Price Reduction Strategy for a Multi-Category Retailer

Abstract

Multi-category businesses often reduce the price of one category to generate purchases for other categories. The extra profit from related purchases will hopefully justify the sacrificed margin in the promoted category, and eventually lead to overall profit increase. The author develops a model incorporating three critical factors that determine the magnitude of the price promotion effect: the profit margins, the sales volumes, and the own- and cross-category price elasticities. The model shows that only in certain conditions can a price cut lead to net profit increase. Retailers reduce the prices of the target category as well as the complementary categories to create the maximal price-cut image. This strategy often results in the loss of total store margin, though the sales increases. The reason for the profit loss is because the retailer has given away the margins of the target category as well as that of the complementary categories. The author suggests a managerial procedure for a storewide pricing decision. The first step is to identify categories into complementary groups according to the cross-category elasticity estimates. The second step then selects carefully a target category for each complementary group. This implementation can maximize the profit increase, increase the sales and still maintain a storewide price reduction image.