting forparameter heterogeneity combine the parameterestimates witha model price endogeneity. They to and profitability simulations of retailer pricing conduct optimalpricing the retailernot to under several scenarios, rangingfromconstraining scenario of to engage in any form pricediscrimination the least restrictive of settingnonlinearprice schedules specificto each store. The pricing as enable the decompositionof profitability a resultofthe difsimulations are greatest when retailers formsof price discrimination. Profits ferent The combine second- and third-degree price discrimination. authorsfind conthat the abilityto engage in second-degree price discrimination than does third-degree price tributes more to retailer profitability discrimination.

Discrimination AnEmpirical of Analysis Price and Mechanisms Retailer Profitability

is Setting pricesto consumers one of the mostcritical of driver retailer and a primary decisionsforthe retailer retailers To typically profitability. increase profitability, In of engagein some form pricediscrimination. practice, to retailers often varypricesacrossstores exploitdemand comdifferences betweenstoretrading areas, a strategy or referred as micromarketingthird-degree to price monly found For discrimination. example, higher pricesare often alterfewer that in stores arelocatedin areaswith shopping the haveaddressed Recent studies natives 2003). (Goodman issue of settingoptimal retail prices on the basis of factors can be that and observed demographic competitive
McCombs of *Romana J. Khan is AssistantProfessor Marketing, School of Business, University of Texas at Austin (e-mail: romana.khan@mccombs.utexas.edu). C. Jainis Dean, Sandy and Dipak of in Morton GoldmanProfessor Entrepreneurial Studies,and Professor Northwestern University Marketing, Kellogg School of Management, to The (e-mail: d-jain@kellogg.northwestern.edu). authorsare grateful Karsten Lakshman Hansen,Michael Mazzeo, and Vishal Krishnamurthi, The authors of drafts thisarticle. on comments previous Singhfortheir School of Business,UniGraduate for thank KiltsCenter Marketing, the of versity Chicago,forthe use of theDominck'sFinerFoods database. confor the JMR thank twoanonymous reviewers their the Finally, authors is This comments suggestions. article basedon an essayfrom and structive doctoral dissertation. author's thefirst

linkedto demandcharacteristics Dube, and (Chintagunta, 1997). Singh2003; Montgomery to Another obviousway forretailers pricediscrimiless discounts based on package size nate is to offer quantity (Cohen 2002; Dolan 1987). In the consumer packaged in severalpackagesizes are offered categoods industry, butbeer, peanut goriessuchas detergents, paperproducts, ter,and analgesics.The largersizes of these products, dimensions whichare identical (e.g., brand alongall other at are offered a lower name, flavor), usually per ingredients, a behind unit designing nonlinprice.'Whenthemotivation is this ear pricescheduleis market segmentation, practice as also known second-degree discrimination (Moorthy price 1984;Mussa andRosen 1978). of is The focusof thisarticle on thesetwomechanisms or discrimination: pricing micromarketingstore-level price discounts and (third-degree pricediscrimination) quantity basedon packagesize (second-degree discrimination). price Store-levelpricingis an effective price discrimination a characteristics whenobservable mechanism provide sigto and nal of consumer sensitivity willingness pay. price
in 1In the grocery thereare exceptions whichfirms charge industry, withsize in categories so per quantity premiums that unitpricesincrease suchas tunaandjuices. Research Journal Marketing of Vol.XLII (November 2005), 516-524

Association 2005,American Marketing 1547-7193(electronic) ISSN: 0022-2437(print),

516

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Price Discrimination Mechanisms and RetailerProfitability

