Service competition in newsvendor retailing with price-matching guarantee.

Author:Geng, Qin
Position:Report
 
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  1. INTRODUCTION

    This paper studies simultaneous decisions of service quality, pricing, and inventory of two competing retailers under demand uncertainty when they both adopt a price-matching guarantee policy. Demand at each retailer is stochastic and dependent on both the price and the service quality. By service, we mean various forms of demand-enhancing activity, which includes customer service, product placement and presentation, promotions, parking lot, advertising efforts, and the overall quality of the shopping experience. The nature of market demand is such that, ceteris paribus, a retailer that increases service quality or reduces price will enjoy demand growth.

    Our work is motivated by the popularity of price-matching guarantee policies in retailing. Many firms today declare that they will match the price of their competitors. This policy can cover a wide range of products, from big ticket items like washers and dryers to low price items including grocery and drug store purchases. Retailers such as Sears, OfficeMax, and Best Buy all offer price-matching guarantees. Some other stores do not advertise their price-matching policy but still match the price upon their customers' request.

    Before matching a lower price, most stores require proof that a competitor is selling an item at a cheaper price. For instance, consumers have to provide evidence of the other firm's price for an identical product--usually this means bringing a flyer or providing a link to another firm's website. Some stores will take customers' word for small price differences. Some companies will call another store to confirm a price. In addition, firms usually have exclusions or limits on their price-matching guarantee policy. For example, stores sometimes refuse to price-match another store's weekend or holiday sales. Some firms will only price match after the customer buys a product from them. Some firms may also balk if the other firm has no inventory of the item. In fact, it is not uncommon for firms to price-match a competitor's price only if the product is available at the competitor.

    The purpose of this research is to provide understanding of service quality, pricing and inventory decisions under the price-matching guarantee policy and demand uncertainty. To this end, we investigate two scenarios: (1) Retailers adopt simple price-matching (guarantee) policy without checking product availability, and (2) Retailers adopt the price-matching (guarantee) policy and will check product availability at the competitor before matching the lower price. To gain further insight, we also examine a baseline scenario in which retailers compete on both service quality and price without price-matching guarantee.

    Through modeling the above four scenarios, we aim to address the following research questions in this paper: (1) How to characterize the equilibrium service quality and price under the two price-matching policies? (2) How do the retailer's service quality decision and the correspondingly other decisions and expected profit compare among the three settings? And (3) How do service quality competition affect our understanding of price-matching guarantee policy?

    To answer these questions, we adopt a game theoretic and newsvendor framework. We consider two retailers that are ex ante identical in the sense that they are undifferentiated in marketing policy and market characteristics. We find that there exists a continuum symmetric Nash equilibrium in the simple price-matching game, and there is a unique equilibrium that is Pareto dominant. In this Pareto dominant equilibrium, retailers provide more service and charge a higher price than in the competitive game. The expected profit in the simple price-matching policy is higher than that in the competitive game if demand is sensitive to price differences and not sensitive to quality differences. We also find that the equilibrium service quality and price increase if demand is more sensitive to quality differences between the two retailers.

    If the retailer checks the other retailer's product availability before matching the price for its consumers, then there might exist an asymmetric equilibrium outcome where one retailer provides more services and charges a higher retail price than the other retailer. In other words, ex ante, identical retailers may end up with different strategies. our extensive numerical study indicates that if demand is not very sensitive to the price differences under the price-matching with product availability policy, retailers may gain more profits than in the simple price-matching game and the competitive game. We attribute this result to less intensive service quality competition and price competition respectively.

    The remainder of this paper is organized as follows. In [section] 2, we review the relevant literature. In [section] 3, we formally define our model and characterize the equilibrium outcome. Models are compared in [section] 4, where we also present numerical examples to supplement the analytical results. We conclude the paper with some remarks on future directions of research in [section] 5. Proofs will be provided upon request to the authors.

  2. LITERATURE REVIEW

    There is a large body of research on the price-matching guarantee in both economics and marketing literature. One well established result is that price-matching leads to monopoly price because the retailer cannot steal consumers from its competitors by undercutting their price and therefore has no incentive to initiate price cuts. This conclusion is based on the assumption that retailers are identical and price-search is costless. In the presence of consumer heterogeneity, retail asymmetry, and costly price search, retailers may utilize price-matching guarantees to price discriminate consumers. Interested readers may refer to Nalca et al. (2010a) for a review of such literature. One paper that touches the issue of service quality is Moorthy and Zhang (2006) which shows that when the service differentiation is large enough, only low-service retailers offer price-matching guarantees. By not using a price-matching guarantee, the high-service retailer position itself as a high-service retailer.

    Our work is most related to Nalca et al. (2010b) which is also the only work we know that studies price-matching policy with inventory decisions. They characterize equilibrium prices and stocking levels when two firms adopt price-matching guarantees under uncertain demand. They find that if simple proof is deemed sufficient for price match, a tacit collusion outcome arises and retailers will make decisions like a newsvendor monopolist. But if firms verify the availability of the product at the competitor's location and match the lower price only if the product is available there, then one firm increases its price and quantity...

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