Risk Aversion and Preference for Store Price Format

Retailers design pricing strategies that can be characterized as a choice of store price format between offering everyday low prices (EDLP) and high / low prices (HILO). EDLP stores set prices which are constant over time, while HILO stores set prices which are higher than EDLP stores on average, but use frequent sales featuring deep discount prices on a smaller set of products. When consumers decide where to shop, they are typically uncertain about retail prices that vary from day to day and place to place. My hypothesis is that a consumer's choice of store price format is driven by attitudes toward the risk involved in basket price variation. To test this hypothesis, I devise a laboratory experiment that consists of two stages. In the first part of the experiment, I use an incentive-compatible lottery choice experiment to identify subjects' risk attitudes. In the second part of the experiment, I use an incentive-compatible choice-based conjoint experiment. My econometric model largely confirms the hypothesis. I find that risk-averse consumers tend to choose EDLP stores while risk-taking consumers HILO stores. Risk-averse consumers may perceive that shopping at HILO stores is risky due to higher price variability and have an incentive to choose EDLP stores. Shopping at EDLP stores may allow consumers to minimize the risk that unplanned purchases of expensive products may increase their basket price. On the other hand, risk-taking consumers prefer HILO stores because they may have a positive probability of finding a product with lower price. The practical implication of the result is that retailers may use store price format as a screening device to attract particular types of consumers. Retailers may design appropriate marketing strategies to their target customers.