Hai Che, K. Sudhir, and P.B. Seetharaman
Executive Summary
The authors propose an empirical procedure to investigate the pricing behavior of manufacturers and retailers in the presence of state-dependent demand (i.e., when consumers' current brand choices are influenced by their previous brand choices). Rather than assuming that firms are perfectly forward looking and accordingly solve for dynamic equilibria that would arise in the presence of such state dependence in brand choices, the authors systematically evaluate whether boundedly rational firms indeed look ahead and, if so, to what extent (i.e., how many periods ahead?) when setting prices.
The authors illustrate the procedure using household-level scanner panel data on breakfast cereals and replicate the substantive results using data on ketchup. The authors find the following: (1) Omission of state dependence in demand biases inference of firm behavior (i.e., tacit collusion is erroneously inferred) when firms are competitive. (2) The observed retail prices are consistent with a pricing model in which both manufacturers and retailers are forward looking (i.e., they incorporate the effects of their current prices on their future profits). However, the firm's time horizon when setting prices is short-term (i.e., they look ahead by only one period), suggesting that firms are boundedly rational in their dynamic pricing behavior. (3) Even a myopic pricing model of firms that accounts for state dependence in demand is a reasonable approximation of the observed prices in the market. The findings have implications not only for policy planners who are interested in understanding the nature of interfirm competition in the cereals category but also for cereal manufacturers that are interested in taking competitors' pricing reactions into account when setting wholesale prices on their cereal brands and for retailers that simultaneously manage retail prices of multiple brands of cereals at their stores.
Biography
Hai Che is Assistant Professor of Marketing in the Haas School of Business at the University of California, Berkeley. He received a BA in Economics at Fudan University, an MA in Economics at the University of Toronto, and an MSBA and a PhD in Marketing at Washington University in St. Louis. His primary research areas include consumer database marketing, pricing, advertising, and sales promotion strategies. He has been researching consumer and firm behavior in grocery retailing, pharmaceutical, and insurance markets, as well as in political advertising campaigns.
K. Sudhir is Professor of Marketing at the Yale School of Management. He was previously on the faculty at the Stern School of Business at New York University. He received his PhD from Cornell University. His research spans a wide range of markets, including automobiles, film, grocery retailing, movies and DVDs, personalization services, banking, and high technology. His research topics of interest include structural models of competition and channels, slotting allowances, personalization services, international diffusion, advertising responsiveness forecasts, and customer lifetime valuation. He received the 2003 Frank Bass Dissertation Paper Award. He was a finalist for the 2001 John D.C. Little Best Paper Award in Marketing Science and received an honorable mention for the 2001 Best Paper Award in International Journal of Research in Marketing. He serves on the editorial boards of Journal of Marketing Research and Marketing Science.
P.B. Seetharaman is Associate Professor of Marketing in the Jesse H. Jones Graduate School of Management at Rice University. Although Seethu continues to engage in applied econometric research pertaining to state dependence in consumers' brand choices eight years after defending his doctoral thesis at Cornell University in 1998, his current research interests have broadened to include industries outside the packaged goods sector, such as energy, direct marketing, movies, automotive, and durable goods. Seethu holds a BTech and MS in Chemical Engineering from the Indian Institute of Technology, Madras, and the University of Utah, respectively. Seethu served on the faculty in the John M. Olin School of Business at Washington University in St. Louis for six years before moving to Houston in 2004. Many of his ongoing research relationships are a legacy from his Wash University days.
Journal of Marketing Research, Vol. XLIV, No. 3, August 2007
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