A Model of Price Promotions with Consumer Search

This paper presents a price discrimination model of price promotions with consumer search. There are two types of consumers differing in their reservation prices, and the consumers with the higher reservation price incur costs in searching for promotions. We consider two variants of the model, one where the seller is a monopolist in both segments of the market, and the other where the seller faces competition in the low reservation price segment. In equilibrium, consumers search decisions are based on their correct expectations about the frequency and depth of promotions, and the firm(s) promotional strategy correctly anticipates the search behavior it will generate. We show that even a monopolist will find it optimal to randomize his promotions in order to price discriminate more efficiently. With competition in the promotional market, the seller becomes more aggressive in his promotional policies, even more so as search costs increase. But the high reservation price consumers end up worse off compared to the monopoly. By distinguishing explicitly between promotions and regular prices, our approach provides a way to build a theory of the choice of promotion vehicles (e.g., coupons, mail-in-rebates, and shelf-price reductions)