A signalling model of loss leader pricing strategy

Abstract

AbstractThe traditional theory of loss leader pricing strategy generally relies on assumptions such as high consumer search cost, product complementarities, and short‐sighted consumer rationality. We argue that with the rise of e‐commerce, consumer search cost is substantially reduced, and in many cases, loss leader goods have no obvious complements but many substitutes. In this paper, we set up a model with both base product and advance product where the latter's quality is observable only to a fraction of the consumers. It is shown that a firm may use loss leader pricing strategy to signal the quality of its advance product to the uninformed consumers. Therefore, as a signalling device, loss leader pricing strategy is conducive to correct the lemons problem.