Chicago Booth Review Podcast Who Sets Supermarket Prices?

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Pradeep Chintagunta: If there are consumers in a market that are willing to pay a high price but demand higher service, and there are consumers who are only willing to pay a lower price but don't require those services, then to leverage all the customers in that market, the parent might choose to price differently across different chains and position them as such.

Hal Weitzman: Parent companies of supermarket chains often delegate the authority to set prices down to the local level. Is that a good idea, and what does it mean for shoppers? Welcome to the Chicago Booth Review Podcast, where we bring you groundbreaking academic research in a clear and straightforward way. I'm Hal Weitzman. Today, I'm talking with Chicago Booth's Pradeep Chintagunta about his research on organizational structure and retail prices. Pradeep Chintagunta, welcome back to the Chicago Booth Review Podcast.

Pradeep: Thanks, Hal. Great to be here.

Hal: Now, we're talking about organization and how the organizational structure of a company can affect retail food prices. Fascinating stuff. First of all, what do we mean by organizational structure?

Pradeep: Essentially, think about a large retailer that operates in different parts of the country needs to make decisions in these different parts of the country. They might organize themselves in terms of geographic divisions, for example. Rather than having just one headquarters making all the decisions, they could have various regional divisions to which they delegate some of the responsibilities that the headquarters would otherwise be making.

Hal: Is that common practice?

Pradeep: It's certainly a widespread practice. I really haven't done any analysis as to the extent to which that it exists, but certainly, the larger an organization becomes, you can see why it becomes more and more difficult to centralize all the functions.

Hal: Okay. That means if we go to a retailer in one state, they have different prices to retail in another state. Not just because of taxes, you mean?

Pradeep: That's correct. That's correct, because things like the local market outlook, the local market competition, the demographics of the people who live there, transportation costs, all these things could differ. As a consequence, prices could be different across the--

Hal: I'm just wondering, because doesn't it make it complicated for advertising? Then you're advertising locally rather than nationally if you're a retailer.

Pradeep: Right, that's certainly possible. A lot of retailers, I think, when they do their advertising at the national level, and I think an example would be something like Whole Foods, you notice that a lot of it is about their assortments, the products, et cetera, rather than things like prices. Whereas a lot of the local advertising, especially in the old newspaper inserts that we used to get, the feature advertising, that would be focused more on prices. The local, I think, now retailers have moved away from those feature ads to providing information on prices in their apps, for example. Those tend to be far more localized.

Hal: Fascinating. I can see now that if you have a centralized structure, that has a different effect on prices than if you have a localized structure. Am I right in thinking that a lot of prior research in your area treated large companies as though they were one single actor rather than these kind of-- what you're describing is a lot of different pricing, which we might not necessarily think about. Is that something that's new, the way you approach it?

Pradeep: First of all, I think I should clarify the context and the context within which the earlier research was done. I think a lot of the earlier work looked at the chain as the unit of analysis. A retail chain would be, for example, Jewel stores in Chicago, that would be a retail chain. What those studies tended to do is that they looked at prices across stores within that chain. Regardless of where they were located, the finding was, by and large, these chains charged uniform prices across all the stores within the chain. That was the finding. Our approach is slightly different because the first observation that we make is that a parent can own multiple chains.

These chains are not necessarily all independent units. They might be owned by a larger organization that we call the parent. By looking at pricing at the parent level, we might arrive at conclusions about prices which are quite different than looking at it at a sub-parent or a chain level. That's, I think, really the point we are trying to make, that really, the organization that we care about is the parent because the parent owns multiple chains, and we want to see how the parent behaves. In some sense, our research is quite consistent with what people have done in the past. They're focused on a different unit of analysis than we have.

Hal: I see. You talked about how the prices are often delegated down to lower levels, and you talked a little bit about why that might be done. Just to cover that, it's done because there are different microeconomies that stores are operating in. Is that right?

Pradeep: Absolutely. For example, a parent can own chains in different states. There could be one chain that operates exclusively in Illinois. There could be another chain that operates exclusively in Florida. These are two different chains. Now, because the context in Illinois is very different from the context in Florida, customers are different, competition is different, prices could be very different in the chain located in Illinois versus the chain located in Florida. For the same parent that owns these two chains, they are having different sets of prices in different areas of the country in which they operate via the chains that they own in those areas.

Hal: Okay. You talk about a new concept for me, price zone. What's a price zone? How's that different from a chain?

Pradeep: The simplest way of thinking about a price zone is a geographic region. In that geographic region, basically, all the stores that the parent owns charges the same price.

