Impact of Store Brands

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RESEARCH PAPER NO. 1026

The Impact of Store Brands on Manufacturer Trade Deals and Retail Price Promotion*

James M. Latiin1

January 1988 Revised December 1988

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Associate Professor of Marketing and Management Science- and-the James and Doris McNamara Faculty Fellow for 1988-1989. The author gratefully acknowledges conversations with Randolph E. Bucklin, Louis P. Bucklin, and Rajiv Lal which led to the research reported in the paper. This paper also benefitted from comments by Peter Reiss, V. Srinivasan, Birger Wernerfelt, participants in the Marketing Seminar at the Australian Graduate School of Management, and members of the second annual Stanford Marketing Summer Camp. This work was supported in part by a grant from the Marketing Science Institute, and the Graduate School of Business, Stanford University.

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The Impact of Store Brands on Manufacturer Trade Deals and Retail Price Promotion

ABSTRACT In this research, we examine the nature ofpromotional pricing activity by manufacturerand retailer. We analyze the relationship as a single-period sequential game between a manufacturer offering a single brand A and an independent retailer who sells brand A and its own store brand B. We begin by showing, in the absence of store brand competition, that while the retailer will discount the price of brand A to take advantage of consumer stockpiling behavior, the manufacturer will not offer trade deals. We then show, in the presence of store brand competition, the conditions under which the manufacturer will use trade deals as an incentive to achieve favorable retaii:pric ng-for-brand A relative to the store brand. KEY WORDS: Retail Price Promotion, Manufacturer Trade Deal, Store Brands

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INTRODUCTION

Every year, manufacturers spend billions of dollars on trade promotion, hoping to provide retailers with some incentive to devote special merchandising support to their brands and pass through price discounts to the consumer at the point of purchase. Growth in promotional spending has increased so substantially that it now accounts for a greater percentageof the marketing budget than does advertising. As tradepromotion expenditures have grown, so too has the occurrence of retail price discounting activity. Consumers, sensitized by the onslaught ofpoint-of-purchase promotion, now purchase an ever increasing volume of product at special discount prices. With the increasing importance ofpromotion has come a considerable amount of research which seeks to explain the existence ofprice promotion. One rationale suggests that pricepromotion is used by a monopolistic seller as a mechanism fortemporal price discrimination. Blattberg, Eppen, and Lieberman (1981) argue that a retailer may use short-term price deals to encourage consumer stockpiling, thereby reducing inventory carrying costs. Theirmodel rests on the assumption that the retailer can discriminate across consumers on the basis of inventory carrying costs. Jeuland and Narasimhan (1985) also offer a rationale based on price discrimination, in which they assume that there is a positive correlation between consumer holding costs and consumption rate. In the context of consumer durables, Sobel (1984) offers a price discrimination argument to explain the occurrence of sales. In each case, price promotion works because the seller is able to encourage purchases by one type of consumer (those with low holding costs or low reservation prices) without a substantial loss in higher margin sales to the second type of consumer (those with high holding costs or high reservation prices). A second rationale offered by researchers is that price promotions are the outcome of a mixed-strategy equilibrium between manufacturers. Varian (1980) was the first to -3-

suggest that the randomized prices ofa mixed strategy could be interpreted as price promotions. In the marketing literature, models based on mixed strategy equilibria have been offered by...
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