To Bargain or Not to Bargain - The Role of Fixed Costs in Price Negotiations

Abstract

Retailers routinely allow consumers to negotiate a discount off the posted price, especially for big ticket items such as home appliances, furniture, automobiles, and real estate, as well as on online platforms such as Amazon, eBay and Alibaba. The profitability of such a strategy, relative to selling only at posted prices, depends on consumers' willingness to initiate a negotiation and ability to negotiate a discount. In this paper, we incorporate a consumers' decision of whether or not to negotiate into a demand model. The decision to negotiate hinges on how the expected discount from negotiation compares to the magnitude of a non-pecuniary cost that the consumer incurs by initiating the negotiation. This cost has implications for consumer demand and firm profitability; the current study shows how this cost can be non-parametrically identified, separately from consumers' ability to get a discount and marginal utility of income. The application of this model to individual-level data on refrigerator transactions reveals that, conditional on negotiating, consumers get, on average, 41% of the available surplus and incur an average cost of $28 to initiate a negotiation, which is relatively smaller than the average gains. Demand estimates show that the magnitude of these non-pecuniary costs' affects retailer profits, and the retailer can increase profits by lowering these costs. A move to fixed pricing not only reduces retailers' profits by 37% but also lowers consumer surplus by 18%. Ignoring these costs results in biased estimates of consumers' willingness to pay, translating to annual losses of $1.6 million in the current study setting.

Keywords: bargaining, fixed pricing, Nash equilibrium, bargaining costs, price discrimination

JEL Classification: D4, C7, L1