Balancing profitability and customer welfare: an application to zone-pricing by a supermarket chain 1

We investigate the impact of price discrimination by a large Chicago supermarket chain. Using a structural econometric approach, we are able to measure the impact on prices, profits and consumer welfare of shifting from a uniform chain-level pricing policy to a regionally-segmented zone-pricing policy. We estimate demand systems for two different product categories using a database containing store-level information on sales, prices, promotions and demographic profiles for each of the stores’ market areas.. As wholesale prices are observed in our data, we investigate the ability of our estimated demand system to generate reasonable approximations of the true data on retailer markups with a zone category management model. Using the structurally-derived retailer and consumer valuation metrics, we study the impact of moving from a zone pricing scheme to an individual store-level pricing policy. Further, we propose alternatives to the store pricing policy in order to address some potential practical implementation problems of that policy. Our results seem to provide reasonable estimates of the underlying pricing decisions in the chain. Specifically, the retail rmarkups obtained from the estimated elasticity structure reasonably approximate the markups observed in the data. In assessing the impact of zone-pricing, we find that benefits (to the store) and costs( to the consumer) of price discrimination vary by product category. Thus, certain products are better-suited to zone-pricing than others. Our recommended alternative pricing policies seem to alleviate some of the losses to consumers, due to store-pricing, while still offering notable profit gains to the retailer.