Hal: Okay. Regardless of what chain this is?

Pradeep: Regardless of the chain. Essentially, what we find is parents that own multiple chains in a given geographic area tend to price very similarly across those chains, and there was one caveat to that, unless these chains are what we call positioned differently. For example, there are some chains that are the traditional grocery chains versus other chains that could be discounter chains, which basically charge much lower prices and provide fewer services. When such chains are owned by the same parent, now you could have zones determined both by the geography as well as the chain because each of the chains offers very different prices.

Hal: Okay. Does that mean, despite what you just said about discount shops, is it more important to know what price zone I'm in rather than what store I'm shopping in? The price zone determines more of the price I pay than the chain?

Pradeep: Absolutely. Absolutely. As we said, chains owned by the same parent tend to coordinate prices within a given geographic area.

Hal: Most of these price zones are geographically separated, but you also, in this research, found situations where you got multiple retail chains operating under coordinated uniform pricing within a single zone. Explain that.

Pradeep: Basically, I think this is similar to the explanation I gave earlier. If you have multiple chains within a given zone, then all the chains charge the same price. That's what we mean by coordination.

Hal: I see. Again, this has to do with it matters less what shop you shop in and matters more what the location of that shop is.

Pradeep: That's right. As long as these shops are all owned by the same parent. Now, if I am a chain that operates across different geographic areas, then it's possible that I charge different prices because the different geographic areas might be zoned differently in the mind of the parent.

Hal: I see. You're going to have one chain that exists across several price zones.

Pradeep: That's right.

Hal: I see. This coordinated pricing across these different stores, what does that tell us about how the parent company makes its decisions?

Pradeep: The parent company essentially is using information on the characteristics of that local market. That's, I think, ultimately what this is. Because the demographics, because the competition, et cetera, is similar across all the chains that it owns in a given geographic area, it makes sense for the parent to price similarly across these different chains, because they're able to look at the information in that local market and say, "Given this information, this is what we are going to charge." One of the things they also want to avoid is that their own chains competing with each other. If one chain ends up charging a lower price, then there is within-parent competition, which I think things like this will--

Hal: Does it have to do with their supply chains as well? Do parents tend to supply different chains within their group? Do they have the same kind of supply chain?

Pradeep: I think a lot of these parents have warehouses. I don't know the exact details, but it makes sense that a warehouse in a given geographic area would supply to chains in that geographic area, regardless of the banner or the name of the chain.

Hal: Is this also true? Is this true for branded products? Is it true for white-label own-brand products as well?

Pradeep: No, this is true across all products. We look at a set of 800 products, and this is what we find across these products. Now, where the private label products help us is that they help us to identify the parent. Because we know that two chains owned by the same parent would offer the same set of private labels, we are able to identify which chains belong to the same parent.

Hal: You found what you call discrimination by chains, where parents assign different price zones to different chain formats, like the discount chain, you talked about that, even when they're in the same market. What's going on there?

Pradeep: There, I think what the parent is trying to do is to leverage the heterogeneity among consumers and competition that exists within the market. If there are consumers in a market that are willing to pay a high price but demand higher service, and there are consumers who are only willing to pay a lower price but don't require those services, then to leverage all the customers in that market, the parent might choose to price differently across different chains and position them as such. Some chains get positioned as traditional chains that provide all the services and charge a higher price. Other chains get positioned as discounter chains that charge a lower price but also don't provide the level of service.

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Hal: Pradeep, in the first half, we talked about your research about organizational structure and how it affects the prices that we pay in the supermarket for the stuff that we buy. Because we're in price zones, we might think we go to a certain chain, but actually, what we're doing is living in a certain price zone, and that's really what's affecting the prices that we pay. We talked about how parent companies think about this. Just so I understand, are these price zones, do they emerge organically? You talked about the economy. Are they related to earnings, or house prices, or the performance of certain companies in that area? What's the background of a price zone?

Pradeep: We haven't quite investigated how these price zones come to be. The only context where we try to do this analysis is when there was a merger that occurred between two parents to create a larger parent. There, what we find is that, in the beginning, when such a merger occurs, the merged parent inherits the price zones of both the constituent parents that ended up merging. If one parent had 12 zones, the other parent had 13 zones, and these two parents merged into a larger parent, then essentially, in the beginning, they're going to be 25 zones that get created.

