Counter-Cyclical Price Promotion: Capturing Seasonal Category Expansion Under Endogenous Consumption

Abstract

This paper provides a new and complementary explanation for a pricing puzzle for seasonal products, namely, counter-cyclical pricing, drawing on the category-expansion effects of price promotions. Our study emphasizes the seasonal fluctuation in promotion frequency rather than the change in aggregate mean price across seasons, which motivates most existing studies. We propose a rationale for the counter-cyclical price promotions: consumers are more likely to increase category demand in response to promotions during periods of high demand, causing seasonally varying promotion effects on category expansion. We show promotion effects are amplified during high-demand periods if the product category is subject to stockpiling and endogenous-consumption behavior; that is, consumption is a function of inventory. Using scanner-panel data on the canned soup category, we find households' purchase patterns are consistent with the endogenous consumption hypothesis. We investigate the seasonally varying promotion effects using the framework of a dynamic inventory model with forward-looking consumers (Erdem, Imai, and Keane, 2003; Hendel and Nevo, 2006) by allowing the consumption rate to be endogenous to household inventory and subject to the exogenous seasonal fluctuation in category preference. Our results indicate the long-run promotion effects are underestimated by 32% during periods of high demand if endogenous consumption is ignored, and that with endogenous consumption, the long-run promotion effects increase by 24% across seasons, implying a larger gain of promotions during high-demand periods, which is a motivation for the counter-cyclical price promotions.