Knowledge that Transforms

We investigate the sensitivity of cross-brand pass-through estimates to two types of pooling: across stores, and across regular price and promotional price weeks. Using the category data from Besanko, Dubé, and Gupta (2005), hereafter BDG, we find consistent support across all 11 categories for the predictive power of the wholesale prices of substitute products for retail shelf prices. A Bayesian procedure is used to address the small sample issues that arise in the absence of pooling. Even though the unpooled results render our inferences for specific cross-brand pass-through magnitudes reported in BDG as imprecise, consistent with McAlister (2007), we do find significant empirical support for cross-brand pass-through. We next assess the sensitivity of cross-brand pass-through estimates to pooling. This requires us to construct a much longer time series of 224 weeks for the refrigerated orange juice category, in contrast with the 52-week samples used in BDG and McAlister (2007). We find strong empirical support for the predictive power of wholesale prices of substitute products for retail shelf prices. In addition, we find evidence of nonzero own- and cross-brand pass-through elasticities for which our inferences are much more precise. These findings are robust to the separation of regular and promotional price weeks. However, the magnitudes of own-brand and cross-brand pass-through are quite different during promotional and regular price weeks. Our results clearly show that with longer data series and more robust models that can handle small sample sizes, there is evidence of cross-brand pass-through, substantiating the findings in BDG. Finally, we comment on why our results are entirely consistent with both the theoretical and empirical literatures on category pricing and retailer behavior.

In this paper, we extend the standard Hotelling model of product differentiation to incorporate a second dimension of consumer heterogeneity that relates to the quantity of the product consumers wish to buy. This extension allows us to derive optimal nonlinear pricing rules chosen by competing sellers when offering differentiated products in the marketplace. It also permits us to assess whether sellers find it optimal to offer quantity discounts in such a setting, and the implications of such discounts on their profitability. We find that offering quantity discounts corresponds, indeed, to equilibrium behavior. The extent of discounting declines the less differentiated the products. Surprisingly, when sellers offer to consumers a choice between two different-sized packages, their profits are, at most, as high as when such a choice is unavailable. Moreover, when utilizing nonlinear pricing rules is not feasible, the profits of the sellers actually decline when they offer consumers a choice between different-sized packages. A limited empirical investigation supports the comparative statics we derive in our theoretical model.

The goal of this brief note is to provide the reader with an appreciation of how this paper was initially conceived, to state what I think are the paper's key insights, and to outline a few of the many challenges and opportunities that still exist in studying channel management issues.

We propose a dynamic programming framework for retailers of frequently purchased consumer goods in which the prices affect both the profit per visit in the current period and the number of visitors (i.e., store traffic) in future periods. We show that optimal category prices in the infinite-horizon problem also maximize the closed form sum of a geometric series, allowing us to derive meaningful analytical results. Modeling the linkage between category prices and future store traffic fundamentally changes optimal pricing policy. Optimal pricing must balance current profits against future traffic; under general conditions, optimal long-run prices are uniformly lower across all categories than those that maximize current profits. This result explains the empirical generalization that category demand in grocery stores is inelastic. Parameterizing profit per visit and store traffic reveals that, as future traffic becomes more sensitive to price, retailers should increasingly lower current prices and sacrifice current profits. We also determine how the burden of drawing future traffic to the store should be distributed across categories; this is the foundation for a new taxonomy of category roles.

Guadagni and Little (1983) had a surprising (to the authors) number of citations, presumably because it was the first paper to build a useful model with UPC scanner panel data. More surprising (but not to the authors) was that the model, compared to those in most academic papers, found widespread practical application. The reason for this was that a small, entrepreneurial consulting firm developed and sold applications based on the model. The paper also generated a substantial follow-on of academic literature. Examples illustrate a few of the directions in which later research went.

In several marketing contexts, strategic complementarity between the actions of individual players demands that players coordinate their decisions to reach efficient outcomes. Yet coordination failure is a common occurrence. We show that the well-established psychological phenomenon of asymmetric dominance can facilitate coordination in two experiments. Thus, we demonstrate a counterintuitive result: A common bias in individual decision making can help players to coordinate their decisions to obtain efficient outcomes. Further, limited steps of thinking alone cannot account for the observed asymmetric dominance effect. The effect appears to be due to increased psychological attractiveness of the dominating strategy, with our estimates of the incremental attractiveness ranging from 3%–6%. A learning analysis further clarifies that asymmetric dominance and adaptive learning can guide players to an efficient outcome.

One of the most controversial findings in Morgan and Rego (2006) was that two widely advocated loyalty metrics, “Net Promoter” and “Number of Recommendations,” have little or no value in predicting the financial outcomes of firms. We argue that neither measure was actually examined and that conclusions about the predictive value of these measures cannot be drawn from their analysis. A primary problem is that the measures used in Morgan and Rego (2006) do not adequately adjust for the presence of neutral word-of-mouth activity. Nevertheless, Morgan and Rego (2006) provide important information regarding other common customer metrics and firm financial outcomes. We are unaware of another longitudinal study that examines the predictive value of satisfaction and loyalty metrics in such a comprehensive way.

We examine the ability of the “Net Promoter” of Morgan and Rego (2006) measure constructed using behavioral word-of-mouth (WOM) data to provide insights into the Net Promoter © customer loyalty concept popularized by Reichheld (2003), which is indicated by a score constructed using attitudinal “intention-to-recommend” data. We show that despite differences in data and operationalization, the two measures are very closely correlated and behave remarkably similarly when examined relative to a third related variable, customer satisfaction.

Switching marketing channels is an expensive and sticky decision. While a number of theories suggest efficiency and strategic differences between channels, there is virtually no work on combining these ideas into an empirically workable methodology to assess the impact of a channel switch. In this study, we undertake to close this gap with an empirical study of the sports drink market, featuring competing producers and heterogeneous channels. We estimate demand and cost parameters for a number of alternative models of competitive interaction and use these estimates to study the switching of Gatorade from its extant (independent wholesaler) channel to the direct store delivery (DSD) channel belonging to Pepsi. Our initial results indicate the following: Pepsi should switch Gatorade to the DSD channel only if (i) the switch decreases Gatorade's manufacturing cost by at least 14%, or (ii) the switch increases the share of profit it can obtain by at least 13%, or (iii) the switch enhances demand by the equivalent of a price cut of 4.96¢ for a 32-ounces package. Absent these increases, Pepsi should not switch. Our methodology and results speak to both managers contemplating a channel switch and antitrust authorities faced with the task of evaluating the consequences of a change in vertical structure.

The strategy Philip Morris adopted in 1993 featured a one-time, permanent, publicly announced price cut, an event referred to as Marlboro Friday. Little is known about the impact of permanent and publicly announced price cuts on consumer brand switching behaviors for an addictive product. In the context of Marlboro Friday, we investigate (1) how consumers' brand choices are affected by a permanent price cut, (2) whether differential and dynamic effects of permanent price cuts occur for different types of consumers, and (3) the implications of publicly announced permanent price cuts on consumer brand switching behavior in the long run. We develop a dynamic structural brand choice model that allows for consumer forward-looking behavior, learning, and addiction, and investigate how consumers adjusted their brand choice behaviors before and after this permanent price cut. Using unique consumer panel data pertaining to cigarette purchases before and after the event, we provide behavioral explanations of whether and how the drastic and permanent price cut represented an effective step to encourage brand switching for an addictive product and a necessary step for Philip Morris to combat the growing market share of generic brands.