Adopting Cost Transparency as a Marketing Strategy: Analytical and Experimental Exploration

Abstract

Should sellers disclose their cost information to potential buyers? If yes, under what conditions should firms adopt this cost transparent strategy? We examine these questions by using an analytical approach followed by an experimental analysis. To begin, we develop a monopolistic model to show that the transparent strategy is optimum if and only if products are of low perceived quality and relatively high unit cost. This result implies that luxury goods firms (with high perceived quality and relatively low unit cost) should not disclose their cost information. Next, our analytical result reveals that the quality differentiation between firms in a duopoly is a key driver for predicting whether different firms should adopt the transparent strategy or not. Specifically, no firm should adopt the transparent strategy when the quality differentiation is high because different firms can set different selling price to segment the market. However, when the quality differentiation becomes less prominent, competitive pricing alone is not sufficient and the transparent strategy becomes the additional lever for firms to segment the market. Using a laboratory experiment, we validate our analytical results to show that as quality differentiation decreases, the adoption of the transparent strategy increases but the selling price decreases.