Competitive Dynamics of Price Promotions

Eric Anderson
Graduate School of Business
University of Chicago
(E-mail: eric.anderson@gsb.uchicago.edu)

Nanda Kumar
School of Management
University of Texas at Dallas
(E-mail: nkumar@utdallas.edu)

Surendra Rajiv
Graduate School of Business
University of Chicago
(E-mail: surendra.rajiv@gsb.uchicago.edu)

July 15, 2001

The paper has benefited from discussions with Birger Wernerfelt, Ram Rao and Sridhar Moorthy. We
also thank the seminar participants at the University of Toronto and the 2001 Marketing Science
Conference in Germany for their comments. The support from the Kilts Center for Marketing at GSB,
University of Chicago to the first and third authors is gratefully acknowledged. The usual disclaimer
applies.
 COMPETITIVE DYNAMICS OF PRICE PROMOTIONS

ABSTRACT

Given the large dollar amounts at stake, manufacturers and retailers devote considerable time and
effort designing and updating promotion calendars. While designing the promotion schedule, some
questions that managers need to address are: How does an unusually large promotional discount offered
impact the timing of the next “sale” and the depth of discount to be offered? Should a deep discount by a
competitor affect the timing or depth of the next promotion? More generally, should one respond to
competitive promotion by adjusting the timing of the next “sale”, the discount to be offered, or both?

To address these issues, we examine a duopolistic market wherein brands repeatedly compete for
heterogeneous consumers: the loyal consumers buy from only one of the brands; the semi-loyal
consumers consider both brands but are willing to pay a premium for the brand purchased last period; the
switchers value the two brands identically and buy the lowest priced brand. Unlike static models of price
promotion, our model incorporates dynamics by explicitly considering “purchase event feedback”: a
consumer’s preference for a brand increases if it was purchased on the last occasion. Allowing for such
long-term effects of price promotion leads to inter-temporal dependence in brands’ strategies.

Our analysis shows that competitive price promotions exhibit several dynamic features. We find
that the likelihood of a brand offering a price promotion depends both on its own prior actions (i.e.,
whether it offered a promotion and if so, the depth of discount) as well as competitive actions. Further, a
brand’s expected price in the current period depends on both its own previous price as well as the
competitor’s previous price. This leads to competitor’s prices exhibiting negative contemporaneous
correlation (i.e., the competing brands “take turns” in offering sales). We also find that these dynamic
features become more pronounced with stronger purchase event feedback effects.

We extend the analysis to an asymmetric brand context and show that, relative to the strong
brand, the expected price of the weak brand in the current period is more influenced by price charged by
strong brand in the previous period. We also find an interesting asymmetry in their competitive response.
The strong brand reacts to the weak brand’s deeper discount in the previous sale by lowering its expected
price this period. In contrast, the weak brand raises its price in response to a deeper discount offered by
the strong brand in its previous sale. Further, we find that in this case, the competitive prices exhibit
positive contemporaneous correlation (i.e., the competing brands are likely to offer a “sale” concurrently).
These results allow us to reconcile the conflicting empirical evidence on the timing of price promotions.

We offer empirical support for our model using an ERIM dataset from 5 different product
categories. Our analysis offers several guidelines for managers on how to respond to competitive
promotions. While deciding on competitive response, managers need to resolve the following key
questions: Does the brand enjoy positional advantage? How salient are the long-term effects of
promotion in this market? How significant is the perceived product differentiation in this market as
reflected in the relative sizes of the loyal and switching segments?

KEY WORDS: Consumer Promotion; Purchase Event Feedback; Markov Perfect Equilibrium; Speed of
Competitive Response; Magnitude of Competitive Response.
 1. INTRODUCTION

Price promotions are an important strategic and tactical tool used widely by both manufacturers
and retailers. As a percentage of total promotional expenditures, trade promotions for packaged goods
have grown from 38% in 1985 to approximately 50% in the 1990s (Cox Direct 1997; Tenser 1996). In
1998, the total spending for trade promotions in the grocery industry as a whole was over $75 billion
1
(Supermarket Business March 1999). While trade and consumer promotion spending has increased
dramatically, the inefficiency of price promotions represents the “number-one concern” among both
manufacturers and retailers as indicated by recent surveys by AC Nielson (8th Annual Survey of Trade
Promotion Practices) and Cannondale Associates (1998 Trade Promotion Spending and Merchandising
Survey). Given the large dollar amount at stake, manufacturers and retailers devote considerable time and
effort designing and updating their promotion calendar (Blattberg and Neslin, 1990; Silva-Risso, Bucklin
and Morrision, 1999) to allocate promotion budgets over “sale” events.
Some of the decisions that managers are faced with while designing the promotion schedule are:
What should be the “normal” inter sale interval and promotional discount? If the firm offers an unusually
large discount (such as a buy-one-get-one deal) should that impact the timing of the next “sale”? Further,
should it also impact the promotional discount to be offered during the following “sale”? In addition,
managers often adjust their promotional calendar in response to competitive actions. Some of the issues
that the practitioners grapple with are: Should an aggressive (i.e., deeply discounted) competitive
promotion affect the timing of the next promotion? Should it also impact the depth of discount to be
offered? More generally, should one respond to competitive promotion by adjusting the timing of the
next “sale,” the discount to be offered, or both?
The answers to these questions are not immediately obvious. To complicate things further, one
observes wide variation in how firms react to a competitor's promotion. For example, the British
supermarket chain Asda, “brought forward [price] cuts planned for the spring” in response to an
aggressive price promotion by the rival chain Tesco (The Guardian 2001). Another recent example is
provided by Samsonite that “accelerated the closeout of Silhouette 6” due to competitive conditions (PR
Newswire 2000). Similarly, price promotions in the airline industry often trigger immediate and
aggressive competitive responses (Godsmark, 1997). However, one also observes instances of
competitors ignoring or tempering their response to competitive price promotions. For instance, when
Impulse, a new entrant to the Australian airline market, offered a $66 price promotion the response by
market leaders Qantas and Ansett was “carefully constrained and heavily conditional” (Bartholomeusz,

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2000). Similarly, when discount chains offered aggressive price promotions on Viagra, a Walgreen’s
manager thus commented on their non-response: “We are not going to participate in that competition”
(Arizona Republic, 1998).
These are not isolated examples. More systematic evidence of variation in competitive response
is presented in Kopalle, Mela and Marsh (1999), who estimate the price response function proposed by
Leeflang and Wittink (1992, 1996) for six brands of dishwashing detergent. For the 30 brand pairs, they
find eight significant negative coefficients and eight significant positive coefficients. While there is
considerable variation in the magnitude of price response, a closer inspection reveals that the nature of
competitive response may be somewhat systematic. To uncover the underlying pattern, we categorize the
three largest share brands (Dawn, Palmolive, and Sunlight) as strong brands and the three lowest share
brands (Ivory, C.W. Octagon, and Dove) as weak brands in Table 1.

