Bait and ditch: Consumer naïveté and salesforce incentives

Antonio Rosato,Fabian Herweg

doi:10.1111/jems.12336

Abstract

AbstractWe analyze a model of price competition between a transparent retailer and a deceptive one in a market where a fraction of consumers is naïve. The transparent retailer is an independent shop managed by its owner. The deceptive retailer belongs to a chain and is operated by a manager. The two retailers sell an identical base product, but the deceptive one also offers an add‐on. Rational consumers never consider buying the add‐on while naïve ones can be “talked” into buying it. By offering the manager a contract that pushes him to never sell the base good without the add‐on, the chain can induce an equilibrium in which both retailers obtain more‐than‐competitive profits. The equilibrium features price dispersion and market segmentation, with the deceptive retailer targeting only naïve consumers whereas the transparent retailer serves only rational ones.

Highlights

Many consumers are familiar with so‐called bait‐and‐switch strategies whereby customers are first “baited” by merchants’ advertising of products or services at a low price but, upon visiting the store, are pressured by salespeople to consider similar, but more expensive, items (“switching”)
In a series of articles appeared in the “The Haggler”—a column in the Sunday edition of The New York Times (NYT)—journalist David Segal describes a somewhat different strategy employed by large retailers like Staples, BestBuy, and others, which he dubs bait‐and‐ditch: escorting shoppers out of the store, empty‐handed, when it’s clear they have no intention of buying an expensive warranty or some other add‐on for some steeply discounted electronic appliance—a practice that employees at Staples themselves call “walking the customer.”
In most of the models in this literature, deceptive and transparent equilibria result in the same profits for the firms as profits gained from naïve consumers via the add‐on are passed on to sophisticated consumers via lower prices on the base good; in our model, instead, both the deceptive firm and the transparent one attain strictly higher profits in a deceptive equilibrium, with the transparent firm potentially obtaining the lion’s share of the total profits

Summary

| INTRODUCTION

Many consumers are familiar with so‐called bait‐and‐switch strategies whereby customers are first “baited” by merchants’ advertising of products or services at a low price but, upon visiting the store, are pressured by salespeople to consider similar, but more expensive, items (“switching”). There exists a subgame‐perfect equilibrium where exactly one retailer offers its agent the compensation scheme in (14) so that he has no incentives to sell the base good without the add‐on; that is, the sales agent walks sophisticated customers out of the store. For too high transportation cost, some naïve consumers purchase from the transparent firms even though the chain commits to sell only the bundle; that is, there is never direct competition between the two deceptive retailers. In most of the models in this literature, deceptive and transparent equilibria result in the same profits for the firms as profits gained from naïve consumers via the add‐on are passed on to sophisticated consumers via lower prices on the base good; in our model, instead, both the deceptive firm and the transparent one attain strictly higher profits in a deceptive equilibrium, with the transparent firm potentially obtaining the lion’s share of the total profits. He shows that loss leading naturally arises in this framework

| CONCLUSION

Pure profit maximization

Chain retailers sell only the bundle

Chains optimal strategy and existence