Thursday, November 26, 2015

Selling Dreams: Pricing under Anticipation

Read the working paper
INSEAD Working Paper 2015/94/DSC

Frequent sales are a characteristic of the modern retail industry despite their significant implementation costs and potential to erode consumers' price expectations. One reason for this is that consumers enjoy looking forward to sales. We model the purchase behavior of ``emotionally rational' consumers, and explain their appeal for sales, by accounting for anticipatory feelings triggered by the prospect of buying at a discount, as well as for the disappointment when anticipated outcomes fail to materialize. At the customer level, our model explains why people overspend---that is, purchase at prices above their valuation---when firms offer sales. As a consequence, sales policies can outperform uniform pricing when a monopolist sells to anticipating customers. In fact, both firm and customers benefit from these anticipatory feelings when firms vary prices. Our model also explains why, in a competitive setting, a firm cannot benefit from adopting uniform pricing when its competitors offer sales. Our results help explain the recent failure of US-based retailers JC~Penney and Macy's to sustain an everyday low price (EDLP) policy.