Do high prices signal high quality? A theoretical model and empirical results
| DOI | https://doi.org/10.1108/10610420410546989 |
| Pages | 279-288 |
| Published date | 01 June 2004 |
| Date | 01 June 2004 |
| Author | Jukti K. Kalita,Sharan Jagpal,Donald R. Lehmann |
| Subject Matter | Marketing |
Pricing strategy and
practice
Do high prices signal high
quality? A theoretical
model and empirical
results
Jukti K. Kalita
Sharan Jagpal and
Donald R. Lehmann
The authors
Jukti K. Kalita is at Merrill Lynch, Marketing Analytics Group,
Plainsboro, New Jersey, USA.
Sharan Jagpal is Professor at the Rutgers Business School,
Newark, New Jersey, USA.
Donald R. Lehmann is George E. Warren Professor at the
Columbia Business School, New York, New York, USA.
Keywords
Pricing, Quality, Consumers
Abstract
This paper has three objectives. First, we developan equilibrium
pricing model in which consumers have incomplete information
about bothproduct qualitiesand prices. Specifically,manufacturers
can usehigh prices to signalhigh quality to uninformed consumers.
Furthermore, prices of anygiven brand can vary geographically
across retailoutlets. We show that previous models are special
cases of our model. Specifically, the hedonic regression model
assumes that consumers have full information about all product
qualitiesand prices.Second, we proposea methodology fortesting
price-signaling models. Third, we test ourmodel using data from
consumer reports for several consumer durable and nondurable
products. The results show that firms use prices to signal quality,
regardlessof whether they marketdurable or nondurableproducts.
The results do not support the popular theory that markets for
experience goods are more efficient than thosefor search goods.
Finally, our model outperforms the standard hedonic regression
model for four of the five pro duct categories analyzed.
Electronic access
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The current issue and full text archive of this journal is
available at
www.emeraldinsight.com/1061-0421.htm
1. Introduction
Standard pricing models are incomplete. As
discussed in detail in section 2, the popular
hedonic pricing model implicitly assumes that
consumers are fully informed about all product
qualities and prices. In contrast, geographical price
dispersion models assume that consumers are fully
informed about product qualities but have
incomplete information about the prices of a given
brand across distribution outlets. Price-signaling
models, on the other hand, assume that consumers
have incomplete information about product
qualities. Thus, manufacturers can use high prices
to signal high quality to uninformed consumers.
However, price-signaling models unrealistically
assume that manufacturers sell directly to
consumers (equivalently, the geographical
dispersion of prices across stores for a given brand
is zero). In practice, many manufacturers use
intermediaries (e.g. retailers) to sell their products.
And, as casual empiricism shows, prices for any
given brand vary across retail outlets.
This paper has three objectives. First, we extend
the standard price-signaling model to allow for a
two-level distribution channel in which
manufacturers sell to retailers who, in turn, sell
products to consumers. Consumers have imperfect
information about both product quality and retail
prices for any given brand. Second, we develop an
empirical methodology for testing price-signaling
models. To our knowledge, price-signaling models
have not been empirically tested before. Third, we
test our model using data from consumer reports.
The empirical results strongly support our
theory. Specifically, firms use price signals to
appeal to uninformed consumers, regardless of
whether they market durables or nondurables.
Contrary to popular theory, the markets for
experience goods (e.g. paper towels) are more
inefficient than the markets for search goods (e.g.
VCRs). Finally, for four of the five product
categories analyzed, our model outperforms the
hedonic pricing model.
2. Review of previous pricing theories
This section reviews the theoretical foundations of
the popular hedonic pricing model, search cost
models, and price-signaling models.
The hedonic pricing model
Consider a perfectly competitive market in which
all consumers and producers are fully informed
about product qualities and prices and firms can
enter or exit the market without cost. Then two
brands with identical combinations of attributes/
Journal of Product & Brand Management
Volume 13 · Number 4 · 2004 · pp.279-288
qEmerald Group Publishing Limited · ISSN 1061-0421
DOI 10.1108/10610420410546989
279
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