SupermarketPricingStrategies

1 Vol. 27, No. 5, September October 2008, pp. 811 828issn0732-2399 eissn1526-548X 08 2705 0811informs 2008 INFORMSS upermarket Pricing StrategiesPaul B. EllicksonDepartment of Economics, Duke University, Durham, North Carolina MisraWilliam E. Simon School of Business Administration, University of Rochester,Rochester, New York 14627, supermarket firms choose to position themselves by offering either everyday low prices (EDLP) acrossseveral items or offering temporary price reductions (promotions) on a limited range of items.

2 Whilethis choice has been addressed from a theoretical perspective in both the marketing and economic literature,relatively little is known about how these decisions are made in practice, especially within a competitive envi-ronment. This paper exploits a unique store level data set consisting of every supermarket operating in theUnited States in 1998. For each of these stores, we observe the pricing strategy the firm has chosen to follow,as reported by the firm itself. Using a system of simultaneous discrete choice models, we estimate each store schoice of pricing strategy as a static discrete game of incomplete information.

3 In contrast to the predictions ofthe theoretical literature, we find strong evidence that firms cluster by strategy by choosing actions that agreewith those of its rivals. We also find a significant impact of various demographic and store/chain characteristics,providing some qualified support for several specific predictions from marketing words: EDLP; promotional pricing; positioning strategies; supermarkets; discrete gamesHistory: Received: March 22, 2006; accepted: February 27, 2008; processed by David IntroductionWhile firms compete along many dimensions, pricingstrategy is clearly one of the most important.

4 In manyretail industries, pricing strategy can be characterizedas a choice between offering relatively stable pricesacross a wide range of products (often called every-day low pricing) or emphasizing deep and frequentdiscounts on a smaller set of goods (referred to aspromotional or PROMO pricing). Although Wal-Martdid not invent the concept of everyday low pricing,the successful use of everyday low pricing (EDLP)was a primary factor in their rapid rise to the topof the Fortune 500, spawning a legion of followersselling everything from toys (ToysRUs) to buildingsupplies (Home Depot).

5 In the 1980s, it appeared thatthe success and rapid diffusion of the EDLP strategycould spell the end of promotions throughout muchof retail. However, by the late 1990s, the penetrationof EDLP had slowed, leaving a healthy mix of firmsfollowing both strategies, and several others employ-ing a mixture of the surprisingly, pricing strategy has proven to bea fruitful area of research for marketers. Marketingscientists have provided both theoretical predictionsand empirical evidence concerning the types of con-sumers that different pricing policies are likely toattract ( Lal and Rao 1997, Bell and Lattin 1998).

6 While we now know quite a bit about where a personis likely to shop, we know relatively little about howpricing strategies are chosen by retailers. There aretwo primary reasons for this. First, these decisionsare quite complex: managers must balance the pref-erences of their customers and their firm s own capa-bilities against the expected actions of their modeling these actions (and reactions)requires formulating and then estimating a complexdiscrete game, an exercise which has only recentlybecome computationally feasible.

7 The second is thelack of appropriate data. While scanner data setshave proven useful for analyzing consumer behavior,they typically lack the breadth necessary for tack-ling the complex mechanics of inter-store goal of this paper is to combine newlydeveloped methods for estimating static games witha rich, national data set on store level pricing poli-cies to identify the primary factors that drive pricingbehavior in the supermarket the game theoretic structure of ourapproach, we aim to answer three questions thathave not been fully addressed in the existing liter-ature.

8 First, to what extent do supermarket chainstailor their pricing strategies to local market condi-tions? Second, do certain types of chains or stores1 Typical scanner data usually reflect decisions made by only a fewstores in a limited number of and Misra:Supermarket Pricing Strategies812 Marketing Science 27(5), pp. 811 828, 2008 INFORMS have advantages when it comes to particular pricingstrategies? Finally, how do firms react to the expectedactions of their rivals? We address each of these ques-tions in first question naturally invites a market pulldriven explanation in which consumer demographicsplay a key role in determining which pricing strategyfirms choose.

9 In answering this question, we alsoaim to provide additional empirical evidence that willinform the growing theoretical literature on pricingrelated games. Since we are able to assess the impactof local demographics at a much broader level thanprevious studies, our results provide more conclusiveevidence regarding their empirical second question concerns the match betweena firm s strategy and its chain-specific particular, we examine whether particular pricingstrategies ( , EDLP) are more profitable when firmsmake complementary investments ( larger storesand more sophisticated distribution systems).

10 Theempirical evidence on this matter is scant this is thefirst paper to address this issue on a broad scale. Fur-thermore, because our data set includes all existingsupermarkets, we are able to exploit variation bothwithin and across chains to assess the impact of storeand chain level differences on the choice of , we address the role of competition posedin our third question by analyzing firms reactionsto the expected choices of their rivals. In particular,we ask whether firms face incentives to distinguishthemselves from their competitors (as in most modelsof product differentiation) or instead face pressuresto conform (as in network or switching cost mod-els)?