Thursday, January 12, 2006

Pricing Follows Art and Science

A group of economists collaborated on a paper in the International Journal of Industrial Organization called “On the Use of Low-Price Guarantees to Discourage Price-Cutting,” a study that attempted to figure out the real figures behind retailer low price guarantees and discount strategies to determine what drives price matching offers. The study is documented in Hal R Varian’s article “Rethinking Why Crazy Eddie Wouldn’t Be Undersold and Other Mysteries” from The New York Times.

The study focused on tire prices advertised in 61 Sunday newspapers in autumn 1996 and the mixed results it produced.

In a sample of 213 ads, 98 contained a low-price guarantee. While 60% of the ads offer to beat their competitors’ prices, 40% offer to meet them. Some 80% of the price beating guarantees applied to advertised prices only.

If guarantees are being used to undermine price cutting from a rival, the two sellers with identical prices will both be inclined to offer a low-price guarantee.

If a retailer generally sells on low prices they won’t offer a low price guarantee. But a retailer with higher or equal prices to a competitor will offer a low price guarantee. A low price seller will only offer to match another retailer’s price 14% of the time, therefore reinforcing the theory the study is based on low price guarantees are motivated by the desire to discourage price cutting.

But some results did not conform to the theory. In 75% of the comparisons, it was low price retailers offering to match only the advertised price.

Although the theory holds for price-matching guarantees, it does not for price beating guarantees and guarantees that only pertain to advertised prices.

Sometimes, studies of tried and tested retail practices don’t immediately yield iron-clad answers. If you take the time to test conventional theories your findings may produce unexpected results that you learn from to build a stronger business.

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