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Market-Based Solutions to Vital Economic Issues
Research
Nov 19, 2020

Perceived vs. Negotiated Discounts – The Role of Advertised Reference Prices under Price Negotiation

Abstract

Retailers routinely post two prices on the price tag – a posted or sale price, and a higher regular or an advertised reference price. Together, these prices create a perception of an initial discount that the consumer is getting. In this paper, we investigate the impact of this initial perceived discount (IPD) on the negotiated discount, demand and revenue when prices can be negotiated. Utilizing data from a large durable goods retailer where consumers are observed in their natural decision making environment, we first provide evidence that an increase in IPD is associated with a reduction in the negotiated discount. Next, we conduct a lab experiment where subjects make negotiation and purchase decisions for multiple products, and are randomly assigned to different values of IPD. Based on the experimental data, we estimate that a $1 increase in IPD lowers the negotiated discount by 4.7 cents, and that 75% of this decrease can be attributed to a reduction in the subject’s likelihood to initiate a negotiation. As compared to fixed pricing, increase in demand accounts for only 54% of the increase in revenue as IPD increases; thereby, pointing to the importance of the effect of IPD on negotiated price. Finally, we find that a seller has an incentive to set an exaggerated advertised reference price under bargaining as compared to fixed pricing. We discuss the implications of these findings for researchers, retailers and policy makers such as the Federal Trade Commission which closely monitor deceptive pricing.


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