[INSERT TABLE 1 ABOUT HERE]

Negative (positive) coefficients in Table 1 indicate that the temporal correlation of price
promotions is negative (positive). In other words, a brand is more (less) likely to promote in the current
period if a competing brand promoted last period. Table 1 shows that the effect of strong brands on other
2
strong brands is either negative or not significant implying alternating retail price promotions. For
competition between weak brands, the effect is mostly insignificant suggesting the timing of promotion to
be independent of competitive action. In contrast, the effect of strong brands on weak brands tends to be
positive (4 of 5 cases) or not significant (4 cases). A similar pattern appears for the effect of weak brands
on strong brands (4 of 6 positive, 3 not significant).
Despite the concerns raised by practitioners regarding designing of effective promotion schedule,
few extant research works have explicitly addressed these issues. In this paper, we seek answers to the
following questions. First, how does a competitor’s past price promotion affect the timing of a current
price promotion and the promotional discount to be offered? Second, how does a firm’s own prior price
promotions affect the timing and depth of current price promotions? Finally, which consumer
characteristics impact the timing and magnitude of competitive response and how a brand’s relative
quality positioning influences its optimal competitive promotional response? We thus analyze the
interrelationship between customer characteristics, firm’s positioning and competitive dynamics.
To address these issues, we initially consider a stylized market with two symmetric competing
brands, each selling one product in multiple periods to three types of consumers: hard-core loyal

1
Even for EDLP firms, price promotions remain an important tool. As Simms notes: “On average, 20% of a
category's volume is being sold temporarily below the EDLP price in the form of promotions” (Marketing 2000)

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customers, semi-loyal customers and switchers. The demand facing each brand varies from period to
period and is endogenous in the sense that a brand’s share of semi-loyal customers is contingent on its
past pricing strategy. Specifically, we assume that the brand with the lowest price in the previous period
attracts a mass of semi loyal customers the next period. The competing brand may still sell to the semi-
loyal customers, but to do so it must offer a “sufficient” discount. This captures the long-term effect of
price promotion since consumers’ current preferences are a function of their past consumption experience
(see for example, Kopalle, Mela and Marsh (1999)). This phenomenon – variously referred to in the
literature as “consumer state dependence” or “purchase event feedback” – is a well-documented finding
from scanner data research (e.g., Guadagni and Little, 1983; Heckman 1991; Roy, Chintagunta, and
Haldar 1996; Allenby et al, 1998).
Because of consumer choice dynamics, the demand facing a brand evolves over time, thereby
impacting its incentive to compete for the switchers. This, in turn, affects the brand’s decisions on
promotion timing and the depth of discount to offer. Our model yields three key managerial results.
First, a brand is less likely to plan successive promotions if consumer state dependence is substantial.
Second, the likelihood of a current promotion and the promotional discount depends on the occurrence
and depth of discount of competitor’s previous promotions. In other words, past competitive actions
affect current promotions. Together, these lead to our third result that both brands promoting concurrently
is less likely if there is substantial state dependence. Thus, our model offers a rationale for “taking turns”
or “alternating brand promotions.” Our explanation is driven by consumer demand, which complements
other explanation such as supply side considerations (Lal, Little, Villas-Boas, 1996) and tacit brand
cooperation (Lal, 1990).
The intuition for these results stems from how firms compete for consumers whose brand
preference changes dynamically. When a brand offers a deep price promotion, it sells to many new
buyers. If some of these buyers exhibit state dependence, they are willing to pay a small premium (i.e.
they are more loyal) in the next period. This decreases the attractiveness of a promotion the next period.
Knowing that a brand is less likely to promote increases the attractiveness of promotion for competing
brands, which generates alternating brand promotions in the category. Whether this occurs depends on
both the number of consumers who exhibit state dependence and their increased willingness to pay for the
brand last purchased.
Our model has several unique features that differentiate it from previous price promotion models.
First, we allow for both short-term and long-term price promotion affects. By incorporating consumer
dynamics, we allow brands to compete for today’s price sensitive customers and for their future business.

2
Such an alternating pattern is also noted in Lal (1990) and Kopalle, Rao, and Assunção (1995).

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Second, because consumer preferences are affected by past consumption a brand’s loyal base is
endogenous to both own and competitor past promotion strategies. Third, by modeling these dynamics
we are able to assess both the likelihood and magnitude of competitive response, which is not feasible in
static promotion models. Finally, if consumer state dependence is not present or if brands do not consider
consumers lifetime value, then our model reduces to a static price promotion model. As such our
approach complements previous work in this area.
From the model, we develop a series of testable hypotheses, which we test on five product
categories. Results in Seetharaman, Ainslie, and Chintagunta (1999) allow us to determine the proportion
of households who exhibit state dependence and the strength of this effect in these categories. Results
from these five categories offer support for our model and demonstrate that our demand-based
explanation plays a role in understanding the dynamics of competitive price promotions.
This paper builds on existing theoretical and empirical work in marketing and economics. By
incorporating consumer choice dynamics we are able to characterize the impact of past competitive and
own promotion on current promotional decisions, thereby extending the insights from the extant static
price promotion models (e.g., Varian 1980; Shilony 1977; Narasimhan 1988; Raju, Srinivasan and Lal
1990; Rao 1991; Banks and Moorthy, 1998). This paper also builds on theoretical models of price
competition in markets with consumer switching costs (e.g., Klemperer, 1987; Farrell and Shapiro, 1988;
Beggs and Klemperer 1992). We endogenize these switching costs by relating them to past market
outcomes, which extends this literature in a spirit similar to the literature on network externality (Farrell
and Saloner, 1985; Katz and Shapiro, 1992; Katz and Shapiro, 1994), brand loyalty (Wernerfelt, 1991)
and loyalty programs (Kim, Shi and Srinivasan, 2001). Empirical models of stochastic consumer choice
behavior in marketing and economics document that consumer preferences exhibit dynamics such as state
dependence and habit persistence (e.g., Heckman 1991; Papatla and Krishnamurthi, 1996; Erdem and
Keane, 1996). Our approach complements these findings as we study how such consumer dynamics
affects competitive behavior. Finally, our approach complements empirical work that documents
competitive price response (Kopalle et al, 1999; Leeflang and Wittink, 1992; 1996) by providing a
framework to explain empirically observed variations in the sign of price response coefficients.
The rest of the paper is organized as follows. In §2, we outline the features of our dynamic
promotion model and provide the rationale behind some of the key assumptions. In §3, we derive the
equilibrium and characterize how a firm’s current promotional decisions depend on its own past
promotions as well as past competitive actions. We also provide comparative results highlighting how
consumer characteristics and the brand’s relative positioning affects the way it should respond to past
competitive promotions. Finally, in §4 we empirically test several predictions from the model. We
conclude the paper with a discussion of the managerial insights that our analysis offers.

