The Power of Revealing True Prices [Consumer Protection]

Does competition make firms more honest? Over 50 years ago, the Federal Trade Commission (FTC) assumed the answer was “yes” when it stopped enforcing its deceptive pricing regulations. Since that time, competition has increased significantly, particularly in the crowded U.S. retail trade. However, contrary to the FTC’s hypothesis, deceptive pricing has proliferated during the same period.

There are thousands of articles, reports, and websites warning about deceptive pricing, showing evidence of it, or reporting news about multimillion dollar lawsuits. Consumers’ Checkbook recently tracked prices of 25 major retailers and concluded that “most stores’ sale prices…are bogus discounts” because “at many retailers the ‘regular price’ or ‘list price’ listed is seldom, if ever, what customers actually pay.”

In a new Journal of Marketing study, we develop a descriptive model to explain why competition is more likely to encourage rather than discourage deception. We then propose a potential solution that would apply to firms using reference prices to promote a sale price for an item. That solution would be to require those firms to add to their price labeling the price at which the item was most frequently offered for sale in the previous business period—what we label its “true normal price.”

Our study starts by critically evaluating two assumptions that underlie the FTC’s “competition discourages deception” theory:

The first assumption is that inflated reference prices are largely ignored by consumers, who focus primarily on evaluating the actual selling price in a promoted deal. As such, price competition pushes selling prices lower and renders reference prices harmless.

However, empirical research gives a different picture. A robust finding in the marketing literature is that the addition of a high regular price stated in a price promotion increases consumer willingness to pay. The research illustrates how much consumers value “getting a good deal,” leading to greater sales for the retailer when comparative prices are used.
The FTC’s second assumption is that competition drives out economic incentives to cheat; that is, more competition creates an economic incentive for firms to be truthful. Any temptation to stray will be constrained by natural market forces like consumer vigilance.

However, a number of recent economic models show the opposite; that is, the greater the competition, the more likely the firm will offer “noisy” information in an attempt to shield itself from this competition and, in the process, increase its profits.

Three recent empirical examples support our overall model development, each of which show:

Consistent seller use of high reference prices at which products are never or rarely sold
Consumer choice being altered by these often fictitious reference prices
Firms experiencing financial gains from posting inflated reference prices

All this leads us to conclude that there is a substantial negative impact of fictitious reference pricing on consumer welfare.

The Value of Firms Telling the Truth

After evaluating several regulatory options, we conclude the best way to create real change in firms’ behavior is to require them to tell the truth. The proposal is to require firms to disclose an item’s true normal price (TNP) whenever comparative prices are used in price communications.

To illustrate, let’s say that a furniture retailer puts a sofa on sale as follows:

Regular Price $1399

Sale Price $599

Let us further assume, as is common, that in the past three months the retailer offered the sofa for sale at a price of $1399 for just two weeks. For the other 10 weeks, the sofa was offered at $599. So, $599 is actually the price that is usually charged for the product.

Our proposal is that this “most regular” price be posted alongside the other two prices as a legally required disclosure when a firm wishes to have a comparative price promotion.

That is:

Regular Price $1399

Sale Price $599

True Normal Price $599*

*Legal Disclosure: True Normal Price = the price most often charged by this retailer in the past three months.

The leads to a question: Does providing TNP moderate the effect of a promoted Advertised Regular Price (ARP)? We examine this question through a controlled experiment with 900 participants, where the participants’ choices in the study determined their total expected compensation. We find that the presence of an ARP with a sale price significantly raises the chance that a consumer will buy. However, adding TNP information eliminates the effect of ARP.

Our results support the premise that TNP provision would reduce or eliminate firms’ incentives to give anything but honest information to consumers in their price promotions, and it would have an impact on average market prices, promotions, frequencies, and firm profits. We hope this study leads to a lively debate on the topic.