DP16947 Loss Leading as a Threat to Brands

Author(s): Roman Inderst, Martin Obradovits
Publication Date: January 2022
Keyword(s): Loss leading, price competition, price promotion, Product Positioning, reference-depending preferences, Relative thinking, vertical differentiation
JEL(s): D11, D22, D43, L11, L15
Programme Areas: Industrial Organization, Organizational Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=16947

Manufacturers frequently resist heavy discounting of their products by retailers, especially when they are used as so-called loss leaders. Since low prices should increase demand and manufacturers could simply refuse to fund deep price promotions, such resistance is puzzling at first sight. We explain this phenomenon in a model in which price promotions cause shoppers to potentially reassess the relative importance of quality and price, as they evaluate these attributes relative to a market-wide reference point. With deep discounting, quality can become relatively less important, eroding brand value and the bargaining position of brand manufacturers. This reduces their profits and potentially even leads to a delisting of their products. Linking price promotions to increased one-stop shopping and more intense retail competition, our theory also contributes to the explanation of the rise of store brands.