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 2. MODEL

We consider a market with two symmetric competing brands, A and B, each selling one product
in multiple periods to three types of consumers: hard-core loyal customers, semi-loyal customers and
switchers. Each brand has a mass of hard-core loyal consumers, l1 and l2 and we assume l1 = l2 = l. In
addition, there is a mass of θ semi loyal customers and a mass of (1+ γ) switching customers in each
period. All customers buy at most one unit each period and we assume that the total size of the market is
3
constant . Intuitively, these three customer types capture different segments of the demand curve. Hard-
core loyal customers are willing to pay at most r for their preferred brand and never consider the
alternative brand. Semi-loyal customers prefer one brand but are willing to pay a premium of at most c
dollars relative to the competing brand’s price. The magnitude of c measures these customers’ degree of
brand loyalty (i.e., the strength of purchase event feedback). Finally, switching customers are loyal to
neither brand and simply purchase the lowest priced product. No customer will ever pay more than r
dollars for either brand.
While the total mass of customers in the market is constant from period to period, the demand
facing each brand varies from period to period and is endogenous. Specifically, a brand’s share of semi-
loyal customers in any period is contingent on its past pricing strategy. We assume that the brand with
the lowest price in the previous period attracts a mass of θ semi loyal customers the next period. The
competing brand may still sell to the semi-loyal customers, but to do so it must offer a discount of at least
c. An example of each brand’s demand curve is given in figure 1. In this figure, we assume that brand A
charged the lowest price in the previous period. Notice that along the x-axis (quantity), the ordering of
the segments differs for brands A and B. Switching customers have the lowest willingness to pay for
brand A, but semi-loyal customers have the lowest willingness to pay for brand B.

[INSERT FIGURE 1 ABOUT HERE]

The dynamic customer behavior in the proposed model can be rationalized in a two-period
overlapping generations (OLG) framework. A unit mass of new customers, who are all switchers, arrives
in the market each period and buy the lowest priced brand. After purchasing, θ of these customers
become semi-loyal to that brand, γ remain switchers, and the remaining customers exit the market. After
a second purchase occasion, all of these customers exit the market. Given these assumptions, it is rational
for each customer to maximize their payoff each period. The key assumption in our model is the

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endogenous change in customer preferences and not the entry and exit of customers implied by the OLG
4
interpretation.
Our modeling of semi-loyal customers is consistent with the empirical findings on state
dependence/ purchase event feedback (e.g., Guadagni and Little, 1983; Heckman, 1991; Roy et al, 1996).
These studies typically find that for most frequently purchased products (FPPs), the probability that a
consumer buys a particular brand increases if she bought it on the last purchase occasion. Consistent with
these findings we allow a fraction of the switchers to favor the brand bought last time (we refer to these
customers as the semi-loyal segment). These studies also find that the state dependence effect decays
with time elapsed since last purchase (Seetharaman, Ainslie, and Chintagunta, 1999). In fact, several
stochastic choice models specify consumer state dependence as a first-order Markov process (Jeuland
1979; Roy et al, 1996). Consistent with this finding, we allow the long-term effect of promotion to persist
for one period: the brand that wins the switchers (i.e., the lowest price) in the current period acquires a
mass of θ semi loyal customers the next period. However, the brand loses the semi-loyal customers if it
fails to win the switchers in the next period. While we acknowledge that in some product categories, state
dependence may persist for longer periods we model it as a first-order process for analytical simplicity (to
limit the state space).
By allowing for such long-term effect of price promotion, the model captures a key managerial
5
practice that is well illustrated by the promotional strategy of Quaker Oats Company. Each fall after
children have started school, Quaker launches a promotion campaign for oatmeal. By offering discounts
and promotions in the fall, Quaker hopes to attract many new parents and remind current parents about
oatmeal. Quaker’s strategy is premised on generating repeat business at the regular price from some of
the customers who purchased on promotion.
In the next section, we analyze inter-brand price competition in the presence of consumer choice
dynamics. The effectiveness of a promotion depends on creating future value and is captured in our
model by two parameters: θ and c. θ captures the number of customers who are affected by past
promotion and c captures the magnitude of this effect. As we show in the next section, attracting

3
The assumption of a constant market size is consistent with Gupta (1988) who finds that price changes primarily
lead to brand switching and not category expansion.
4
To demonstrate that entry and exit was not a key assumption, we considered a model with static customer
segments (i.e. no entry or exit) and different assumptions on consumer preference formation. We assume that
switchers remain indifferent and loyal customers remain loyal. However, θ semi-loyal customers loyal to firm i
become loyal to firm j in period t+1 if pj,t < pi,t-c. In this model, the current period payoffs are identical to our
proposed model but the continuation payoffs differ. The consumer preference formation in this static model is
somewhat unnatural, so we prefer the OLG interpretation.
5
We thank a brand manager at Quaker Oats Company for this insight.

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switching customers with a price promotion generates some semi-loyal customers, which allows a brand
to charge a higher price in the future. For a current promotion to generate future value both parameters
must be positive and “large.”

3. ANALYSIS OF DYNAMIC PROMOTIONAL STRATEGIES

We begin by characterizing the dynamic Markov perfect equilibrium for two similarly positioned
brands (§3.1). We show how the number of switchers, semi-loyal, and loyal customers affects promotion
frequency, promoted price, and expected demand. In §3.2 we highlight the dynamic aspects of
promotional strategies predicted by the proposed framework that are distinct from the insights from static
promotion models. Specifically, we discuss how a brand's current promotional decisions are affected by
past competitive promotions and its own prior promotions. Our analysis to this point considers
symmetrically positioned brands, and in §3.3 we consider competitive promotions when a strong brand
competes with a weak brand. We assume that the strong brand is able to generate more semi-loyal
customers. This extension allows us to assess how relative brand positioning (symmetric vs. asymmetric)
affects optimal promotion response.
Having characterized the equilibria for both the symmetric and asymmetric cases, we then
address a main issue in this paper: how to respond to past promotions. In §3.4, we show how the size of
different consumer segments and relative brand positioning affects optimal promotion response. Finally,
in §3.5 we relate our model predictions on price correlations to several stylized facts. While this provides
face validity for our analytical results, we conduct a more in-depth empirical investigation in §4.

3.1 Equilibrium Analysis and State Contingent Strategies

To understand how the two brands, A and B, compete in this market, we first develop the current
period profit functions and then extend these to the multi-period payoffs. We then determine the optimal,
dynamic pricing strategies for both the brands and analyze how a brand's promotion frequency and depth
of discount depends on the size of its semi-loyal customer segment.

