Price-Matching Guarantees, Retail Competition, and Product-Line Assortment
37 Pages Posted: 3 Nov 2003
Date Written: September 2003
Price-matching guarantees (PMGs) are offers to match or beat a competitor's price on a specific item. Such guarantees are extremely common in U.S. retail practice, and appear on their face to be very beneficial to consumers because they make an implicit promise to the consumer that she "won't pay more" by shopping at the PMG-offering retailer. However, the evidence about why PMGs are used, and their effect on prices, consumer welfare, and retail profitability is mixed. Some authors have found that PMGs can actually facilitate tacit collusion between competing retailers, not competition. Others find that mitigating factors such as "hassle costs" limit the collusive impact of PMGs. The limited empirical evidence in the area provides some support for the collusive view but overall it is inconclusive.
The existing analytic literature makes the assumption that each retailer sells a single product that is identical with (or completely substitutable for) the product of any competing firm. But, in reality, competing retailers often sell multiple products, and these products do not always overlap. This poses a conundrum for theory. Since PMG's only apply when consumers find a lower price on the same item at a competing store, why would retailers ever offer PMGs and not have identical product lines?
In this paper, we start with the real-world observation that some retailers may be more space-constrained (have less shelf space) than others, and we seek to address the conundrum by examining firms' competitive incentives to offer PMGs, and the implications of doing so, in a world where retailers may vary in their ability to carry a broad (versus a narrow) product line. These issues are particularly relevant, given that, in practice, most if not all retailers face some limitations on their shelf space.
Our results show that with unlimited shelf space, competing retailers both offer PMGs and both stock the entire available product line. Monopoly pricing prevails, consistent with the earlier literature. But in a market with asymmetric shelf-space availability, either product variety will be severely limited or retailers will offer different arrays of products. Weak substitution between products leads to the latter, with pricing between the differentiated-products Bertrand and monopoly levels; strong substitution leads to the former, with pricing at the monopoly level. In a market where both retailers are shelf-space-constrained, the equilibrium strategies also depend on the degree of substitutability of products in the market. If products are weak substitutes, the retailers carry non-overlapping product lines, differentiated-products Bertrand pricing prevails, and PMGs are not offered. In contrast, if products are not very differentiated, the retailers carry the same product, offer PMGs, and set monopoly prices.
In short, our results demonstrate that the nature of product variety, and the availability of retail shelf space, are key market characteristics that jointly and strongly affect the optimality of PMGs and the resulting pricing, profitability, and consumer welfare characteristics of the market. product-line assortment
Keywords: Price-matching guarantees, retail competition,
JEL Classification: D4, L5, M3
Suggested Citation: Suggested Citation