517

after enter there customers purchase sizes who However, consumers a store, remains sig- for high-volume large across can toretailer nificant customers the that retailer andmake important an contribution heterogeneity categories among the to revenue. some At has Note this chains, consideration necessary grocery exploit. that though information in lead of"big which only characteristics tothe institution deals" stock aisles, (i.e., engage micromarketing demographic ofthe store's isreadily the the size available from There also customers) (e.g., largest ineach category. may becompetCensus the to consumer's from discountersoffer that Bureau), individual willingness itive pressures, particularly mass is unobserved. Because these areunob- larger atdiscounted Special sizes attention also pay preferences prices. may an of retailers offer array package allow- begiven categories high can to with volume the in larger sizes. served, sizes, tosegment themselvesself-selection Inadditiontheir of to for store traffic retailer and ingconsumers by importance their alternative ontheir willingness profitability, categories also shape price based own to these the preferred may of store. combination The ofthese factors pay. image the may The of articletodecompose contribu- cause retaileroffer is the the to discounts the than objectivethis deeper quantity of tion these price two discrimination mechanisms discrimination alone (i.e., price objective necessitates. Although and toretailer for of factorsour in model quantity discounting micromarketing) prof- weaccount some these developUnder we on discriminationprimary asthe motiment, focus price itability.2 "pure" third-degree discrimination, price but unit are same vation offering for discounts. stores, per prices the vary prices across quantity across each sizes Under secondOuranalysis dataon theover-the-counter uses package within store. pure (OTC) same all across from chain discrimination, arethe degree prices price analgesics category a large supermarket inthe but sizes. The area. in forms price of stores, perunit prices across vary package Chicago Theretailer engages both on from that for is, positive impact retailer profitability the"com- discrimination; prices products significantly vary bined" stores across across and and retail show (i.e., stores, observed prices strategy varying across prices significant sizes within store) been documented each has well inthe quantity with price tablet with discounts, the per decreasing literature. and bottle Although observed size. the discounts (1997) Chintagunta, marketing Montgomery quantity may and find 4% of Dubd, Singh (2003) profit between and be anindicationsecond-degree discrimination gains price by the 16% when retailer store-level sets nonlinear also differences. We retailer, could beduetocost price the they schedules. between the demonstratea significant that ofthe However, do not they distinguish proportion observed twosources price of differences across stores and inprices to retailer's decision. (i.e., nonlinearity isdue the pricing across Weestimate a category demand model a sizes). using random Toour the empirical that coefficients specification.model The allows hetfor knowledge,only study specifilogit the size discrimina- erogeneity inpreferencestoboth due observed unoband cally explores useofpackage as a price tion mechanism consumer inthe factors. use instruments We to control price for packaged industry served goods isthat Cohen of Cohen studies nonlinear by and Villas-Boas (2002). 1998; (Besanko, pricing endogeneity Gupta, Jain the manufacturerpaper industry finds a inthe towel and that and Winer due 1999) tounobserved such shelf factors, as substantial ofthe inper prices variation unit across space product and location. allow dynamic We for portion promosizes be toprice effects price on andpromotion package can attributed discrimination. tion sensitivity response the ofpricing for and Despite importance (Foekens, strategy retailer parameters 1999). Leeflang, Wittink Allowthere ofthe accounts strategic for profitability,is limited understanding relative ingfor parameter dynamics adjustofthe discrimination mechanisms available to ments purchasing in behavior stockpiling; Van see efficacy price (e.g., the retailer. isanimportant because mecha- Heerde, This issue each and 2004) Leeflang, Wittink following promotions. nism distinguished the ofinformation is both type avail- Wecombine estimates the from demand model by parameter able the to retailer consumer about and the a of maximization to preferences type with model retailer category profit ofheterogeneity inconsumer that under pricing preferencesis exploited. simulate optimal and prices profitability four is This alsoanimportant issue the enables managerial because costs policies. Comparing across profits pricing policies involved eachpricing with should weighed us todecompose be into the sources approach profitability different of the discrimination and understand the relative against associated profits. requires price Micromarketing importance store-level systems, entail which considerable time ofeach profits. for pricing andresourcesdetermine implement. to and In contrast, a Weorganize rest the the of article follows: the as In next discount schedule is uniform allstores section, present demand that across we the model. we quantity Then, describe isconsiderably toimplement. article easier This to data the results the estimaattempts the and empirical from demand out measure gains profitabilityeach tion. provide the in from We a detailed overviewthe of retailer's in role parse and discrimination the of discrimination price approach. setting and price analyze impact price Ingeneral, differencescannot accounted that be for onprofitability. wepresent conclusions our from price Finally, differencesattributed are toprice discrimination. research. the bycost the tooffer However, retailer be motivated may quantity MODEL FORMULATION discounts reasons than for other market As segmentation. store considera- Wemodel consumer demand the mixed (2002) Chintagunta demonstrates, traffic using aggregate tions competitioninfluence pricing. and also retailer model and which been has (McFadden Train Quan- logit 2000), discounts serve acquisition retention as and tools applied both in and to tity may marketing economics estimate demand differentiated (e.g., for Levinsohn, products Berry, andPakes1995).The estimation allows for approach 2Wedo notconsider which price first-degree discrimination, involves and controls price for endogeneity. parameter heterogeneity to to In grocery setting prices accordingeachperson's willingnesspay. the Weassume the that observed market are shares driven are of pricing (for setting, targeted coupons oneform this by strategy anapplisee and cation, Rossi, 1996). individual McCulloch, Allenby choices. we that i Formally, assume consumer

