Profiting from the Decoy Effect: A Case Study of the Online Diamond Marketplace

Abstract

The decoy effect (DE), first introduced by Huber et al. (1982), has been robustly documented across dozens of product categories and choice settings using lab experiments. However, in the literature, the DE has never been verified in a real marketplace. In this paper, we empirically test and quantify the DE in a major online diamond marketplace. We develop a diamond-level proportional hazard framework by jointly modeling market-level decoy-dominant detection probabilities and the boost in sales upon detection of dominants. Results suggest that decoy-dominant detection probabilities are low (10%-29%) in the diamond marketplace; however, upon detection, the DE increases dominant diamonds’ sales hazards significantly (2.3-4.4 times). To understand the DE’s managerial significance, we quantify its profit impact and find that it contributes 21.4% of the diamond retailer’s profit. Finally, we explore various strategies that might help the retailer to further increase profitability. We find that the retailer’s profit can increase up to 5.4% via effective utilization of the DE.

Keywords: Decoy Effect, Attraction Effect, Asymmetric Dominance Effect, Context Dependent Choice, Proportional Hazard Model, Diamond Pricing

JEL Classification: M31