presentation

Source: Scitovszky (1944-45)

Back in the day, an apple was an apple.

Source: Scitovszky (1944-45)

Today, it‘s a bit more complicated...

As a consumer you have a great information disadvantage.

Source: Akerlof (1970)

How can you find out the true quality of a product?

Source: Akerlof (1970)

Source: Cooper (1984)

Source: Cooper (1984)

Source: Cooper (1984)

SIGNALING QUALITY WITH PRICES

ALEXANDER KRAEMER | BOCHUM | AUGUST 2010Student of Management and Economics (Diplom), ID.no. 108 004 216 923alexander.kraemer@rub.de

Theoretical Literature

Firms I Consumers

Empirical Literature

Overview I Aspects

Resumé

References

Agenda

Theoretical Literature

Why signal?

the informed the uninformedSource: Koku (1995)

Source: Koku (1995)

Why signal?

information gap

the informed the uninformed

Why signal?

Building a bridge over the information gap

Source: Koku (1995)

An example: Job application

Source: Spence (1973)

Indices

Gender, age or race

Ex ante observable information

Signals

Work experience, education or motivation

Ex post obeserable information

Can be manipulated by applicant

Manipulation of signals might incur costs

Source: Spence (1973)

Price

Time

Skimming Strategy

Penetration Strategy

Costs

Source: Robinson (1975), Koku (1995)

Pricing strategies

Source: Cooper (1984)

Mixed qualities Non-constant costs can play important role

Average costs can rise when sales fall

Reduction of false signaling firms

Increase of information on quality

Leaving some false firms, but also good

High quality firm

Low quality firm

High costs

Willing to restrict sales volume

Will lose less sales volume

Over time less costly to signal

quality

Low costs

Fakes quality

Will lose great sales volume

Over time high costs to signal

false quality

Source: Bagwell & Riordan (1991)

High and declining prices

Freeriding low-quality firms

Source: Alpert et al. (1993)

High information asymmetry

Nothing prevents signaling with high prices

Price does not reveal the true quality of a product

The use of price as a signal depends on...

Consumers‘ ability to detect quality variation

Level of price awareness of consumers

Availability of other cues of quality

Actual quality variation

Price variation

Source: Zeithaml (1988)

Source: Jones & Hudson (1996)

Consumers rely on more than one signal

There is an optimum number of signals

The more expensive the product

the more signals the consumer uses

When is price relevant?

Source: Zeithaml (1988)

Relationship between price, quality and value

Source: Wolinsky (1983); Gabor & Granger (1966)

Consumers have certain quality expectancies

Consumers penalize firms who signal the wrong

quality

Existence of expectancy equilibria

Prices may serve as signals which differentiate

quality levels

Consumers have qualities they will spend money on

Prices signal true quality in every equilibrium

Empirical Literature

Price-Quality Correlations

Source: Steenkamp (1988)

Most products price and objective quality are positively correlated

Most correlations are weak and vary over time

Strength of correlation depends on two factors

Type of product (durable vs. nondurable)

Degree of price despersion in a product category

Price is a poor market signal of quality for most products

Price-Quality Relations

Source: Faulds & Lonial (2001)

Price-Quality Relations

Source: Faulds & Lonial (2001)

Cultural differences Prices have an allocative effect in china

No quality is transported

Low prices have same effect as high prices

Source: Erevelles et al. (2001)

What Price Quality?

Source: Horowitz & Lockshin (2002)

What cues do consumers use to select wine?

Quality ratings by James Halliday as dependant variable

Analysis of Australian and New Zealand wines

Influence of cues is different for each of the wines

e.g. Regional influence on wine quality and the winery style

Some producers might be better than others

Positive relationship between price and quality

Relationship is not linear

Increase in price does not explain equal incraese in quality

What Price Quality?

Source: Horowitz & Lockshin (2002)All prices in Australian Dollars(1 AUSD = 0.72 EUR as of 19.08.2010)

Consumers go into a store with a style and a price range and then

look for wines within those parameters

How do consumers use signals to assess quality?

Source: Gergaud & Livat (2007)

Analysis 6,000 European wine consumers

Speciality of paper: connoisseurs & nonconnoisseurs

Do all consumers use signals in the same way?

How do consumers use signals to assess quality?

Source: Gergaud & Livat (2007)

Prices as Quality Signals

Source: Schnabel & Storchmann (2010)

Following Bagwell & Riordan (1991)

price signals respond positively to wine quality

price signals respond negatively to increasing information

Usage of two Datasets

Main Wine Trade Fair & Gault Millau wine guide for Germany

Small fraction of uninformed buyers

Prices as Quality Signals

Source: Schnabel & Storchmann (2010)

Resumé

Quality is signaled by prices

Theoretically:

the long run will increase the level of quality

(decrease of low quality firms due to costs)

Empirically:

Price-quality correlations are weak and vary over time

Different cultures, different price-quality perceptions

Consumers know what they want to buy

State of information matters

Resumé

Thank you for your attention. Questions?

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