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518

JOURNAL OF MARKETING RESEARCH, NOVEMBER 2005

chooses either ofJproductsthe one in categorythe or noi chooses Theprobability consumer that option. purchase attimefrom s is t store j product (1)

Wemeasure size variables. Thus, dummy package with for category three a with we varisizes, usetwo dummy and with medium as the size base. ables, sstnall stage, the a consumer hasa strong who for the Intuitively, preference for size havea weaker large willlikely preference the We for smaller and versa. account heterogeneity size, vice inandcorrelation for between and preferencesize,6small asfollows: 51arge, (5)

0 i= s where 1,...,I; j 1, J;t= 1, T;and = 1,..., S. Theinclusiondemographic accounts correlaof factors for t on characteristics ofproduct timein This j at depends the in due factors. Correlation tion sizepreferencetoobserved of for presence store size(sj);price anindicatorthe s: (pits); factors inpreferencestounobserved is captured /, due by term a price price the promotion aninteraction between (dits); matrix. variance-covariance unobserved of and presencea promotion x dits); the (to (pits at individual level Weaggregate model the specifiedthe and as the characteristicssuch advertising researcher) (its), level. general estimarket atthe shares store The topredict correlated mation which be availability, may potentially coupon for involves theparametersthe finding approach I's consumerpref- individual-level that with and representing price; parameters a market model produce predicted for sensi- share size price erence brand(aii), for j preference (bi), market (Berry share closest theobserved to 1994; the topromotionsand impact Nevo (;), tivity responsiveness (yi), The section describes dataandthe the 2000). next character- estimation of onprice V. promotion sensitivityWeinclude results. store environment ofeach to istics the of competitive (CEits) that alternativesconinthe for account variations shopping RESULTS demand Data their have making purchases. sumers for Category varieffect a a shifters includeseasonal and dummy (DSts) from on OTCanalgesics Weusedata the category the ina of the able indicate presencea pharmacy store. to area a in Chicago over Finer chain the Dominick's Foods influences promoofprior for The model allows dynamic in we store each For week, observe one-year period. each on tions price response (ii) sensitivityandpromotion (yi) Product Code of sold each numberunits for Universal ifcon- the and 1999). example, (Foekens, Leeflang, Wittink For whether onprice itwas the promotion, of because a deep (UPC), UPCprice, increase and sumers inventory stockpile the we the (from margin which can and (Hendel Nevo2003;VanHeerde, and retailer's thetransition compute pricediscount ofprescription-only wholesale With cost). to and 2004), may Leeflang, Wittink they belesssensitive status Advil, toOTCnonprescription (e.g., Aleve), the weeks. insubsequent Weallow price sensitivity drugs price for retailers. has the importance category gained analgesics of and recency on the todepend both depth the parameter that and Resources reports infood massInc. Information Similar Leeflang, market price previous promotions. toFoekens, tablets increased salesof oralanalgesics stores, sum a weighted we Wittink's approach,compute and (1999) and 1999 January between billion 4.5%to$2.73 January _ ofprior promotions: = ViT , - Pj,tv), price PRit an trends the make analgesics 2000. categoryimporactual tant These isthe where isthe price, nonpromoted pi,t pi,t regular for retailers. area expansion grocery for used weeks prior history tocomof and price price, v isthe weuse For model the estimation, 11products, consisting is the measure= 8).The (v sensitivity parameter offour price pute and and brands Advil, Brand) (Tylenol, Bayer, Store mean andthedynamic three of nowa functionan overall (y) UPCs The sizes(25,50,and100tablets).3 selected of (ypp): price impact recent promotions We sales for account 62%oftotal inthe category. provide inTable 1. statistics the descriptive 0 (2) ofbottles in sold the share The market shows percentage is size. eachbrand Tylenol themarket leader, capturing on to we responsedepend the more 25%ofthe promotion Similarly,allow and than volume, italsohasthe category with expectathe since duration previous promotion (wj), no in share eachsizegroup. Notably, onesize since the that longer duration previous tion the promotion, greatestbe the We all brands. across the most to popular appears to promotion isthe the (tw): stronger responsethe would for the the compute price consumer pay 100tablets a and bottle For size. Tylenol Bayer,consumer ineach buy(3) 0 as size in smallest would twice much tabletsthe 100 pay ing size. in largest Overas a consumer 100tablets the buying and for Wealsoallow observed unobserved heterogene- all,theretailer the offers discounts, quantity significant in brand A), preference sizepreference and (ai), ity the the with So, example, declines size. for ofwhich magnitude The parameters savings greatera customer upfrom to50 sensitivity parameters.preference (yi) price 25 trades if are of deviation standard and are variables, a is the competitor 50 than tablets ifheorshetrades from to 100tablets. up distribution: the 4
0
market share: has 3Thestore brand onlytwosizes with significant than rather 12.Note has our and medium large; thus, model 11products low of size the include extra-large because itsvery share. we that do not