3.1.1 Payoffs

Let pi be the price and Πi be the current period profits of brand i ∈ {A,B}. Without loss of

generality, we assume the (constant) marginal costs for both the brands to be zero. The profit of each
brand depends on whether the brand has acquired a base of semi-loyal customers. For brand A, the
current period payoffs are:

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  pA l if pB < p A

Π A = ( p A, pB | Semi − Loyal = 0) =  p A (1 + γ + l ) if pB − c ≤ p A ≤ pB
 p (1 + γ + θ + l ) p A < pB − c
 A if

 pA l if pB + c < p A

Π A = ( p A, pB | Semi − Loyal = θ) =  p A (θ + l ) if pB ≤ p A ≤ pB + c
 p (1 + γ + θ + l ) p A < pB
 A if

Profits for brand B are defined analogously. To interpret the payoffs, consider the demand for
brand A when it has θ semi-loyal customers (Figure 1). If brand A undercuts brand B, then brand A sells
to all three segments. If brand A charges a price premium of less than c then brand A sells to the semi-
loyal and loyal customers. Finally, if brand A charges a premium in excess of c then brand A only sells to
loyal customers. Similar logic underlies brand A’s payoff when it has no semi-loyal customers.
Each brand’s pricing strategy recognizes the dynamic nature of consumer behavior and hence the
fact that current prices affect future payoffs. In our stylized model, the only historical information that
affects current payoffs is which brand offered the lowest price in the previous period. Given the behavior
of semi-loyal customers, past market shares capture identical information. Thus, we can summarize all
payoff relevant previous information by keeping track of the semi-loyal customers. Since the model is
symmetric with respect to the size of the customer segments, there are two demand states that we label the
focal state (FS) and the alternative state (AS). In the focal state, brand A has a semi-loyal segment of size
0 and brand B has a semi-loyal segment of size θ; in the alternative state, brand A has θ and brand B has 0
semi-loyal customers.
Given the current period payoffs, we can now compute the continuation payoffs in each state. Let

Vi FS and Vi AS be the continuation payoffs to brand i in the focal state (FS) and the alternative state (AS).

Similarly, Fi FS ( p ) and Fi AS ( p ) are the CDF of brand i in each state. We employ symmetry and let

V1 = VAFS = VBAS , V2 = VBFS = VAAS , F1 = FAFS = FBAS , and F2 = FBFS = FAAS . Thus, the subscript 1 (2)
refers to the state when a brand has 0 (θ) semi-loyal customers. Fs and Vs, s ∈ {1,2}, are the mixing
distribution and continuation pay-off, respectively, of a brand in state s. The discount factor is δ ≤ 1 and
the continuation payoffs in each state are:

V1 = p[(1+γ)[1-F2(p)] + θ[1-F2(p+c)]+l] + δ[V2[1-F2(p)] + V1F2(p)] (1)

V2 = p[(1+γ)[1-F1(p)] + θ[1-F1(p-c)]+ l] + δ[V2[1-F1(p)] + V1F1(p)] (2)

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 To interpret equation 1, consider the continuation payoff in state 1. The first two terms represent
the brand’s expected current payoff from charging a price of p. The brand sells to the loyal customers
with probability 1, to the semi-loyal customers with probability [1-F2(p+c)], and to the switchers with
probability [1-F2(p)]. Recall that the competing brand is in state 2 and selects a price, p2, from F2. Then
F2(p) = Prob(p2≤p) is the probability that the competing brand undercuts price p. The last term in
equation 1 is the discounted expected future payoff. With probability [1-F2(p)] the brand transitions from
state 1 to state 2; with probability [F2(p)] the brand remains in state 1. Similar logic underlies equation 2.
6
We consider only symmetric Markov perfect equilibrium. By definition, in Markov perfect
equilibrium each brand’s payoff is a function of payoff relevant states. In our model, the size of each
brand’s semi-loyal segment completely determines the current state and other historical information is not
used in computing payoffs.

3.1.2 Equilibrium Analysis

We now derive the unique equilibrium of this dynamic game. As the following lemma notes,
7
there is no pure strategy equilibrium.

Lemma 1: There is no pure strategy equilibrium.

The intuition for non-existence of pure strategy equilibrium is similar to Narasimhan (1988) and
Raju, Srinivasan and Lal (1990). When prices are “high” at least one brand has incentive to undercut the
rival but if prices are “low” then one brand deviates to “high” prices. Thus brands must randomize prices
to prevent either undercutting or deviations to higher prices.
As there is no pure strategy equilibrium, we focus on mixed strategies. To fully characterize the
equilibrium, we need to identify the continuation payoffs (V1, V2), the mixing distributions (F1, F2), and

the maximum and minimum price in each state (p1, p , p2 , p ) . The state contingent equilibrium
1 2
mixing distributions are:

6
See Villas-Boas (1993) for a discussion on the advantages of using Markov perfect equilibria over other
equilibrium concepts.
7
Proofs of all the Lemmas, Propositions, and Results are provided in the Technical Appendix that is available from
the authors on request.

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  0 0 < p < p1

 1 −  V2 − δV1  + l p1 ≤ p < p2 -c
  θ(p+c)  θ
 

  V − δV1  l
F1 = F ( p | semi − loyal = 0) =  1−  2 + p2 -c ≤ p < p2
  θ p2  θ
 p(1+γ +θ + l )-V (1 − δ)
 2
p2 ≤ p < p1
 p(1+ γ )+ δ(V2 − V1 )
 p1 ≤ p
 1

 0 0 < p < p2

 p(1+γ + l )+δV2 − V1
p2 ≤ p < p1
 p(1+γ ) + δ(V2 − V1 )
F2 = F ( p | semi − loyal = θ) = 
1 − 1  V1 − δV2 − (1 + γ + l )  p1 ≤ p < p2
 θ  p-c 


 1 p2 ≤ p

A key intuition in later propositions rests on the asymmetry of F1(p) and F2(p) and is illustrated in
Figure 2. Note that the brand in state 1 places relatively more mass on all prices less than r, i.e. f1(p) >
f2(p) for p<r. As θ increases, the price distributions become more asymmetric: f1(p) - f2(p) increases and
the mass point on p=r increases. While not shown in Figure 2, as c increases and γ and l decrease the
price distributions become more asymmetric. In the absence of asymmetry in Fs(p) , there are no price
dynamics in the model.

[INSERT FIGURE 2 ABOUT HERE]

To fully characterize the mixed strategy equilibrium, we need to consider three regions of
parameter space. The support of the mixing distributions in the two states is depicted in Figure 3.

