Research Note: Price Discrimination as an University of Chicago, 1101 East 58th Street, Chicago, IL 60637 Sloan School of Management, M.I.T., E56-305, 38 Memorial Drive, Cambridge, Massachusetts 02139 [email protected] [email protected] Abstract
We would normally expect this type of offer to increase de-mand or, at a minimum, leave demand unchanged. How- Firms often search enthusiastically for distinguishing traits that ever, because installment-billing offers target credit-con- they may use to price discriminate between segments. Yet thereare occasions in which firms forgo the opportunity to price strained customers, we predicted that the introduction of discriminate and instead charge a single price. Traditional ex- installment billing would prompt an unfavorable quality in- planations for why retailers forgo the opportunity to price dis- ference and reduce demand among quality-sensitive cus- criminate focus on the cost of discriminating, including oper- ational costs, explicit discrimination costs, and implicit We empirically investigated this prediction in a large- discrimination costs. In this paper we identify an additional scale field test with a catalog that offers premium-quality reason for why firms may forgo an opportunity to price dis- jewelry and gifts. Two versions of the catalog were created: criminate. By revealing that a product is being sold to a broad a test version that contained an installment-billing offer, and range of segments, a retailer implicitly claims that the product a control version in which installment billing was not of- is suitable for each segment. However, claiming that a premi- fered. Importantly, the prices in both the test version and um-quality product is suitable for price-sensitive consumers control version were identical. Approximately 240,000 cata- undermines the credibility of a retailer’s quality claim.
logs were mailed, and customers were randomly assigned The signaling explanation was motivated by extensive dis- to either the test version or control version. Results show cussions over more than a year with a major catalog retailer that the installment-billing offer (test version) was associat- that sells premium-quality jewelry and gifts. Discussions with ed with both a reduction in the number of orders received managers revealed that they were reluctant to use any price- and a reduction in aggregate revenue. Offering installment discrimination mechanism that signals their products are tar- billing resulted in approximately $15,000 in lost revenue.
geted at price-sensitive customers. For example, the catalog The only plausible explanation for this counterintuitive find- does not include sale or clearance sections and does not target ing appears to be the signaling theory.
more price-sensitive customers by using separate items. How- To investigate the long-term effects, the catalog agreed to ever, management was under some pressure to consider in- survey their customers to measure how an offer of install- stallment-billing offers, which allow customers to pay over a ment billing affects their customers’ quality perceptions.
series of periods rather than in a lump sum. Management Similar to the field test, two versions of a catalog were cre- feared that offering installment billing may adversely affect ated, and customers were randomly mailed a catalog, along customers’ quality perceptions and demand.
with a short survey. Respondents were asked to browse To investigate this issue, we develop a general game-the- through the catalog and return their responses in a reply- oretic model, illustrate how the model extends to installment paid envelope. The findings are consistent with customer billing, and conduct a large-scale field test. The general beliefs in the signaling model: Offering installment billing model illustrates how selling to multiple segments may lead lowers the perceived quality of the items in the catalog.
to an adverse quality signal. We illustrate how the model The field test and survey findings were both statistically extends to installment-billing offers in a direct-mail catalog.
significant and managerially relevant. Together, the results Installment-billing offers allow customers to spread the total convinced the catalog not to include installment-billing of- payment over a series of payments. All customers have the option of using installment billing, and customers who use (Signaling; Price Discrimination; Installment Billing; Promotions; the plan receive an economic benefit (an interest-free loan).
Vol. 20, No. 3, Summer 2001, pp. 315–327


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