Potential Profitability and Decreased Consumer Welfare Through Manufacturers' Cents-Off Coupons

Abstract

It seems peculiar that so little attention has been paid to potential adverse effects of manufacturers' cents-off couponing policies especially considering the volume and cost of their distribution. In fact, it has been reported that in 1985 a total of $180 billion worth of coupons was issued. The majority were distributed blindly--approximately 60 percent in freestanding inserts, 31 percent printed in newspapers and magazines, and the remaining nine percent by mail or attached to the product package itself. Thus, given the reported four percent redemption rate, approximately $7.2 billion worth of coupons was used in 1985 (Clements 1986). On the cost side, one survey estimated the cost of freestanding newspaper inserts to be approximately $7 per thousand with the cost increasing for other types of distribution (Clements 1986). If it is assumed that the average coupon value is $0.30 and the cited cost figure is employed, a low estimate of the fixed cost of coupon distribution in 1985 would be $4.2 billion. Clearly, even this rough estimate demonstrates that couponing costs are not a trivial use of resources. Although the formal model of third-degree price discrimination employed in this paper occupies a time-honored position in the literature of economics, its implications in this area appear to have been widely ignored by consumer advocates. The fact that potential losses resulting from cents-off couponing are is some sense voluntary (all consumers have the option of redeeming coupons) may account for this lack of interest because this type of price discrimination is not prohibited under the Robinson-Patman Act. Also, the view that manufacturers' cents-off coupons are mainly promotional may alleviate concern over the types of losses discussed here. This paper examines the potential magnitude of the increase in oligopolistic manufacturers' profits due to a policy cents-off couponing and the resulting changes in consumer welfare and resource allocation. In addition, evidence is presented in support of the hypothesis that observed couponing policies of U.S. manufacturers are motivated by their desire to increase profits through third-degree price discrimination--a practice that results in welfare losses to consumers. Third-degree price discrimination involves the ability of a producer to separate customers into two (or more) distinct demand groups and charge two (or more) different prices to members of each group. In contrast, first-degree price discrimination or perfect price discrimination involves selling each unit of a good at its demand price with the last unit being sold at marginal cost. Second-degree price discrimination or block pricing entails selling the first block of output associated with the price of say, [P.sub.1] or greater at [P.sub.1], the second block associated with a demand price less than [P.sub.1] but greater than or equal to [P.sub.2] at [P.sub.2]([P.sub.1] > [P.sub.2]), and so on until the last block is sold at marginal cost. While some of the conclusions of this paper have been dealt with by other researchers (Narasimhan 1984; Phlips 1983; Robinson 1933; Schmalensee 1981; Tirole 1988; Vilcassim and Wittink 1987; Yamey 1974), the approach taken here differs in that it attempts to quantify the probable magnitudes of the welfare effects and profit potential of oligopolistic manufacturers' couponing policies within the framework of a third-degree price discrimination model. An innovative simulation approach which offers a useful alternative methodology for future research is introduced. Moreover, the idea that products redeemed with a coupon carry additional marginal cost of redemption is incorporated into the analysis. As is expected, this will lower the quantity produced when compared to the outcome under single oligopolistic pricing. This investigation will be limited to markets in which products are already well established and the demand curves facing each firm in a market will be assumed to be constant. …