[INSERT FIGURE 3 ABOUT HERE]

In region III, c ≥ c** and there is sufficient state dependence such that semi-loyal customers are
8
“locked in” to the brand last purchased. In this case, the mixing distributions of both brands have the

same support and brands may set a maximum price of r. In region II, c** > c ≥ c* and there is moderate

Formally, the critical values of c, e.g. c and c , are a function of parameters ζ = {r,δ,γ,l,θ} (e.g. c = c (ζ ) ).
8 * ** ** **

For example, if ζ = {5.0, 0.95, 0.5, 0.2, 0.5}, then c ≈ 3.65, c ≈ 3.75 .
* **

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competition for semi-loyal customers. The brand without semi-loyal customers attempts to steal these
customers with prices in the range [p1 ,r-c] while brand with semi-loyal customers protects them by

pricing in the range [p1 ,r). Finally, in region I, c < c* and there is aggressive price competition as both

brands offer p<r. For exposition, we focus our exposition on c ≥ c** , but the complete results for all
9
regions are discussed in the Technical Appendix.
Our model is closely related to static price promotion models considered by Shilony (1977),
Varian (1980), Narasimhan (1988), and Raju et al. (1990). Reassuringly, our dynamic framework is
consistent with static promotion models. For example, if brands behave myopically (δ=0), the region we
10
analyze is equivalent to Raju et al. (1990). Analogous to Varian (1980), both the brands have the same
lower bound on price, which equals
p = r(θ + l)/[1+γ+θ + l + δθ]. (3)

The lower bound on price is identical for both brands because semi-loyal customers are “locked in” and
brands compete on price for switching customers. In region III, the state contingent price distributions
are:

p(1+γ +θ + l )-V2 (1 − δ )
F1 ( p ) = F ( p | semi − loyal = 0) = , (4)
p(1+γ )+δ (V2 − V1 )

p(1+γ + l )+δ V2 − V1
F2 ( p ) = F ( p | semi − loyal = θ ) = . (5)
p(1+γ ) + δ (V2 − V1 )
Further, the continuation payoffs for the two brands, which are defined as the expected
discounted cash flows from each state, equal:
V1 = p (1 + γ + l + δθ)/(1-δ), (6)

V2 = p (1 + γ + l + θ)/(1-δ). (7)

Not surprisingly, the brand with semi-loyal customers has a greater continuation payoff (V2 > V1).
Further, as firms become less myopic (δ increases), the intensity of price competition for switchers and
semi-loyal customers decreases, thereby increasing the continuation payoffs. We now consider the effect

9
As shown in the Technical Appendix, we obtain closed-form expressions for the equilibrium in Regions I and II by
solving a system of six non-linear equations.
10
The exact distribution in Raju et al (1990), Proposition 6 can be found by setting θ=1, l=γ=δ=0, and lw=0, ls =c
where lw and ls are the parameters in Raju et al (1990). Substituting these values into (4)-(5), we get p =r/2, V1 =
r/2, V2 = r.

- 11 -
of a brand’s current share of semi-loyal customers, the number of switchers, and the number of loyals on
promotion frequency (Lemma 2), the expected promoted price (Lemma 3), and the expected state
(Lemma 4).

3.1.3 State Contingent Strategies

The first aspect of a brand’s promotion strategy that we consider is promotion frequency
(alternatively, the likelihood of a brand offering a promotion in any given period). The number of semi-
loyal customers creates two important strategic considerations. First, more semi-loyal customers increase
the opportunity cost of promoting to acquire switching customers. Thus, we expect a brand with more
semi-loyal customers to promote less frequently. Second, the brand without semi-loyals recognizes the
reduced incentive to promote of the competing brand. Because a promotion is more likely to be effective
(i.e., “win” the switchers), the brand without semi-loyals is more likely to promote. This leads to the
following lemma:

Lemma 2: Consumer State Dependence and Promotional Frequency

a) A brand is more likely to offer a “sale” if it does not have semi-loyal customers, i.e.

Pr ( p < r | semi − loyal = θ ) < Pr ( p < r | semi − loyal = 0 ) .

b) The frequency of promotion in a product category is decreasing in θ and is increasing in γ and

l.

Due to the opportunity cost, brands promote less frequently as the degree of state dependence
increases. Analogously, brands promote more frequently when there are relatively more switchers (γ
increases). While θ and l both represent a type of loyal customer, the comparative statics differ. We find
that as l increases brands engage in more frequent promotions. The difference in these results stems from
the asymmetry of l and θ in our model. Recall that an increase in l implies that both firms have more
loyal customers while an increase in θ creates more asymmetry (only one firm acquires them). If we
relax the symmetry assumption on l we obtain similar results for θ and l.
A second aspect of a brand’s promotion strategy is the expected promoted price. A key factor
that affects each brand’s promoted price is competition for semi-loyal customers. When c is large,
c ≥ c** , the brand with more semi-loyals offers a higher expected price but both brands have the same
expected promoted price. The intuition for this result is that the semi-loyal customers are “locked-in” and
brands only compete for switchers. Conditional on promoting (p<r), both brands have the same attracting
power over switchers and hence offer the same expected price (analogous to Narasimhan (1988)). For

- 12 -
lower values of c, c < c** , there is competition for both switchers and semi-loyals and the expected
promoted price is greater for the brand with semi-loyals.
To gauge the relative magnitude of each brand’s promoted price, we analyze the difference in
expected promoted price:
D = E ( p | p < r , semi − loyal = θ ) − E ( p | p < r , semi − loyal = 0 ) . (8)

The difference in promoted price is determined by two factors. In the current period, the brand
with semi-loyals trades off charging higher prices vs. competing aggressively for switchers (i.e., current
margin vs. current volume trade-off). The second factor is that brands compete for future demand, and
hence trade-off current margin with future volume. When state dependence effects are small (c and θ),
the future value of switchers is low and the trade-off is dominated by current period considerations. For
small increases in θ, the firm with semi-loyals finds it more attractive to concentrate on this segment and
raises its price. Recognizing this, the competing brand also raises its price (strategic complements), but
this is a second order effect and D increases. Conversely, when state dependence effects are large, the
trade-off is dominated by future considerations. A large fraction of current switchers will pay a
significant loyalty premium in the future, which increases the intensity of price competition and D
decreases. To illustrate, we plot D vs. θ in Figure 4.

[INSERT FIGURE 4 ABOUT HERE]

Our insights on consumer state dependence and promoted price are summarized in the following
lemma.

- 13 -
 Lemma 3: Consumer State Dependence and Promoted Price
a) For all positive values of c, the expected price of the brand with θ semi-loyal customers, is
larger than the expected price of the brand with 0 semi-loyal customers.

b) If c ≥ c** then both brands offer the same expected promoted price. However, for c < c** the
brand with fewer semi-loyal customers offers a lower promoted price, i.e.,

D = E ( p | p < r , semi − loyal = θ ) − E ( p | p < r , semi − loyal = 0 ) ≥ 0 .

Further, the expected promoted price is increasing in θ and l and is decreasing in γ.

c) D is non-negative for all c and θ. D=0 for c=0 and c ≥ c** ; for c ∈ (0, c** ), c is increasing

for c < ĉ and decreasing for c > ĉ . If l > l* then D is increasing for θ < θˆ and decreasing

for θ > θˆ .