Now, unfortunately, what that leads to is that there's going to be a lot of overlap in the geographies, unless these parents are located in very distinct areas. In the case we looked at, there was overlapping territory. Now you have multiple zones within the same geographic area, which leads to the problem that I mentioned earlier, that there's now competition, for example, within chains owned by the same parent because of the merger. What we notice is that it takes some time for the new parent to actually evolve to a new zone structure based on the zones that it inherited from the two organizations that merged.

That ends up in the total number of zones actually reducing from that 25 to a much lower number, because now you rationalize across those overlapping areas, you merge the zones, et cetera. I think we have a good idea as to what ends up in this evolution from one structure to the other. We know that this thing takes time, because in our example, it took about two years for them to come up with these new zones. We do know that there are organizational frictions that play a role in determining these zones.

I think, ultimately, it is going to be factors like the nature of the consumers in those different markets, the nature of competition in those different markets, the costs that the parent has to incur in supplying the product. All these are going to be factors that end up creating the zone. Then, finally, this also has to be large or small enough for the local division to take responsibility for all the stores in that zone. I think you don't want a zone to be too large, that it has too many different types of customers in there. I think all these considerations come into play when these zones get created.

Hal: Is there an average size for these zones?

Pradeep: No. I think, in some cases, it could be a single state, for example. I think some people have thought of that as being a zone, but it could, especially when you have smaller states. I think this could span multiple states as well.

Hal: Okay, but here we are sitting in Chicago. Are there multiple price zones in Chicago? You have massive differences in wealth. Are there different price zones based on where you are in the city, or is Chicago a one zone?

Pradeep: I can't speak directly to our data, but I can go back historically to the Dominick's data, where Dominick's used to be a supermarket chain that operated in the Chicago area, and it had 100 different stores in the Chicago area. Dominick's, their pricing strategy was explicitly zone-based. They had multiple price zones within the Chicagoland area. It's certainly possible that chains can have these smaller zones as well.

Hal: Okay. It's like buying gas. You could drive a little bit and get a better deal.

Pradeep: It is possible.

Hal: I just want to map on the parent to this delegated authority to set prices. As you say, parents want these price zones to be contiguous. They want them to be non-overlapping, and you described that, but the dynamic that makes that important is because the pricing authority is delegated down? Is that right?

Pradeep: Right.

Hal: Just talk a bit more about how the price zone and the delegated authority interact.

Pradeep: I think the fundamental idea is that the division which is responsible for pricing in that zone, or the person in charge of that division, knows a lot more about the local market than the person sitting in headquarters, which could be very, very far away from that region. Because of the fact that those folks in that division are much closer to the market, they have a better understanding of what's happening in the market. As a consequence, it makes sense for the headquarters to delegate the pricing responsibility down to the area where people are actually closer to the market.

Hal: Okay. Are we assuming that those decisions that are being taken at local level are "correct" then? Are they the profit-maximizing decisions?

Pradeep: This is a question that clearly, I think, has come up. I think earlier literature has pointed to the fact that the pricing decisions might be far from optimal. In fact, I think studies have actually shown that. What we do, however, is when we do the analysis at the zone level, what we find is the prices are still not "optimal," but they are much closer to optimal as we define it than the earlier literature has found. This is another reason that we argue it's important to look at pricing at the parent zone level. I think it gives you a much better picture of the decision-making that is happening in these zones or divisions than you would get if you looked at the analysis from a very different perspective.

Hal: One of the things you looked at in this research is how retailers respond to soda taxes, these taxes that are put on to make sure that people aren't guzzling too much sugar through fizzy drinks. You found that in some markets, parent companies chose not to include the soda tax in the shelf price, in the price that you see for the drink on the shelf, but instead you've got it added on at the register. Were they transparent about that? Presumably, on your receipt, it says soda tax. What's the significance of that difference of putting it on the shelf or putting it on the checkout?

Pradeep: One of the things is that when you think about soda taxes, most of these were implemented in specific cities. These cities, it turns out, are part of larger zones. If you want to change the price in a given city, then you have prices which are different from the prices of the rest of the zone. Now, to communicate this information, you'll have to incur additional costs. Why is that? Because typically, when I have the same price across the entire zone, then by using one set of flyers, for example, the features that I talked about earlier, or the prices in the app, you can standardize that across all stores within the zone.

Now, if a particular city, you change prices, then you will have to have prices specific to that city that you're communicating to the consumers. Instead, if I hold the shelf price constant, then I don't have to change in any of the shelves--

Hal: It's just more efficient.

Pradeep: It is more efficient [unintelligible 00:21:25] lower cost.