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Mechanisms and RetailerProfitability Price Discrimination Table 1

DESCRIPTIVE STATISTICS Size (Number ofTablets) Market Share(%) Priceper 100 Tablets Costper 100 Tablets

519

Brand

Units Sold on Promotion (%)

Tylenol Tylenol Tylenol Advil Advil Advil Bayer Bayer Bayer brand Store Store brand

25 50 100 25 50 100 25 50 100 50 100

8.9 11.1 7.6 7.3 5.1 2.2 2.5 2.0 4.9 6.2 4.2

14.08 9.98 7.14 12.08 10.38 8.23 10.64 7.62 4.95 4.98 3.29

9.04 7.52 5.93 8.08 7.4 6.25 7.6 5.34 3.73 1.92 1.51

10 11 10 19 15 16 22 28 10 22

and Thepercentage ofunits onpromotion sold indicates a that shifters, interaction ence, mix, demand marketing size, All ofthe sizes on fixed effects a negative have larger is sold promotion effects. thebrand percentage sign greater of large ofthe share We that than smallest the size. because the outside good.4 find In addition salesinformation, dataon the Tylenol the to we use has greatest preference, is consismean which characteristics andcompetitive environmenttent its with large share. demographic category ofeachstore's area. the next of is to marketing mix. trading Wecapture demographic The set variablesrelated the characteristics customer ofthe with follow- The the onprice coefficient (-1.18) negative, expected. is aswe population ofthe that Thestandard of distribution parameter ofthis deviationthe ingvariables: (percentage population is age60 over ageof60),ethnic the ofthe that we for of (percentage population (.49)indicates after account sources observed is that black Hispanic), or HHsize ofhouse- heterogeneity, significant there is unobserved (percentage heterogeneity holds thestore with ormore in five area and in price The which we variable, members), sensitivity. promotion ofhouses the in store valued homevalue area at measured proportion sold promotion, asthe of units on indi(percentage more $150,000). capture competitive than We the environ- cates presence a temporary reduction. the of Promoprice ment each of with store measuresthe of distance the tions from the increase likelihood of The coefpurchase. negative store different ofcompetitors: (the to Jewel largest ficient thepriceand promotion on interaction (-.04) types chain indicates consumers more that are sensitive toward area), (EDLP) supermarket inthe everyday-low-price price and Toaccount factors could for that shift promoted items. store, drugstore. we an for a store The results some show evidence parameter of demand, include indicator whether hasa dynamics. and term winter Theinteraction ofprice the with measure recency of and pharmacy department a seasonality for months. of has coefficient (.18), depth prior promotion a positive There alsocause concern some is for that observed vari- indicating the that more recent deeperpromotion, or a the with unob- lessprice sensitive consumers. may reflect are This also ables, particularly may correlated the price, be served factors The of variable asan effects are responsive consumersless to stockpiling because (its). inclusionthe Hits interaction price raises with also some con- price when have high a Theinteraction of endogeneity they inventory. cerns becauseislikely there some it that is serial correlation promotion weeks with since indicates previous promotion in sjts. Because useprior we to effectiveness increases longer has the time prices compute there that promotion PP.its, willlikely a correlation be between and~ts. To since previous (.05). elapsed the promotion PPits for endogeneity, account this we constructinstrument Theprice an interaction show demographic parameters that that a weighted is function ofprior wholesale and and variables a significant onprice have price, we competitive impact this same as PPits. instrument sensitivity.negative The set The x onthe coefficients price age60 compute inthe way alsoincludes wholesale package and x area (-1.3)and interactions that indicate size, local price, (-3.16) price HHsize older and households tobe more tend demographics. people large price Aswediscussedthe in "Model Formulation" we sensitive. positive The x coefficient price homevalue onthe section, allow a no-purchase toenable for that inaffluent areas (.36) option category expansion interaction indicates consumers and contraction changes the with in marketing Inour tend belessprice mix. to sensitive. coefficients price The onthe we the of that each and interaction drugstore EDLP, and are data, observe numberhouseholds visit terms, competitor store each in week. the From Information Resources fact- positive. Inc. Because competitor the variables measure disthe we consumers analgesics tance the from store, interpretationpositive the ofthe coefbook, know onaverage, that, buy three a year. usethis times We information tocompute the ficients as the is that distance a competitor from increases, share the of outside such not consumers enter- price decreases. results These that good, that all sensitivity suggest asthe the on week in market analgesics. for ing store a given are the
DemandModelResults