The caveat l > l* ensures that the opportunity cost of promotion is significantly great and the
model reaches region III for large values of θ.
Lemmas 2 and 3 take the current state as given and we now consider how past prices and market
characteristics affect the likelihood of each state. If a brand in state s charges a price p, the probability of
it transitioning to state s′ ≠s is [1- Fs′ (p)]. Thus, the steady state transition probability from state s to state

s′ is given by:
ps

τ s′s = ∫ (1 − F ( p) ) f ( p)dp .
ps
s′ s (9)

The steady state transition probabilities, τ11 = τ22 and τ21 = τ12, are affected by the size of each customer
segment. For example, in region III, τ21 = (M+θ)/(2M) where M=(1+γ+θ+l). We summarize the impact
of past prices and consumer characteristics on current demand in the following lemma.

Lemma 4: State Transition Probabilities

a) Decreases in own past prices or increases in competitor’s past prices increase the probability
of state 2 (i.e. the likelihood of acquiring semi-loyal customers).

b) The likelihood that a brand transitions from state s to state s′ , where s, s′ ∈{1, 2} and s ≠ s′ ,
is increasing in the size of the semi-loyal customers (θ) and is decreasing in the size of
switchers (γ).

Thus, an important property that distinguishes our model from previous promotion models is that current
demand is affected by past prices. Further, it can be shown that brands are more likely to transition

- 14 -
between states than remain in the same state (i.e. τ21> ½). We now discuss the dynamic features of the
model.

3.2 Impact of Past Price Promotions on Current Promotional Decisions

Should a brand respond to competitive price promotions or should it ignore it? If it should
respond, how do past competitive promotions affect a brand’s promotional decision in the current period?
Does a brand’s own past promotion impact whether it should offer a “sale” now and if so, how deep a
discount should it offer?
Recall that the empirical study by Kopalle, Mela and Marsh (1999) does not provide a definitive
answer to these questions: there are instances of both response and non-response to competitive price
cuts. Further, we see both “aggressive” (i.e., price cut triggering competitive discount) as well as
“accommodative” response (i.e., a brand raising their price in response to a price cut). Also note that the
extant theoretical models of price promotions (e.g., Narasimhan 1988; Raju, Srinivasan and Lal 1990;
Banks and Moorthy 1998) do not shed much light on these questions either. These models typically
employ a static game framework that considers the competitive interaction between the competing brands
as a one-shot event. The mixed-strategy equilibrium of the static game is then interpreted in a temporal
sense by invoking a result due to Benoit and Krishna (1985). The implication of this result is that the
equilibrium characterized for the static game is also the equilibrium of a repeated game wherein brands
play the static game in each period with brands making independent and identical (IID) draws from the
equilibrium distributions. This conceptualization corresponds to competitive price promotions being a
memory-less process: current promotional decisions are independent of history and depend neither on
11
competitive promotions nor on its own past promotions.
Unlike static promotion models, our framework incorporates the notion of “response to
competitive promotions.” As the following proposition states, our framework suggests that the
probability that brand i offers a “sale” in the current period is higher if the competing brand j offered a
“sale” in the previous period. We summarize this in the following proposition:

11
In the terminology of the hazard function literature (Heckman, 1991), promotional strategies in static models
exhibit neither own nor cross duration dependence.

- 15 -
 Proposition 1: Likelihood of Response to Competitor
A brand is more likely to offer a “sale” (discounted price) in the current period if
a) the competing brand offered a “sale” in the previous period, i.e.,

(
Pr p it < r | p j ,t −1 < r , j ≠ i ) (
> Pr p it < r | p j ,t −1 = r , j ≠ i . )
b) the competing brand offered a deeper discount in the previous period, i.e.,
∂ Pr ( p it < r ) ∂ p j ,t −1 ≤ 0, j ≠ i.

The intuition for this result is as follows: If brand j posted the “regular” price in period t-1, it is
certain to lose all the switchers to brand i. However, if brand j posted a “sale” in period t-1, it is possible
that it retains the semi-loyal customers (provided its price is lower than that of brand i). Thus, brand i is
more likely to have no semi-loyal customers in period t if brand j offered a “sale” in period t-1. From
Lemma 2, it follows that brand i is more likely to offer a “sale” in period t. The second part of the
proposition shares similar intuition: the lower the price posted by brand j in week t-1, the more likely it is
to retain the semi-loyal customers and hence the higher the likelihood of brand i offering a “sale” in week
t.
Having established that a brand is more likely to offer a “sale” when the competing brand offered
a “sale” in the previous period, it is natural to ask the question: How do competitive prices move in
response to price promotions? As the following proposition notes, in the event of a “sale”, brand i offers a
lower promoted price if brand j offered a “sale” in the previous period compared to when brand j offered
its “regular” price in the previous period.

Proposition 2: Price Response to Competitor’s Past Actions

a) If state dependence effects are moderate (c < c** ), a brand offers a lower promoted price
if the competing brand offered a “sale” in the previous period, i.e.,

E  p it | p it < r , p j ,t −1 < r, j ≠ i  < E  p it | p it < r, p j ,t −1 = r , j ≠ i  .

If c ≥ c** , the expected promoted price is independent of competitors’ past

promotions.

b) The expected promoted price in the current period decreases if the competing brand
offered a deeper discount during the previous period, i.e.,
∂E ( p it | p it < r ) ∂ p j ,t −1 ≥ 0, j ≠ i.

The intuition for this result is similar to that of Proposition 1 and follows from Lemma 3.
Variation in the expected promoted price between brands is due to competition for the semi-loyal

- 16 -
customers. When c is sufficiently large, semi-loyals are locked in and the expected promoted price is the
same for both brands. For lower values of c, the brand without semi-loyals competes aggressively for
these customers by offering deeper discounts. A more aggressive promotion by a competitor in the period
t-1 increases the likelihood that a brand does not acquire semi-loyal customers. In turn, this lowers the
expected promoted price in period t.
Propositions 1 and 2 consider how a brand should react to past promotions by a competitor.
Next, we investigate the impact of own past promotions on a brand’s current promotional decisions. As
noted earlier, the extant static models of price promotions (e.g., Narasimhan 1988; Raju, Srinivasan and
Lal 1990) predict no impact of a brand’s own past promotions on current promotional decisions. Thus, a
brand is as likely to offer a promotion immediately following a deep price discount as it is after not
12
having offered a “sale” for many weeks. As the following proposition states, price promotions
characterized in our dynamic model are affected by both the depth and occurrence of own past
promotions.

Proposition 3: Promotion Frequency and Own Past Promotions

A brand is more likely to offer a “sale” (discounted price) in the current period if
a) it posted a “regular” price (non-discounted price) in the previous period, i.e.,

Pr ( p it < r | p i ,t −1 = r ) > Pr ( p it < r | p i ,t −1 < r ) .

b) it did not offer a deep discount in the previous period, i.e.,

∂ Pr ( p it < r ) ∂ p i ,t −1 ≥ 0 .

