Why do manufacturers issue coupons? An empirical analysis of breakfast cereals

Nevo and Wolfram

Presented by Huanren (Warren) Zhang2/22/2012

Static Monopoly Price Discrimination

• Couponing is a tool for price discrimination• Only more price-sensitive customers bother to

clip, save and use coupons• Manufacturers can use coupons to sort

customers into groups with distinct price elasticities.

However…

• Procter & Gamble’s senior vice president of advertising once said

“I don’t like couponing. Period.”

Static Monopoly Price Discrimination

• : profit when the consumers are faced with full price and price with coupons

• is continuous and twice differentiable with a unique optimum at

• : profit with uniform price, peaked with optimum at

• Proposition:

Price Differentiation

A direct implication of the proposition is that coupons and shelf prices are positively correlated

Relevant Liturature• Existing work uncovered patterns consistent with

the price-discrimination interpretation of coupons:– Coupon users have more elastic demand than nonusers

(Narasimhan 1984)– Low-priced generic products have lower market shares if

the brand-name manufacturers coupon heavily (Sethuraman and Mittelstaedt, 1992)

– Larger percentage of consumers use coupons for brands with higher shelf prices (Vilcassim and Wittink, 1987)

• Few work is done on the relationship between shelf prices and coupons

Static Monopoly Price Discrimination

• Unrealistic for cereal markets– Not monopoly– Ignores the changes in demand over time – Manufacturers do not sell the shelf price to retail

consumers– Managers set coupon policies that may not fully

internalize profit-maximizing incentives

Other models

• Oligopoly Price Discrimination• Dynamic Demand Effects• Retailers’ Objectives• Retailer or manufacturer costs

Oligopoly Price Discrimination

• Under symmetry assumptions, the conclusion of monopoly price discrimination can be carried onto oligopolistic industries (Holmes 1989)

• BUT, under certain conditions, price discrimination may lead to lower prices and profits (Corts 1998)

Oligopoly Price Discrimination

• Professors Prefer Raisin Bran

• Students prefer Cheerios

Oligopoly Price Discrimination

To increase profit, Raisin Bran offers coupons to students

To keep the market share and profit, Cheerios may reduce the shelf price

To compete with Cheerios, Raisin Bran may also reduce its shelf price

P ↓

P ↓

Oligopoly Price Discrimination

• Prices fall for all consumers if the coupon users and nonusers have different brand preferences (“best-response asymmetry”)

• Assess the influence of strategic interaction by investigating the effect of the presence of coupons for competing brands

Dynamic Demand Effects

• Low-valuation consumers are willing to postpone purchases

• Sellers periodically lower prices to clear out low-valuation consumers

• Coupons are issued in response to inter-temporal patterns in demand (accumulation of low-valuation consumers)

Dynamic Demand Effects

• Coupons tend to follow periods of low-volume sales

• The quantity demanded would be lower following a period when coupons were issues

Dynamic Demand Effects

• Coupons tend to follow periods of low-volume sales

• The quantity demanded would be lower following a period when coupons were issues

• Coupons can also be used to induce repeated purchase

Retailers’ Objective Functions

• When they have market power, the retailers (e.g. supermarkets) may not change the shelf prices according to the whole sale prices set by the manufacturers

• Can use wholesale prices to examine whether the changes on shelf prices are driven by retailer or manufacturer behavior

Retailer or Manufacturer Costs

• In periods when demand is expected to be low, manufacturers may simultaneously issue coupons and reduce prices to generate more sales

• Managers may reduce price and issue coupon to achieve market share goals by the end of the company fiscal year

Data

• Cereal Price Data: IRI Infoscan Data Base collected by a marketing firm in Chicago

• Coupon Data: research company, Promotion Information Management (PIM)

The Model

• : brand fixed effects• : city fixed effects• : time trend of in prices• : brand-fixed effects to vary by city • : city-fixed effects to vary across quarters• : the quarter effects to vary by brand

We need to understand the negative correlations between prices and coupons

Cross-Brand Effects

The negative coefficients are driven by the interaction between manufacturers’ and their competitors’ couponing

Dynamic Effects

• Reduced-form Vector Autoregressive (VAR) model

Dynamic Effects

Dynamic Effects

Coupons and prices Granger-cause volume but not vice versa

Dynamic Effects

• Coupons and prices Granger-cause volume but no vice versa

• Manufacturers’ decisions to coupon are not a function of previous quantities sold

• Coupons may induce consumers to try new brands

Conclusion: Why Coupons?

• Strategic interactions between manufacturers• Incentives given to the people within firms

who make decisions about coupons• The effects of coupons on repeat purchases