Hal: This is what I think of. One of the frustrations of not being a native United Stater is that, in the UK, where I grew up, you see a price, that's the price you pay. You get your little grubby coins, and that's what you hand over, you know exactly what you hand over. Of course, every non-American who comes to the United States gets frustrated because when they get to the front of the line, then they suddenly find that the price has changed.

Pradeep: That's right.

Hal: I always assume that the reason for that is because, McDonald's or whoever wants to advertise a $1.99 burger, it's just easier for them to say it's $1.99 and not get involved with the real prices. Is that the reason? It seems deceptive, but I assume it's actually done for efficiency's sake.

Pradeep: Exactly. I can run the same ad all over the country, which says that my burger is $1.99. Same thing over here. For the entire zone or the entire division, if I can advertise one price for Coca-Cola, then it's much more efficient than having to advertise one price for the city where the tax was implemented and the rest of the price zone. I think by essentially not putting the price, changing the price on the shelf, you're able to retain those efficiencies. Whereas if you had to change the price on the shelf, now you had to do something different.

Hal: Who would put the price on the shelf? People who don't have large chains where the chain is only in one price zone? Is that the idea?

Pradeep: I mean, yes. I think it's--

Hal: Or only in one city.

Pradeep: Yes, or one city. I think one city is obviously the easiest because then you can choose to do whatever you want. Now, what we do find is that different parents behave quite differently. It's not all parents who behave in this fashion. There are chains where I think they have to absorb the cost by changing the price on the shelf as well. We do see these differences, but we think the parents that choose not to actually change the shelf price are doing this for reasons of efficiency and cost saving.

Hal: It's not a psychological thing. Once you've got it in your basket, you've mentally already bought it. When they tell you, "Actually, it's going to be more," you just pay it?

Pradeep: That is an entirely different line of--

Hal: That's what it feels like sometimes.

Pradeep: Yes.

Hal: You get to the checkout, and you find that it's actually more.

Pradeep: Different prices, yes.

Hal: Ultimately, you're not really paying attention to the individual price of the products, so it passes you by, but you're saying that's not the reason. Thinking of another example would be, in Chicago and in many cities, there's a plastic bag tax, which changes some people's behavior. Either they bring bags, or they just suck it up. If you don't have a bag, ultimately, you just pay whatever it is, the ¢7 per bag, because you have no choice by that point. It's not advertised anywhere, except right at the moment of the checkout. You're saying you're not sure that that's what's going on with the soda taxes.

Pradeep: No. I think there is some work that has been done by a former colleague of mine, Sarah Moshary, who's now at Berkeley, where they looked at what happened if you put in all the fees. I believe this context was on a ticketing website. What would happen if you put in all the fees before you get to the checkout? I think there's a constant complaint that people have, that if you go to the checkout and suddenly see these massive fees, then they feel that they have been duped because they were expecting a much lower price. They look at this very interesting context where the company ran an experiment where they bundled the entire price. Then looked at whether bundling all these fees into one prize increases the purchase rates at the end of the funnel.

What they found, in fact, was the reverse happened. Because once you bundle everything, a lot of people drop out in the early stage of the funnel. Whereas if you add the fees at the end, a lot of people have come up to this point, and many of them will just continue even when they see the fees at that end.

Hal: I think Airbnb is a company that's been forced to advertise the real price-

Pradeep: That's right.

Hal: -because of all sorts of extra fees they were adding on. If these parent companies delegate pricing responsibility down, and if ultimately that doesn't result in maximum profits, is it a mistake to delegate in this case?

Pradeep: No, I think it also depends upon, by not delegating, whether you do a better job or not. Since we don't know what that counterfactual would be where just one entity does the price setting throughout the entire country, I don't think we can really conclude one way or the other. Certainly, I think our point that we are trying to make in the paper is the unit of analysis is important. By thinking of the parent as the unit of analysis, it appears that prices are much closer to optimal than you would have if you had chosen a different unit of analysis. That's all I think we can say based on our research.

Hal: Okay. Pradeep Chintagunta, thank you very much for coming and talking to us about organizational structure and prices we pay in the supermarket. Thanks for coming back on the Chicago Booth Review Podcast.

Pradeep: Thanks for having me, Hal.

Hal: That's it for this episode of the Chicago Booth Review Podcast, part of the University of Chicago Podcast Network. For more research, analysis, and insights, visit our website at chicagobooth.edu/review. When you're there, sign up for our weekly newsletter so you never miss the latest in business-focused academic research. This episode was produced by Josh Stunkel. If you enjoyed it, please subscribe, and please do leave us a five-star review. Until next time, I'm Hal Weitzman. Thanks for listening.

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