Theresults the of demand model estimation in appear Table Wegroup variables five brand 2. the into sets: prefer-

4Because space of wereport the fixed considerations, only brand effects. Parameter estimates the of terms related observed unobserved to and hetare on erogeneity available request.

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520 Table 2
DEMAND MODEL ESTIMATION RESULTS Parameter Estimate BrandPreference

JOURNALOF MARKETING RESEARCH, NOVEMBER 2005

Standard Error

Tylenol Advil Bayer Store Tylenol

-2.59* -3.02* -4.86* -3.59* -2.59* -1.18* .49* .13* -.04* .18* .05* 1.02* 1.35* -3.42* 2.05* -1.04* .22* .04* -.46* .03 -.01
-1.30* .70* -3.16* .36* .90* -.65 .66* -.87* .83* -4.12* -.76 .39* -.70* 4.40* .57

.38 .39 .25 .22 .38 .14 .16 .04 .02 .02 .01 .17 .25 .14 .81 .41 .01 .01 .11 .21 .04
.35 .35 .14 .14 .8 .8 .1 .32 .32 .92 92 .16 .16 .39 .39 .31 .31 1.26 1.26 .72 .72 .09 .09 .1 .97 .97 .7 .7

Mix Marketing

Price Price: standard deviation Promotion x Price promotion x Price recency-depth of promotion prior x ln(weeks since Promotion promotion) Small tablets) (25 standard deviation Small: (100 Large tablets) standard deviation Large: Small covariance large

Size

DemandShifters

Winter Pharmacy

Competitive Effects

to Distancedrugstore DistanceEDLP to DistanceJewel to

for small which beduetothe ence the influence size, may ofbudget constraints onethnic households. Weinclude presence anin-store the of and pharmacy a winter variable category as demand shifters. We dummy find demand analgesicsgreater the that for is during winter which not is surprising.alsofind the We that presseason, of ence a pharmacy increases demand the for analgesics catThe that presencea pharmacy, is of which egory. finding the for effect drugs, primarilyprescription alsohasa spillover onOTCdrugs good is news the for retailer because more are a tocompete addingpharmacy department supermarkets Howwith and discounters 2003). drugstores mass (Singh this is overestimatedresult the as a of ever, effect likely location decision because of the endogeneity pharmacy will in a retailers openpharmacies areaswith strong for demand medical supplies. as cateWealsoinclude distancesclosest to competitors We that fewer demand shifters.expect with purchasing gory of making a purchase in the venues anarea, likelihoodnot ondistance the to The coefficient willdecrease. negative to are closest likely drugstore that implies consumersmore when is nodrugthere from store analgesics the purchase ondistancethe to closest in area. coefficients store the The are not EDLPstore and (.03) Jewel (-.01)supermarket sigonthe with coefficient nificant aresmall and compared the of that category our variable (-.46).Given the drugstore to that distance is itis surprisingthe analysisanalgesics, not indetermining the is more closest the important drugstore of outside share the good. results the The key empirical reveal following insights:
of for as a 'Preference size varies significantly result unobof that an which indicates offering array prodserved factors, can tool sizes each with different within brand be a useful ucts condifferences between and consumers capturing for sorting sumer segments. varies observed 'Consumer sensitivity with demographic price for an andcompetitive factors, indicating opportunity thirdstore-level discrimination bysetting prices. degree price of as sizes for 'Preference different alsovaries a result observed to an factors, signaling opportunitycombine demographic the and second- third-degree discrimination byvarying price across stores. schedule discount quantity