The intuition for this result is as follows: If brand i posted the “regular” price in period t-1, it is
certain to lose all the switchers to competing brand j. However, if brand i posted a “sale” in period t-1, it
is possible that it retains the semi-loyal customers in period t (provided its price is lower than that of
brand j). Thus, brand i is more likely to have no semi-loyal customers in period t if it did not offer a
“sale” in period t-1. From Lemma 2, if follows that brand i is more likely to offer a “sale” in period t.
The second part of the proposition shares similar intuition: the lower the price posted by brand i in week
t-1, the more likely it retains the semi-loyal customers and hence the lower the likelihood of it offering a
“sale” in week t.
Proposition 3 demonstrates that own past promotions affect the timing of current promotions.
The next proposition, which follows naturally from Lemma 3, demonstrates that the depth of discount is
also affected by past promotions.

- 17 -
 Proposition 4: Expected Promoted Price and Own Past Promotions
a) If state dependence effects are moderate (c < c** ), a brand offers a lower promoted
price if it offered a “sale” in the previous period, i.e.,

E  p it | p it < r , p i ,t −1 < r  < E  p it | p it < r, p i ,t −1 = r  .

If c ≥ c** , the expected promoted price is independent of own past promotions.

b) The expected promoted price in the current period increases if the brand offered a
deeper discount during the previous period, i.e.,
∂E ( p it | p it < r ) ∂ p i ,t −1 ≥ 0.

In summary, our model predicts that when consumers exhibit state dependence, current
promotional strategies are affected by past own promotions and past competitor promotions. A deep
discount offered by the competing brand not only makes a retaliatory promotion more likely but also
leads to deeper price cuts, provided state dependence effects are not too strong. In contrast, a deep price
discount offered by a brand makes it less likely that it will offer a promotion in the following period,
especially one accompanied by deep discounts.
13
3.3 Model Extension – Competitive Promotions by Asymmetric Brands

The results thus far have focused on two identical competitors. However, in several categories,
strong national brands often compete against weaker competitors (such as generics and store brands) who
may generate less loyalty. Our model easily accommodates such a case and, as we show in §3.5, offers
predictions consistent with several stylized facts. To analyze the promotional dynamics with
asymmetrically positioned brands, we consider a market with two brands that we label “weak” and
“strong”. We interpret the parameter c as each brand’s ability to generate loyalty and assume that cs > 0
and cw = 0, where cs and cw are the loyalty premiums that the semi-loyal customers are willing to pay for
the strong and weak brands, respectively. If the strong brand has the lowest price this period, then in the
following period the strong brand sells to θ semi-loyal customers. In contrast, if the weak brand has the
lowest price, then in the following period the θ potential semi-loyal customers remain in the market but
behave like switchers (cw=0).
Analogous to our analysis of the symmetric case, we consider how both own and competitive
actions in the past affect promotion frequency and expected promoted price. Similar to the symmetric

12
In the terminology of the hazard function literature, the hazard rate of price promotion stays constant.

- 18 -
case, the probability of either the strong or weak brand promoting in the current period is lower if the
brand offered a “sale” in the previous period. Further both brands are less likely to promote following
their own price promotion, especially if it is accompanied by a deep discount. Competitive promotions
have the opposite effect. While both firms respond to past competitor’s promotions by increasing the
likelihood of promotion in the current period, the rationale is quite different. Promotions for the strong
brand are more frequent in the bad state because this increases future volume via semi-loyal customers (cs
> 0). In contrast, the weak brand does not generate semi-loyal customers (cw = 0). One might conclude
that this would result in intense price competition in the bad state. However, the weak brand recognizes
that profits are greater in the good state because prices are higher. Thus, the weak brand promotes less
frequently in the bad state with the expectation that future prices will increase.
For expected promoted price, the intuition and results for the strong brand are similar to the
symmetric case. We find that the expected promoted price of the strong brand is greater following its
own previous sale. Analogously, the expected price of the strong brand is decreasing in own past price
and increasing in competitive past prices, i.e.

(
∂E p t
strong
| pt
strong
<r ) < 0; and
(
∂E p t
strong strong
| pt <r ) > 0.
∂p ∂p
strong weak
t −1 t −1

However, the expected price and response of the weak brand offer an interesting departure from the
earlier results.

Proposition 5: Expected Price of Weak Brand

a) The expected price of the weak brand is greater following a “sale” by the strong
brand in the previous period, i.e.

(
E p tweak | p tstrong
−1 ) (
< r > E p tweak | p tstrong
−1
=r . )
b) The expected price of the weak brand is increasing in own past price and decreasing
in competitive past prices.

(
∂E p t
weak
| pt
weak
<r ) > 0; and
(
∂E p t
weak
| pt
weak
<r ) < 0.
∂p ∂p
weak strong
t −1 t −1

The rationale for the weak brands dissimilar behavior is as follows. When the strong brand offers
a discounted price in the previous period ( ptstrong
−1 < r), it gets the semi-loyal customers who are then

willing to pay a loyalty premium cs. The weak brand recognizes that the strong brand does not have an

13
The analytic details of the asymmetric model can be found in the Technical Appendix.

- 19 -
incentive to compete aggressively for the switchers, and hence charges high prices. Intuitively, the weak
brand plays a “follower” role and raises its price as it expects the strong brand to raise its price. In §3.5,
we relate Proposition 5 to the observed correlation of prices for weak vs. strong brands.
We now turn to the main issue raised in this paper: how to respond to competitors’ promotions.

3.4 Product-Market Characteristics and the Intensity of Promotional Response

Examples in the Introduction (§1) suggest that managers have some discretion over both the
timing of promotion and the promoted price. A brand manager may be able to shift forward the next
planned sale event or allocate additional funds (e.g., “street money”) to achieve a lower promoted price.
Two key parameters in our model, θ and c, capture different aspects of state dependence. As such, we
consider how variation in these parameters affects competitive response.
We develop two metrics to capture competitive reactions: response speed and response
magnitude. These are defined as:

∂ Pr ( p it < r )
Response Speed = , j ≠ i.
∂ p j ,t −1

∂E ( p it | p it < r )
Response Magnitude = , j ≠ i.
∂ p j ,t −1

Response speed captures the notion that time to the next “sale” offered by a brand is reduced by a deep
competitive promotion (i.e., the “sale” occurs sooner). We measure this by the change in the likelihood
of a brand offering “sale” in the current period as a “reaction” to a competitor’s past price cut. Our earlier
example demonstrated that Asda altered the timing of a promotion in response to a deep price cut by
Tesco. The response speed represents the degree to which promotion timing is affected by competitor’s
actions. Response magnitude captures the notion that a brand prices more aggressively in “response” to a
competitor’s deep price discount. We measure this by the change in current expected promoted price in
response to past competitive price changes. In practice, a deep discount by a rival brand may cause a
brand manager to allocate additional trade dollars and obtain a lower promotion price.
We now summarize the impact of market characteristics on the intensity of response to
competitive promotions in Result 1.

