Price-matching guarantees, retail competition, and product-line assortment

Price-matching guarantees (PMGs) are offers to match a competitor's price on a specific item. Such guarantees are extremely common in U.S. retail practice, and their impact has been studied in several published papers. The existing analytic literature models each retailer as a single-product seller; most work assumes that each retailer's product is identical with (or completely substitutable for) the competitor's product. In reality, competing retailers often sell multiple products, and these products do not always overlap, or may overlap partially but not totally. Furthermore, retailers that offer PMGs routinely exclude certain offerings from PMG coverage. This raises the interesting question of how product variety and product-stocking factors affect retailer decisions about offering PMGs.

In this paper, we simultaneously consider three factors of retailing importance that imply results consistent with PMG use and nonuse: the ability to choose to stock the same product as, or a product differentiated from, a competitor's offering; the possibility of shelf-space limitations on the ability to stock complete variety; and the category-demand-enhancing effect of variety. These are sensible and realistic descriptive factors shaping retailers' product and pricing decisions, and because they have not been considered jointly in the prior literature on PMGs, their joint consideration helps to expand our understanding of the drivers of PMG implementation and impact. In the presence of these three factors, we examine retailers' decisions about whether to offer a PMG, what product(s) to stock, and how to price the product(s) stocked.

Our results show that shelf-space limitations have an important influence on PMG provision: in particular, when retailers are shelf-space constrained, and product substitutability in the category is sufficiently large, choosing to use PMGs (which by definition also requires stocking identical products) is strictly less profitable than enduring Bertrand (price) competition but enjoying retail product differentiation. The result that PMGs can be profit-reducing relative to head-to-head retail competition is a novel one, driven in our model by the opportunity costs of stocking identical products, i.e., the inability to benefit from the demand-enhancing effects of variety and the differential (small or large) between Bertrand pricing and PMG pricing levels. We further show that under asymmetric shelf-space availability, either product variety will be severely limited or retailers will offer a different array of products. Weak substitution between products leads to the latter, with pricing between the differentiated products Bertrand and monopoly levels; strong substitution leads to the former, with pricing at the monopoly level. Our results also show that with unlimited shelf space, both competing retailers offer PMGs, stock the entire available product line, and enjoy monopoly pricing. Given our focus on product variety issues, we also relate our results to the literature on branded variants.

Our results demonstrate that the nature of product variety, the availability of retail shelf space, and the category-demand-enhancing effect of variety are key market characteristics that jointly and strongly affect the optimality of PMGs and the resulting pricing and profitability characteristics of the market.