Interaction Terms Pricex age60 Pricex ethnic Pricex HHsize Pricex homevalue Pricex drugstore Pricex Jewel Pricex EDLP Smallx age60 Smallx ethnic Smallx HHsize Smallx homevalue Largex age60 Largex ethnic Largex HHsize Largex homevalue

* = significance.

the we Inthe section, explore retailer's strategy next pricing model from demand to estimates the and the use parameter to of pricediscrimination the investigate contribution retailer profitability.

RETAILERPRICINGAND PROFITABILITY in increases an area, alternatives of availabilityshopping alsoincreases. sensitivity price PriceDiscrimination Evidence Retailer of to base variables relativethe the Wemeasure sizeeffect the discounts be duetoeither Observed may quantity size that medium Wefind consumers the size. prefer small or wholesale manufacturer's pricing price theretailer's this size least the most the (-3.42); is (1.02)and large the be that discounts cannot quantity Typically, for paper strategy. with alsoconsistent Cohen's (2002) findings the toprice attributed discrimare by differences explainedcost size for large the deviations The towel category. standard the from wholesale Because prices size the (2.05)andfor small (1.35)preference parameters ination.5 we we observe and the retailer's average margin compute inconsumer of the indicate presence heterogeneity prefer- manufacturer, in covariance factors. negative ences tounobserved The due with costs labor 5There also other orshelving associated differcould be that indicates versus size for small large (-1.04) preferences that orin inbulkier sizes, refrigcategories products require for the ent especially lower a size for small implies a high utility utility the for manufacofequal our However, assumption (except the house- eration. fordifferent is quitecosts fortheanalgesics oflarge with size. Areas a greater proportion large reasonable sizes turer price) size. for the have holds a greater the differences because physical we preference large Notably, categoryuseinthis analysis empirical small. sizes relatively different are have ethnic with areas a large prefer- across population a greater

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Price Discrimination Mechanisms and RetailerProfitability Table 3

RETAILER PRICING BEHAVIOR Number of Tablets Bottle per Average Margin p per Bottle: - c ($) Average Markup per Bottle:(p c)/p(%)

521

Brand

NLR (%)

Tylenol Tylenol Tylenol Advil Advil Advil

Bayer Bayer Bayer

Store brand Store brand

25 50 100 25 50 100 25 50 100 50 100

1.26 1.23 1.21 1.49 1.98 .76 1.14 1.22 1.53 1.77

36 25 17 33 29 24 29 30 25 61 54

63 55 60 52 25 32 76

in an reflec3. markup bottle Table Toprovide accurate per of tion theretailer's we these decision, compute pricing numbers the actual wholesale retail per and using price bottle rather price 100 than per tablets. size the is greatest the for large Onaverage, marginthe is and least the the for small and markupgreater size, the for smaller Aswediscussed the sizes. previously, strategic the considerations price cause beyond discrimination may retailer offer to discounts. we quantity Although do not demonstrate the absence other of for possible explanations the observed the indicates the that retailer patterns,evidence uses ina discounts strategic that consismanner is quantity with discrimination. in tent price Inaddition, variation the and across and that indicates margin markups products sizes the retailer following rule thumb setting isnot a fixed of in its relativewholesale to price price. that variable are costs equal across Assuming other prodof ucts different wecan account the for prosizes, precisely of nonlinearity prices is duetothe inretail that portionthe We retailer's decision. measure nonlinearity the due pricing tothe retailer Cohen as percentage ofthe (NLR; 2002) the in retail that be nonlinearity prices (P25-P50) cannot accountedby nonlinearity for the ofwholesale (W25prices
W5o):
(6) 0

