commonplace book redux

The four biggest British supermarket chains all offer some form of price-match guarantee, promising that their customers could not save any money by shopping elsewhere. On the face of it, they seem like a good thing: a sign that fierce competition is lowering prices. But economists have long been suspicious of such promises, which can leave consumers worse off.

The problem is that price-match guarantees can blunt the logic of competition. Suppose a car dealership worries about a rival undercutting its prices and stealing customers. Even if the dealership can respond by cutting its prices too, it might lose sales in the interim. A price-match guarantee offers a pre-emptive defence. […]

There is no evidence that Britain’s current crop of price-match guarantees has hurt consumers. However, researchers have linked similar promises elsewhere to sustained high prices for groceries (Hess and Gerstner 1991), tyres (Arbatskaya et al. 1999a) and even shares (Edlin and Emch 1998). Wonks have confirmed the finding in the laboratory, too (Datta and Offenberg 2005). […]

Another mooted justification for the guarantees is price discrimination: selling to different types of consumers at different prices. For instance, if some customers are too busy to shop around, a firm can sell to them at a high price while using a guarantee to attract more price-sensitive, hassle-tolerating customers. This is great for profits, but sometimes benefits consumers too.

Finally, a price-guarantee may be an attempt to signal genuinely lower prices and thus stand out from the crowd. That is probably how most consumers interpret them. This works only if there is a genuine difference in efficiency between rival stores, such that only one can afford to sell on the cheap. Then, the nimble firm might want a price war in order to speed the lumbering one’s demise. In such circumstances, any attempt by the lumbering firm to collude tacitly is futile; if it offers a guarantee, its bluff will be called. So when low-cost firms make such promises, consumers can take them as a sign of a competitive offering.

This does not seem to be what is happening in Britain, however. There, it is the more expensive supermarkets that are promising to match each others’ prices. Only one has pledged to match the deals on offer at Aldi and Lidl, nimble low-cost rivals that are making inroads into the market.

The Economist, Guaranteed profits, 12 February 2015