Why do manufacturers issue coupons? An empirical analysis of breakfast cereals

1. Why do manufacturers issue coupons? An empirical analysis of breakfast cereals Nevo and Wolfram Presented by Huanren (Warren) Zhang 2/22/2012

3. Static Monopoly Price Discrimination • Couponing is a tool for price discrimination • Only more price-sensitive customers bother to clip, save and use coupons • Manufacturers can use coupons to sort customers into groups with distinct price elasticities.

4. However… • Procter & Gamble’s senior vice presidentof advertising once said “I don’t like couponing. Period.”

5. Static Monopoly Price Discrimination • : profit when the consumers are faced with full price and price with coupons • is continuous and twice differentiable with a unique optimum at • : profit with uniform price, peaked with optimum at • Proposition:

6. Price Differentiation A direct implication of the proposition is that coupons and shelf prices are positively correlated

7. Relevant Liturature • Existing work uncovered patterns consistent with the price-discrimination interpretation of coupons: • Coupon users have more elastic demand than nonusers (Narasimhan 1984) • Low-priced generic products have lower market shares if the brand-name manufacturers coupon heavily (Sethuraman and Mittelstaedt, 1992) • Larger percentage of consumers use coupons for brands with higher shelf prices (Vilcassim and Wittink, 1987) • Few work is done on the relationship between shelf prices and coupons

8. Static Monopoly Price Discrimination • Unrealistic for cereal markets • Not monopoly • Ignores the changes in demand over time • Manufacturers do not sell the shelf price to retail consumers • Managers set coupon policies that may not fully internalize profit-maximizing incentives

9. Other models • Oligopoly Price Discrimination • Dynamic Demand Effects • Retailers’ Objectives • Retailer or manufacturer costs

10. Oligopoly Price Discrimination • Under symmetry assumptions, the conclusion of monopoly price discrimination can be carried onto oligopolistic industries (Holmes 1989) • BUT, under certain conditions, price discrimination may lead to lower prices and profits (Corts 1998)

11. Oligopoly Price Discrimination • Professors Prefer Raisin Bran • Students prefer Cheerios

12. Oligopoly Price Discrimination To compete with Cheerios, Raisin Bran may also reduce its shelf price To increase profit, Raisin Bran offers coupons to students P ↓ To keep the market share and profit, Cheerios may reduce the shelf price P ↓

13. Oligopoly Price Discrimination • Prices fall for all consumers if the coupon users and nonusers have different brand preferences (“best-response asymmetry”) • Assess the influence of strategic interaction by investigating the effect of the presence of coupons for competing brands

14. Dynamic Demand Effects • Low-valuation consumers are willing to postpone purchases • Sellers periodically lower prices to clear out low-valuation consumers • Coupons are issued in response to inter-temporal patterns in demand (accumulation of low-valuation consumers)

15. Dynamic Demand Effects • Coupons tend to follow periods of low-volume sales • The quantity demanded would be lower following a period when coupons were issues

16. Dynamic Demand Effects • Coupons tend to follow periods of low-volume sales • The quantity demanded would be lower following a period when coupons were issues • Coupons can also be used to induce repeated purchase

17. Retailers’ Objective Functions • When they have market power, the retailers (e.g. supermarkets) may not change the shelf prices according to the whole sale prices set by the manufacturers • Can use wholesale prices to examine whether the changes on shelf prices are driven by retailer or manufacturer behavior

18. Retailer or Manufacturer Costs • In periods when demand is expected to be low, manufacturers may simultaneously issue coupons and reduce prices to generate more sales • Managers may reduce price and issue coupon to achieve market share goals by the end of the company fiscal year

20. Data • Cereal Price Data: IRI Infoscan Data Base collected by a marketing firm in Chicago • Coupon Data: research company, Promotion Information Management (PIM)

21. The Model • : brand fixed effects • : city fixed effects • : time trend of in prices • : brand-fixed effects to vary by city • : city-fixed effects to vary across quarters • : the quarter effects to vary by brand

22. We need to understand the negative correlations between prices and coupons

23. Cross-Brand Effects The negative coefficients are driven by the interaction between manufacturers’ and their competitors’ couponing

24. Dynamic Effects • Reduced-form Vector Autoregressive (VAR) model

25. Dynamic Effects

26. Dynamic Effects Coupons and prices Granger-cause volume but not vice versa

27. Dynamic Effects • Coupons and prices Granger-cause volume but no vice versa • Manufacturers’ decisions to coupon are not a function of previous quantities sold • Coupons may induce consumers to try new brands

29. Conclusion: Why Coupons? • Strategic interactions between manufacturers • Incentives given to the people within firms who make decisions about coupons • The effects of coupons on repeat purchases