Consumer sophistication, word-of-mouth and 'False' promotions

Not all retail price promotions provide consumers with additional monetary value. For instance, a retailer might raise the retail price of an item just before a sale and then “promote” the product by listing the initial price as the sales price. This paper addresses the question “under what conditions would a firm give such a ‘false’ promotion and with what regularity?” with an analytical model composed of two competing retailers and two segments of consumers. The duopoly firms sell substitutable products in a finite number of periods to consumers. In each period, each firm can choose to offer a real promotion, a false promotion, or no promotion. One segment of consumers is sophisticated and is able to discern false promotions based on the two firms’ promotional offerings. The other segment of consumers is naive and trusts each firm’s claimed promotional offering. Sophisticated consumers pass information on the existence of false promotions via word-of-mouth (WOM) to a fraction of naive consumers. We find that the possibility of offering false promotions can improve the payoffs for both firms, especially when the market is more competitive. Moreover, even when consumers can identify that a firm is offering a false promotion and pass this information to others, a firm still finds it optimal to offer such promotions from time to time. In general, the firm is more likely to offer false promotions in an environment with lower competition, fewer sophisticated consumers, and weaker WOM.