Variable Pricing: A Customer Learning Perspective

Recent works question the benefit of Promotional Pricing (Hi-Lo) formats. In this essay, we characterize a setting in which cost-disadvantaged firms would rationally and profitably opt for the Hi-Lo format. Essentially, cost-disadvantaged retail firms, such as mall outlets and smaller chains lacking the economies of scale of their rivals, charge higher prices than their cost-competitive rivals. These firms will want to and are able to reduce customer sensitivity to price differences by pursuing a variable pricing (Hi-Lo) strategy, whereas a cost-advantaged firm will wish to pursue Every Day Low Price (EDLP). We demonstrate that in experimental settings consumers’ sensitivity to payoff differences declines in observed payoff variability. We then show that in real settings, lower price firms experience reduced market share during high price variability periods.