Volume Discounts, Loss Leaders, and Competition for More Profitable Customers

Authors:
Patrick DeGraba
Working Paper:
260

When some customers are more profitable to serve than others, one might expect sellers to compete more vigorously for the more profitable customers. One way sellers might do this is to sell goods that are purchased primarily by the most profitable customers using a lower mark-up than on other goods. This allows the firms to give discounts to more profitable customers without offering them to less profitable customers. This paper presents a model in which competing multi-product firms facing customers that purchase different quantities of goods, set prices in this manner. This model suggests a theory of multi-product pricing in which the markup on any particular product is inversely related to the average profitability of the customer that purchases the good. One interesting implication of this paper is that loss leader pricing might be viewed as a way for firms to compete more vigorously for more profitable customers. Such an explanation offers another characteristic of products that should be used as loss leaders. This explanation provides potentially testable implications about the types of goods that can (or ought to) be used as loss leaders and can explain why grocery stores sell turkeys as loss leaders at Thanksgiving and lower the price of eggs at Easter, but not flowers on Mother's Day, or candy on Valentines Day.