Reports

Dynamics of Consumer Response to Price Discounts

James M. Lattin and Randolph E. Bucklin, 1988, 88-111

Subject
The time-varying aspects of consumer response to promotional price discounts.

Type of Report
Explication of model; empirical testing.

Objective
To model consumers' response to price discounts as a dynamic phenomenon and to empirically test the model using household level purchase records collected through supermarket scanners.

Method
Reviews literature on consumer response to price; develops an analytical model for response to price discounts incorporating time-varying behavior of consumers; tests the model empirically using scanner data.

Target Audience
Packaged goods marketers and academic researchers.

Conclusions
In today's supermarket environment, consumers are frequently exposed to temporary price discounts. This research describes a model of how consumers form expectations about future price discounting, based on their previous exposure to such activity at the point of purchase. This expectation is the reference price discount for the brand. The research assumes that consumers use such points of reference as bases of evaluation; at each purchase opportunity, consumer response is influenced by the disparity between the reference price discount and the actual status of the brand.

As shown in the figure below, response is hypothesized to be greatest when the consumer has no expectations of a price cut (i.e., the reference price discount is zero). This response reflects not only the economic value provided by the deal, but also the unexpected "bargain" value of finding a special offer on the brand. When consumers encounter frequent discounting on a given brand, they may come to think of it as a discounted brand and expect to find it regularly offered at a discount(i.e., reference price discount is positive). When this happens, the difference between the actual discount and the consumer's reference price discount narrows and the "bargain" value of the deal disappears. The decline in response is the "wearout" associated with the deal.

If the consumer continues to perceive the brand as available on deal and the brand returns to regular price, response will actually fall below the baseline level. This drop has been called the "sticker shock" effect: Consumers expect to find the brand available at a discount and are unpleasantly surprised to find the higher price.

Since a consumer's reference price discount is difficult to measure directly, the proposed model captures it indirectly from the consumer's exposure to the brand. The model holds that a consumer's exposure to the brand's point-of-purchase promotional pricing determines whether the consumer thinks of it as a discount or non-discount brand. At low levels of exposure to discount pricing, the consumer thinks of the brand as a non-discount brand and establishes a reference price discount of zero. At high levels of exposure to discount pricing, the consumer thinks of the brand as a discount brand and establishes a positive reference price discount. In this threshold model, at some point the exposure to the brand on discount "outweighs" the exposure to the brand at regular price and the consumer's point of reference changes.

In addition to modeling the consumer's brand-level response as a function of reference price discount, the approach is extended to category-level response. At the category level, consumers are hypothesized to develop reference category values which depend on prior exposure to discounting activity by all available brands in the category. Reference category value is also conceptualized in a threshold formulation; this value increases when recent exposure to deals in the category tips the consumer's perception of the category from non-discount to discount

The brand and category-level response hypotheses are empirically tested by calibrating brand choice and purchase incidence models using IRI scanner data on ground coffee for a store-loyal panel. The results for brand choices show that the reference price discount for a brand has a significant impact on consumer response. The model yields a statistically significant improvement in fit when tested against a model of brand choice not incorporating reference effects. The results for purchase incidence show that reference category value also has a significant impact and that the model incorporating these effects outperforms a model without them.

Researcher Comments
The authors reflect

"Although recent research has documented the success of promotional pricing in stimulating immediate sales response, concerns about the long-run implications of price promotion continue to mount. If consumers come to expect price cuts as the rule rather than the exception, then price promotions lose their ability to boost sales and become unprofitable. This research addresses this issue by incorporating the dynamic nature of consumer response.
"The findings in the brand choice model imply that frequent discounting by manufacturers can increase expectations and ultimately undermine consumer response to a brand. The purchase incidence model suggests that consumers who have established a reference value for a product category are more likely to buy from the category during deal periods and avoid buying during non-deal periods. In the long run, overly intensive discounting may end up (1) redistributing demand, (2) lowering baseline sales, and (3) increasing the proportion of sales made at discounted margins. These implications suggest that manufacturers should consider the long-run effects of the discounting policies as well as the short-term effects on sales volume in formulating promotional strategies.
"Future research on the dynamics of consumer response to deals should aim to develop improved measures of reference price discounts and reference category values. Perhaps controlled experimental research might help to improve our understanding. The model should also be extended to address the purchase quantity decision in addition to purchase incidence. Such an extension would permit us to model category and brand volume directly and assess the profitability of different promotional policies."

About the Authors
James M. Lattin is Associate Professor of Marketing and Management Science and the James and Doris McNamara Faculty Fellow for 1987-88 at the Graduate School of Business, Stanford University. Randolph E. Bucklin is a Ph.D. Candidate at the Graduate School of Business, Stanford University.

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