Working Paper: CEPR ID: DP16947
Authors: Roman Inderst; Martin Obradovits
Abstract: Manufacturers frequently resist heavy discounting of their products by retailers, especially when they are used as so-called loss leaders. Since low prices should increase demand and manufacturers could simply refuse to fund deep price promotions, such resistance is puzzling at first sight. We explain this phenomenon in a model in which price promotions cause shoppers to potentially reassess the relative importance of quality and price, as they evaluate these attributes relative to a market-wide reference point. With deep discounting, quality can become relatively less important, eroding brand value and the bargaining position of brand manufacturers. This reduces their profits and potentially even leads to a delisting of their products. Linking price promotions to increased one-stop shopping and more intense retail competition, our theory also contributes to the explanation of the rise of store brands.
Keywords: loss leading; relative thinking; reference-dependent preferences; product positioning; vertical differentiation; price competition; price promotion
JEL Codes: D11; D22; D43; L11; L15
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Retailers' deep discounting (L81) | Reduced perceived importance of quality among consumers (L15) |
| Reduced perceived importance of quality among consumers (L15) | Diminished brand value for manufacturers (L68) |
| Diminished brand value for manufacturers (L68) | Reduced manufacturers' profits (L11) |
| Increased retail competition (L81) | Reduced manufacturer profits (D45) |