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Article Excerpt
Although negotiating over prices with sellers is common in many markets such as automobiles, furniture, services, consumer electronics, etc., it is not clear how a haggling price policy can help a firm gain a strategic advantage or whether it is even sustainable in a competitive market. In this paper, we explore the implications of haggling and fixed prices as pricing policies in a competitive market. We develop a model in which two competing retailers choose between offering either a fixed price or haggling over prices with customers. There are two consumer segments in our analysis. One segment, the hagglers, has a lower opportunity cost of time and a lower haggling cost than the other segment, the nonhagglers. When both retailers follow the same pricing policy, then a haggling policy is more profitable than a fixed-price policy only when the proportion of nonhagglers is sufficiently high. We find two kinds of prisoners' dilemma: under some conditions, a more profitable haggling policy can be broken by a fixed-price policy, and under other conditions, a fixed-price policy can be broken by a haggling policy. Surprisingly, we show that under some conditions, an asymmetric outcome with one retailer haggling and the other offering a fixed price is also an equilibrium.
Key words: competitive strategy; marketing strategy; price discrimination; game theory
History: This paper was received August 1, 2001, and was with the authors 15 months for 2 revisions; processed by Sridhar Moorthy.
1. Introduction
Finally, no price guessing and no games. You can shop CarMax hassle-free by browsing our lot or shopping through our computer AutoMation touch-screen inventory.
CarMax Brochure
"No haggle" means that every Saturn retailer should stick to whatever price it decides to sell at. The retailer should give you the same price regardless of your bargaining skills.
Saturn's Website
Although negotiating prices with sellers is common in many product categories such as consumer electronics, white goods, services, etc., nothing piques consumers' interests quite like the process of negotiating the price of a car. Interestingly, this interest is largely negative because of the dreaded negotiation with the dealer. Indeed, this has led some firms, such as Saturn and CarMax, to eliminate the price-negotiation process and move to "no-haggle" prices. However, in an industry well known for its price-negotiation process, a priori it is not clear how committing not to negotiate can give a firm a strategic advantage. In this paper, we focus on competing retailers' strategic incentives to adopt haggling or fixed-price policies. There are two central questions in our analysis: (1) Can a retailer gain a strategic advantage either by committing not to negotiate or by giving customers the option to negotiate, and (2) how sustainable are fixed-price and negotiated-price policies in a competitive market? We answer both questions by developing a model of two competing retailers and examine how customer heterogeneity affects the two firms' equilibrium choices of pricing policies.
>From a seller's perspective, haggling is useful because it potentially can serve as a price discrimination mechanism that allows the seller to charge different prices to different consumers. For example, an initial price offer can depend on the seller's beliefs about differences in consumers' reservation prices (e.g., Ayres and Siegelman 1995), their abilities to haggle (Arnold and Lippman 1998), or their cost of time. The basic idea is that the firm can bundle the good for sale with a characteristic, in this case haggling, that is costly for consumers. Chiang and Spatt (1982) show that differences across consumers in their valuation of time can allow a monopolist to imperfectly price discriminate, so that the price of the good depends on the amount of time the consumer expends at the store. Thus, a consumer who waits longer by haggling for an extended period of time may pay a lower price. However, the essential question of how haggling works in a competitive environment is less clean In the automobile industry, many dealers have experimented with fixed prices, but subsequently reverted back to haggling, claiming that consumers were merely using their fixed price to get a better deal at a competing haggling dealer (J. D. Power and Associates 1992). This suggests that a commitment to a fixed price may fall apart in a competitive environment. In this paper, we look at the differences between haggling and fixed prices in a competitive environment, and study how customer heterogeneity affects the equilibrium pricing policy.
The benefits of discrimination by segmenting the market are well established--as long as consumers differ in their valuations of a product, then a firm earns higher profits if it differentiates its offering to consumers with differing valuations. For discrimination to be observed in equilibrium, not only do consumers have to be willing to buy the product at the stated price, but each type of consumer has to buy the package that is intended for him or her. We develop a model in which haggling can serve as a discrimination device. In particular, the basic structure of our model assumes that the market consists of two types of consumers: low- and high-price sensitivity. The low price-sensitivity consumers have a higher cost of haggling than the high price-sensitivity consumers. Thus, under certain conditions, a seller can use consumers' propensity to haggle as a means of identifying their sensitivity to price. Consumers in our model are distributed uniformly along a Hotelling (1929) line and they can purchase the product from either of two retailers located at opposite ends of the line. Retailers can offer either a single fixed, advertised price or they can price discriminate by advertising a price and then haggling over this price with some customers; in equilibrium, customers with high haggling costs pay the advertised price and the low haggling cost customers pay a lower, negotiated price.
