49 Pages Posted: 5 Dec 2009
Date Written: December 4, 2009
Firms in several markets try to attract consumers by offering discounts in other unrelated markets. This promotion strategy, which we call "cross-market discounts," has been successfully adopted in the last few years by many grocery retailers in partnership with gasoline retailers across North America, Europe and Australia. In this paper, we use an analytical model to investigate the major forces driving the profitability of this novel promotion strategy. We consider a generalized scenario in which purchases in a source market lead to price discounts redeemable in a target market. Our analysis shows that this strategy can be a revenue driver by simultaneously increasing prices as well as sales in the source market, even though sales are negatively elastic in price, ceteris paribus. Moreover, it distributes additional consumption (motivated by the discount) in two markets and, under diminishing marginal returns from consumption, this can simultaneously increase firm profits and consumer welfare more effectively than traditional nonlinear pricing strategies. Our study provides many other interesting insights as well, and our key results are in accordance with anecdotal evidence obtained from managers and industry publications.
Keywords: fuelperks, PowerPump, retail promotions, nonlinear pricing, competition, game theory
JEL Classification: M31
Suggested Citation: Suggested Citation