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Supermarket Competition: The Case of Every Day Low Pricing

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  • Rajiv Lal

    (Stanford University)

  • Ram Rao

    (The University of Texas at Dallas)

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    Abstract

    Every Day Low Pricing (EDLP) strategy has proved to be a successful innovation resulting in higher profits to supermarkets adopting it in competition with Promotional Pricing (PROMO). Conventional wisdom attributes this success either to lower costs or to EDLP better serving time constrained consumers, while discouraging cherry pickers who seek promotions. However, it is unclear that such cost savings are being fully realized since EDLP stores also engage in price promotions. Also, continued existence of PROMO stores means that costs are not the only factor, and they compete effectively without relying just on the cherry pickers. Furthermore, experimental evidence suggests that a supermarket cannot obtain higher profits by merely setting constant low prices, leading to the question: exactly what makes EDLP successful? This question is of particular relevance to both academics and practitioners who have been intrigued by the success of this retailing strategy. More generally, the retailing issues addressed in this paper, the economic analysis of competition, and the empirical findings should be of interest to the broader community of researchers and managers. We investigate the factors contributing to EDLP's success by analyzing the competition between supermarkets through a game theoretic analysis of a market consisting of both time constrained consumers and cherry pickers. Key features of our model are: consumers shop and purchase a basket of goods based on price announcements by stores and rational expectations of unannounced prices; stores carry more than one good and compete through prices, service, convenience, and appropriate communication strategies; and no exogenous cost asymmetries. We derive the conditions under which retailers choosing different strategies (EDLP and PROMO) is a perfect Nash equilibrium. Our analysis shows that the EDLP store's offering of constant every day low prices is an equilibrium outcome, endogenously determined. Successful implementation of the EDLP strategy involves communication of relative basket prices, implying that merely setting constant low prices is not viable. We further demonstrate that while time constrained consumers find every day low prices at EDLP attractive and cherry pickers the promotions at PROMO, clientele effects are in fact more complicated. Specifically, in equilibrium the PROMO store offers a higher service level as desired by time constrained consumers and the EDLP store a lower service level in keeping with the needs of cherry pickers. This choice of service by the two stores results in a cleaner segmentation of the market. The higher relative basket price and service at the PROMO store results in a larger base of time constrained consumers to shop at the PROMO store and a larger base of cherry pickers to shop at the EDLP store, even though some cherry pickers continue to visit the PROMO store to avail of the price specials. In this way, our results contradict the conventional wisdom on EDLP strategy as being mainly geared towards time constrained consumers. Finally, industry profits are higher in an EDLP-PROMO equilibrium than when stores adopt identical strategies. Our analysis and results also offer a more complete characterization of the EDLP and PROMO strategies. Indeed, we show that EDLP and PROMO strategies are positioning strategies, rather than merely pricing strategies, with different elements: price/promotions, service, and communications. While the EDLP store uses basket prices to attract both segments, the PROMO store uses service and price specials to compete in the time constrained and cherry picking segment, respectively. Given these different approaches of the two stores, the communication strategies of the EDLP and the PROMO stores emphasize these differences as well. In this way we show, as suggested by Corstjens and Corstjens (1994), that positioning in a retail context involves developing multidimensional strategies appealing to all segments, while each element of the strategy may focus on a different consumer segment. This is in contrast to the traditional view of segmentation in which different products in a product line, for example, are designed to appeal to different segments. We complete the analysis by examining the data from the trade press and a survey conducted in a major metropolitan area. These data, while limited in scope, support our theoretical results.

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    File URL: http://dx.doi.org/10.1287/mksc.16.1.60
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    Bibliographic Info

    Article provided by INFORMS in its journal Marketing Science.

    Volume (Year): 16 (1997)
    Issue (Month): 1 ()
    Pages: 60-80

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    Handle: RePEc:inm:ormksc:v:16:y:1997:i:1:p:60-80

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    Related research

    Keywords: retail competition; every day low pricing; segmentation and positioning; consumer expectations; game theory;

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