from base and makespercentage a adjustment the price then to zones. this base determine inother pricing Although pattern not does hold every for UPC,itsprevalence implies that the when retailer prices zones, may varies over there be some adjustmentinvolved. fixed rule Given evidence the the that retailer in disengages price wedecompose contribution the toprofitability crimination, from type price each of discrimination mechanism.? Using the results the of demand wesimulate estimation, optimal under scenarios. prices several We assume theretailer prices maximize that sets to which consistent the is with assumpcategory-level profits, in tion made most studies Kim, and (e.g., Blattberg, Rossi and Dhar and 1995; Sethuraman, 1995) isalsoinline Raju, with industry toward the trend The category management. retailer's are wholesale paid the costs the price to manufacturer each for product and fixed overhead (F) of cost (wi) a the The retailer's istodetermaintaining category. problem mine price eachproduct thecategory every the of in in week maximize to profits: category
(7)
0

and Optimal Pricing Retailer Profitability

Table4 shows thepercentage theNLR varies that of between and 25% 75%.Onaverage, 50% approximatelyof theobserved in retail is nonlinearity price due to the retailer's decision. pricing Anexamination ofprices across stores reveals the that retailer different for same at charges prices the productdifferent For same source, stores. the data (1997) Montgomery andChintagunta, andSingh the Dube, (2003) report existence price of zones within which retailer prices. the sets Forthe we levels of category, find tothree analgesics up in week.6 price any Insome the a uniform across cases, retailer charges price the chain the for smallest while the for size, varying price the sizes. itappears the that retailer a sets larger Ingeneral,
6The number price of zones increased time. has over data a Using from later period, time Dube, (2003)find to 16price Chintagunta, andSingh up zones.

Given wholesale andparameter the estimates from prices the demand in model Equation wecansolve the for full 1, of vector optimal retail maximizes prices (p*),which 7. Equation Shifts theretailer's in pricing policy mayleadto a from competitionstrategic and in response the adjustments consumer and have for cusbehavior, itmay implications tomer store To concerns, loyalty. allaythese previous research imposed has constraints optimization onthe problem. that Dube, Singh (2003) Chintagunta, and require optimal do decrease consumer welfare. prices not Montgomery that and do (1997)requires average prices revenues not increase. we the that share Similarly,impose constraint the with suggested weighted average does increase the price not observed optimal For prices. chain-level weusethe pricing,
?Note wefocus the that on short-term of and objective price setting take the of as a the assortment array product offerings given. Although product is decision alsoan endogenous we that are variable, believe these longterm decisions.

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522

JOURNAL OF MARKETING RESEARCH, NOVEMBER 2005 Table 4

IMPACTOF DIFFERENT PRICING POLICIES ON PROFITABILITY to (Standard Deviation) ChangeinProfits Switching (%) from Chain Uniform Chain Nonlinear Pricing Store Uniform Store Nonlinear Pricing

Average Weekly in StoreProfit Thousands Dollars of (Standard Error) No PriceDiscrimination

Chain uniform

67 (9) 86(10) 73(10) 92(11) 75(10) 87(11) -21(5) -9 (2) -25(5)

26(9)

10(9) -13(2)

34(10) 6 (3) 21 (5)

SecondDegreeOnly Third DegreeOnly

Chain nonlinear Store uniform Store nonlinear

15(2) -5 (2) -18(4)

