9. SIGNALING QUALITY WITH PRICES
ALEXANDER KRAEMER | BOCHUM | AUGUST 2010
Student of Management and Economics (Diplom), ID.no. 108 004 216 923
alexander.kraemer@rub.de
16. 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)
17. Pricing strategies
Price
Penetration Strategy
Skimming Strategy
Costs
Time
Source: Robinson (1975), Koku (1995)
18. 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
Source: Cooper (1984)
19. High and declining prices
High quality firm
Low costs
Fakes quality
High costs
Will lose great sales volume
Willing to restrict sales volume
Over time high costs to signal
Will lose less sales volume
false quality
Over time less costly to signal
quality
Low quality firm
Source: Bagwell & Riordan (1991)
20. Freeriding low-quality firms
High information asymmetry
Nothing prevents signaling with high prices
Price does not reveal the true quality of a product
Source: Alpert et al. (1993)
21. 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)
22. When is price relevant?
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
Source: Jones & Hudson (1996)
24. Prices signal true quality
in every equilibrium
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
Source: Wolinsky (1983); Gabor & Granger (1966)
26. Price-Quality Correlations
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
Source: Steenkamp (1988)
29. 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)
30. What Price Quality?
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
Source: Horowitz & Lockshin (2002)
31. What Price Quality?
Consumers go into a store with a style and a price range and then
look for wines within those parameters
All prices in Australian Dollars Source: Horowitz & Lockshin (2002)
(1 AUSD = 0.72 EUR as of 19.08.2010)
32. How do consumers use signals to
assess quality?
Analysis 6,000 European wine consumers
Speciality of paper: connoisseurs & nonconnoisseurs
Do all consumers use signals in the same way?
Source: Gergaud & Livat (2007)
33. How do consumers use signals to
assess quality?
Source: Gergaud & Livat (2007)
34. Prices as Quality Signals
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
Source: Schnabel & Storchmann (2010)
37. 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
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Quality
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Advertising Model