Optimal Price and Advertising Policy for a Convenience Goods Retailer

Abstract

Convenience goods are bought without much consideration or effort on the part of the consumer. Buyers don't try to get the best bargain when purchasing individual convenience items. Instead, they adapt their store choice habits so that they can expect, on average, good value for money in the long run. Store choice is governed by aggregate information which is received on the price levels of stores. This is embodied in store price images. A store price image is defined in the subsequent paper as a perceived difference between the store's price level and a reference level that consumers expect of stores about which they have no particular information. Store price images are learnt adaptively over time. We propose a theoretical model of store price image adaptation and a two-stage sales response model. According to the latter, a store's price image and advertising determine the number of customers attracted per period. Sales per visit, however, depend only on the prices actually observed in the store. For this sales model, we have studied the optimal price and advertising policy making simple assumptions of cost. Our main interest is the interaction between optimal advertising and price image. It turns out that image improvement is achieved mainly through pricing; increased advertising follows only after the price image has been improved. Therefore, as long as the price image is poor relative to some optimal equilibrium level, a larger portion of the marketing budget should be allocated to lower prices rather than to advertising. In phases where the price image declines towards the equilibrium, however, heavier advertising is profitable.