When both retailers follow identical pricing policies, we find that they would both be better off with a haggling price policy only when the proportion of nonhaggling customers in the market is sufficiently high. Even in equilibrium, we find that only when the proportion of consumers who do not want to haggle is sufficiently high will both firms adopt a haggling policy. When this proportion is low, then a retailer can do better by unilaterally deviating from a haggling to a fixed policy. This creates a prisoners' dilemma for the retailers--although both would be better off with a haggling policy, each retailer's incentives to deviate to a fixed price policy forces both to offer fixed prices. In addition, we find the prisoners' dilemma also works in the other direction--although both would be better off with fixed-price policies, they both end up with less profitable haggling price policies. Finally, we also find that we can have an asymmetric equilibrium In which one retailer follows a fixed-price policy and the other a haggling policy. An asymmetric equilibrium is interesting in that it softens the competition between the two retailers.
Price competition between haggling retailers is also analyzed in Bester (1989, 1993). However, the primary focus of these papers is the analysis of pricing sub-games and not the choice of pricing policies. In contrast, our interest is in the retailers' choice of pricing policies and the effect of consumer heterogeneity on these policies. Thus, our work is more closely related to papers addressing the choice of haggling versus fixed-price policies. Several important papers have related market characteristics to the price policy chosen by sellers. For example, Riley and Zeckhauser (1983) show that when a seller has incomplete information about buyer types, the seller always prefers to post a price than to haggle. This occurs because there is a single seller who incurs a cost as consumers arrive sequentially at the store. (1) On the other hand, Wang (1995) shows that when bargaining and posting prices entail the same costs, then the seller is better off bargaining. This suggests that overall cost considerations are what lead to posted price selling--when a seller has many objects to sell to a large number of buyers, then we are more likely to see posted prices. Finally, in some cases we see we can have markets in which hagglers and posted-price sellers coexist (Spier 1990, Bester 1994).
Our work is also related to Corts (1998), who considers the choice of price discriminating or charging a uniform price by two vertically differentiated firms. In his analysis, the two competing firms engage in all-out competition when they price discriminate, but not when they adopt uniform prices. As a result, although both firms would be better off with a fixed price policy, the prisoners' dilemma forces both firms to price discriminate. Our model differs from Corts in that we consider two horizontally differentiated firms selling identical, branded products, and price discrimination occurs as part of a bargaining process between the buyer and the seller. In addition, Corts (1998) does not have customer heterogeneity in terms of haggling costs, which is an important determinant of pricing policies in our work. Interestingly, in contrast to Corts, we find that the prisoner's dilemma can work in the opposite direction--a fixed-price policy breaks the more profitable price-discrimination policy of haggling.
In considering a variety of different selling formats, Wernerfelt (1994) shows that price advertising, seller colocation, and bargaining can all be effective when consumers do not have full information and incur search costs in evaluating the product. He shows that under certain conditions of low search costs and a high level of competition, two sellers may choose a bargaining policy to shield themselves from Bertrand competition. Bargaining is attractive in Wernerfelt (1994) because prices are not advertised and buyers bargain down from their individual valuations. In contrast, in our model, prices are advertised and bargaining consumers always have the option of paying the advertised price. Our focus is on the case where buyers have full information about the quality of the product sold at competing retailers but differ in their cost of bargaining. Thus, our model applies to the case of many product durables, such as cars and electronics, where consumers choose between two retailers, knowing that the identical product is available at competing locations.
Our work is also related to research on the adoption of everyday low pricing (EDLP) versus promotional pricing by supermarkets (e.g., Lal and Rao 1997, Bell and Lattin 1998). Although a fixed-price policy bears some similarity to an EDLP strategy, the problem we address differs on several important dimensions. First, we focus solely on cases where a consumer has to purchase a single, big-ticket item, such as a car or a washing machine, from a single retailer. The EDLP research looks at a basket of goods that would allow some consumers to make purchases at both stores. Purchasing a basket of goods leads to the interplay among product categories and retailers that is crucial to the EDLP context. Second, we allow consumers to negotiate prices at the retailer; thus, the same retailer charges different prices to different consumers. In contrast, stores that use promotional pricing pull in consumers through advertised specials on selective products, but once at the store, all customers pay the same price for the good. Finally, EDLP and promotional pricing strategies arise when consumers are not fully informed about prices before they visit the store. In contrast, we consider the case where consumers have full information through advertised prices.
The outline of this paper is as follows. In the next section, we lay out our assumptions about retailers and consumers. In [section] 3 we analyze three strategies that can be seen in the market. In [section] 4, we present the equilibrium analysis and we conclude the paper in [section] 5.
2. Model
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