An Empirical Analysis of Price Discrimination Mechanisms and Retailer Profitability

Abstract

Retailers typically engage in some form of price discrimination to increase profitability. In this article, the authors compare the impact on retailer profitability of two price discrimination mechanisms: quantity discounts based on package size (second-degree price discrimination) and store-level pricing or micromarketing (third-degree price discrimination). Whereas the latter has been well addressed in the marketing literature, there is limited empirical research on the use of quantity discounts for price discrimination. Using store-level sales data, the authors estimate a structural demand model, accounting for parameter heterogeneity and price endogeneity. They combine the parameter estimates with a model of retailer pricing to conduct optimal pricing and profitability simulations under several scenarios, ranging from constraining the retailer not to engage in any form of price discrimination to the least restrictive scenario of setting nonlinear price schedules specific to each store. The pricing simulations enable the decomposition of profitability as a result of the different forms of price discrimination. Profits are greatest when retailers combine second- and third-degree price discrimination. The authors find that the ability to engage in second-degree price discrimination contributes more to retailer profitability than does third-degree price discrimination.