Secondand Third Degree Current Policy Pricing

Actual Optimized

the restrictive to chain-level uniform policy, pricing, most nonlinear the store-level policy, pricing, leastrestrictive shows would by profits increase 34%.Thedecomposition the in from that increase profits nonlinear (26%)is (8) pricing from greater the pricsignificantly than increase store-level 0 If firm to one nonlinear (10%). the were set chain-level ing would increase 26%compared we the For store-level scenarios, compute share price the schedule, by profits pricing if the the with chain-level uniform schedule. observed for store and Conversely, price price each weighted (ps) impose store-level were setuniform to atthe level. thefirm constraint store prices, profits under would uniform with Wecompute increase 10%compared chain-level prices the profits optimal and implied by scenarios: the After firm set chain-level nonlinthe has a following pricing optimal pricing. nonlinear from ear schedule, moving chain-level pricprice for Theper price unit .Chain discrimination): (no uniform price increases nonlinear tostore-level by pricing profits an ing There no are sizesandstores. is across eachbrand constant of the reflect importance additional Overall, results the 6%. stores. or in across discounts variationprices quantity of tothe .Chainnonlinear finding flexibility firm's The profit. critical price (puresecond-degree discrimination): pricing for that same schedule is the Thefirm a quantity sets discount disto is the this quantity ability offer analysis that firm's all stores. more size based counts onpackage contributes toitsprofThe ',Store price uniform third-degree discrimination): (pure stores. across to than its does ability vary prices itability stores doesnotoffer but firm across can share chain (pc)toconlevel weighted average atthe price share strain optimal weighted average paid: the price (sj) discrimination mechathe of Weinvestigate impact price ofthe nisms retailer on through profitability a comparison based from discounts on to profits quantity contribution store-level We size pricing. find an into us exercise enables todecompose This profitability package versus schedule atthe that optichain conlevel set discount malquantity and understand discrimination sources the different ofprice than store-level more Table ofeach profits. 4 shows tributes toprofitabilitydoessetting for the relative importance here discounts. key The insight is without quantity the under different prices for average weekly profits thechain a larger that procaptures discounting adequately quantity are in profit outcomes The scenarios. differences pricing indemand does than store-level of heterogeneity atthe and economically portionthe statistically significant .05level are a discount In terms, setting quantity the we report percentage pricing. practical For each significant. scenario, also increase level to at chain leads a significant in schedulethe For with scenarios. refinprofits difference compared other than to and easier implement setting and expected profits is alsomuch the we erence, alsoreport actual profits the that can the store-specific The under the firm to setoptimal were suggest managers prices. results (if prices) profits scheddiscount task on simpler ofsetting focus the Notethat firm's current quantity profits expected policy. pricing instore-level before to to are current pricunder firm's the profits investing policy equal profits ules increase pricing ofstore-level the the ing across nonlinear schedule a pricfrom Although combination systems. price settingsingle contributes discounts with is which consistent Chintagunta, and significant Dube, ing and quantity chain, involved incremental theremany complications in profits, a (2003) approach. Singh's store-level scenarios that are shows there across pricing. implementing profits Comparing disof of that relative Note the to nonlinear and efficacyeach type price prices significant from ability set gains the of on nature consumer mechanism from crimination If were stores. a store tochange across tovary depends the prices
quantity vary prices a per price, determines unit For the discounts. eachstore, firm for which the is same all sizes. and second- third-degree dis.Store nonlinear (combined price for discount schedules The can crimination): firm setquantity eachstore. CONCLUSION

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Price Discrimination Mechanisms and RetailerProfitability

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and whether retailer information the has orsig- This result further the that preferences emphasizes notion recommendanals about preferences. these For discounts toserve tions the for retailer's behavior consider should the quantity optimal as aneffective discrimination itis of and consumers manufacturers. mechanism,impor- impact both price in volA limitation article that tant people that differtheir valuationadditional of ofthis is the though consumer ume the of product that retailer information demand and the on has model allows dynamics, retailer for the pricing ofwillingness Forexample,all the distribution topay. if model not. islikely ifconsumers demand does It that adjust in consumers limited have ofa the will retailer alsoincorporate consumption productgen- strategically, expectations discounts onpackage will about based size future demand when eral, quantity using changes it setscurrent price. not aneffective be Thiswould better mechanism. be for segmentation captured allowing dynamic by Theeffectiveness of third-degree discrimination retailer such the would choose a price pricing, that retailer onwhether observed the characteristicsfor sequence optimal over Although believe used of time. we depends prices on basis that for retailer will have an concurrently consumersthe segment segmentation allowing dynamic pricing not oftheir topay. torelate on substantive ofour results research directionwillingness Attempts preference impact the andprice todemographiccom- ally, expect there beanimpact the and we that will on shape of sensitivity parameters variables yielded results. research thenonlinear schedules time. have mixed Some over petitive price Appropriately hasfound evidencea relationship price of between sensitiv- incorporating in the demand and dynamicsboth consumer andobserved which the etal. 1995), retailer models an avenue further for (Hoch ity demographics pricing presents canbeexploited pricing for the However, major- research. purposes. of research found has characterisity previous demographic REFERENCES ticsto be poorly correlated preference with parameters Steven (1994),"Estimating T. 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