Price-Matching Guarantees as a Direct Signal of Low Prices
A Price-Matching Guarantee (PMG) is a firm's promise to reimburse its consumers if they find a lower price elsewhere. Most PMG promises are advertised together with a statement that the firm offers low prices, such as “we are so confident that our prices are the best in the industry we are willing to back them with a price-match guarantee”.
Experimental evidence finds that consumers perceive stores that offer a PMG to have low prices. Hence, a PMG may act as a signal of low prices which attracts consumers to the store.
However, once the consumer enters the store, it seems that there is no incentive for the firm to actually charge a low price. The firm could offer a PMG to attract consumers and then charge a high price knowing that, once the consumer is in the store, he will still purchase the product, even at such high price, because consumers are usually time constrained at the moment of purchase.
It appears that the consumer belief that PMG stores charge low prices paradoxically leads those stores to charge high prices. This prediction is not consistent with empirical evidence that finds that, in many markets, PMG stores do offer lower prices than the remaining stores.
The economics and marketing literature have solved this apparent paradox by finding that if firms are sufficiently asymmetric, PMGs can be a credible signal of low prices. For example, if two retailers face different costs for the product they sell, only the retailer with low cost offers a PMG and it optimally charges the lowest price. The retailer with high cost refrains from offering a PMG because, if it did, it would sell to its consumers at a suboptimal price.
The previous literature finds that, if firms are differentiated (e.g. different costs or service quality), a PMG may serve to communicate such differentiation to consumers. In the above example, consumers would infer that a PMG store has lower costs and, for that reason, it also charges a lower price. However, PMGs exist in many markets where firms are almost identical.
An interesting question, from a managerial standpoint, is whether it is possible for otherwise identical firms to differentiate themselves by their PMG strategies. This paper finds that a PMG can be a credible signal of low prices even if firms are identical. In this case, a PMG acts as a direct signal of low prices: consumers perceive PMG stores to have low prices not because they expect them to have low costs or low service, but simply because they offer a PMG.
A critical aspect behind this result is that a PMG allows consumers a grace period in which they can search after purchase (usually between one week to one month). If a consumer visits a PMG store and finds that it charges a high price, the consumer may still buy the product because he may be time constrained at the moment of purchase. However, the consumer may have some free time later to search for a lower price. In that case, he will return to the store to collect a refund.
A PMG store anticipates that if it charges a high price many of its consumers will return to collect refunds. For this reason, it is optimal for the PMG store to actually charge a low price.
Mamadehussene, S. (2018). Price-Matching Guarantees as a Direct Signal of Low Prices. Journal of Marketing Research.
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Quarterly Newsletter – 2017:Q3
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