(The) effect of loss leader pricing in online and offline markets

Abstract

As the Internet emerges as a viable shopping channel, online malls are trying various marketing strategies to lure more profitable buyers. One of the frequently adopted tactics in marketing is loss leader pricing. Practitioners have recognized that this does not seem to work in online marketplaces while it has been widely employed in traditional channels. Considering that the new channel has less friction in the market, this study develops an economic model that captures consumer shopping quantity choices based on shopping channel characteristics. Using a duopoly model based on Transaction Cost Economics, it is shown that the lowered transaction costs in the Internet increase cherry-pickers so that the effectiveness of the loss leader pricing strategy is diminished. In addition, we extended the model with the advertising option where the equilibrium of not providing loss leader pricing remains unchanged. The results are supplemented by our empirical evidence. The empirical data shows that loss leader pricing in fact generally attracts a great number of cherry-pickers to the Internet.