- 20 -
 Result 1: Response Speed and Magnitude
a) The response speed is weakly increasing in θ and c.

b) The response magnitude is strictly increasing in θ for θ <θ% and decreasing

thereafter. The response magnitude is increasing for c <c% and is weakly decreasing
14
thereafter.
When we refer to competitive response, we consider how a brand with θ semi-loyals changes its
strategy in response to a price cut by the competing brand. If the brand retains semi-loyals (i.e. acquires
the switchers in the current period), then there is no change in state and hence no change in strategy.
Therefore, the intensity of response is higher if the competitor’s price cut increases the likelihood of
losing semi-loyal customers (i.e. not acquiring the switchers in the current period). With stronger state
dependence, the brand with semi-loyal customers finds it more attractive to target its semi-loyal
customers rather than fight for switchers. This, in turn, makes him more vulnerable to competitive price
cuts, which increases the likelihood of a promotion response the following period (Result 1a).
Given that a promotion response occurs when the brand loses the semi-loyal customers, the next
issue is does the brand also change the promoted price. The extent of price response depends on D (see
Lemma 3), which initially increases with state dependence effects (c and θ) and then declines to zero.
This explains the intuition behind Result 1b.
Note that Result 1 suggests that when state dependence effects are small (c and θ), the preferred
mode of response is to reduce the promoted price. For moderate values of c and θ, brands respond by
adjusting both the timing of the next sale and the depth of discount. Finally, for large values of c and θ,
brands respond by moving “sale” events forward, but do not vary the promoted price. We elaborate on
this finding in our discussion of managerial implications in §5.
Result 1 considers symmetrically positioned brands, and we now consider how relative brand
positioning affects response speed and magnitude. Similar to the symmetric case, the response speed of
the both brands increases as the number of semi-loyals and the degree of loyalty increase. Further, the
response magnitude of the strong brand follows a similar pattern as the symmetric case (inverted u-
shape). However, we find that whether a brand responds by changing the timing of a “sale” or altering
the promoted price depends on the brands relative positioning.

14
For r =5, c=3.7, δ=0.95, l=0.2, γ =.5, θ% ≈ 0.45 ; r =5, δ=0.95, l=0.2, γ =.5, θ=0.5, c% ≈ 3.6 .

- 21 -
 Result 2: Relative Brand Positioning and Response Speed and Magnitude
a) The response speed of the weak brand is greater than the response speed of the strong
brand.
b) The response magnitude of the strong brand is greater than the response magnitude of
the weak brand.
Result 2a follows from recognizing that the payoff and prices of both brands is greater in the
good state. Thus, both brands have an incentive to promote in a manner that increases the likelihood of
the good state. The strong brand tends to promote frequently in all states to increase the likelihood of the
good state the next period. In contrast, the weak brand always promotes in the good state but promotes
much less frequently in the bad state to increase future payoffs. Because the difference in promotion
frequency between states is greater for the weak brand than the strong brand, a price cut by the strong
brand has more impact on the weak brand’s promotion frequency.
The intuition for the price response of each brand is as follows. In the good state, the strong firm
has θ semi-loyals and the current margin/volume trade-off places upward pressure on the strong brand’s
price. In the bad state the strong firm has 0 semi-loyals and concern for future volume places downward
pressure on current prices. In contrast, the weak firm never has semi-loyals and there is relatively less
upward pressure and less downward pressure on the weak brand’s price. Because the difference in
promoted price between states is greater for the strong brand than the weak brand, a price cut by the weak
brand has more impact on the strong brand’s promoted price (Result 2b).
In the symmetric case, the response of each brand can be termed “reactive”. In contrast, in the
asymmetric case, the weak brand “responds” to the strong brand's price promotion by raising its expected
promoted price. Thus, the weak brand adopts an “accommodative” posture and the strong brand adopts a
“passive” posture to the price promotion of the weak brand. Thus, our model predicts that the nature of
competitive response is affected by relative brand position. We discuss these implications in §5.

3.5 Implications for the Temporal Pattern of Competitive Prices

Our model also offers predictions on temporal pattern of own and competitive prices. In this
section, we relate the degree of state dependence and relative brand positioning to the pattern of prices we
expect to observe. Finally, we use these predictions to interpret a series of stylized facts, including results
from Kopalle et al (1999).

3.5.1 Temporal Price Movement

Our model offers predictions on serial promotion correlation as well as contemporaneous
correlation. Specifically, define serial correlation as SC = Corr( pti , pti- 1 ) and contemporaneous

- 22 -
correlation as CC= Corr( pti , pt j ). We are interested in how these correlations vary with the degree of

state dependence and relative brand positioning.

We first consider serial correlation and summarize our insights in the following result.

Result 3: Serial Correlation and Brand Positioning

For symmetric brands, own correlation is negative (i.e. SC < 0). For asymmetric brands,
own correlation is negative for the strong brand and positive for the weak brand (i.e.
SC strong < 0 and SC weak > 0 ). If either c=0 (cs=0) or θ = 0, then own correlation is zero.

From Propositions 3 and 4, it follows that own promotions are negatively correlated (SC < 0). A
brand is more likely to charge a higher price in period t following a promotion in period t-1, which
induces a negative correlation. This result holds in the asymmetric case for the strong brand but not for
the weak brand. If the weak brand raises its price in period t-1, the strong brand is more likely to gain the
switching customers. Thus in period t, the strong brand is less likely to promote and raises its price. As a
follower, the weak brand also raises its price in period t. If there is no ability to generate semi-loyal
customers (c=0 or θ=0), then there are no dynamics in our model and serial correlation is zero.

Predictions on the contemporaneous correlation also depend on the number of semi-loyals and
relative brand positioning. We summarize these in Result 4.

Result 4: Contemporaneous Correlation and Brand Positioning

For symmetric brands, the contemporaneous correlation is negative (CC < 0), while for
asymmetric brands the contemporaneous correlation is positive (CC > 0). If either c=0
(cs=0) or θ = 0, then contemporaneous correlation is zero.

In the symmetric case, our model predicts that firms behave in a “reactive” manner (Result 1),
which creates a negative contemporaneous correlation. In the asymmetric case, the weak brand behaves
like a follower (Result 2), which creates a positive contemporaneous correlation. Finally, if there are no
dynamics (c=0 or θ=0) the contemporaneous correlation is zero.

3.5.2 Explaining Stylized Facts

Results 3 and 4 allow us to reconcile conflicting empirical evidence on the timing of price
promotions. Lal (1990) observes that manufacturers of dishwashing detergents tend to offer trade deals at
different times rather than at the same time. Similarly, Kopalle, Rao, and Assunção (1995) note that

- 23 -
 15
within many supermarkets, Coke and Pepsi tend to be promoted in alternating weeks. In contrast, Rao,
Arunji, and Murthi (1995) find that for several product categories (e.g., toilet tissue, baby diapers,
ketchup), there is no correlation in the timing of price promotions of competing brands. These findings
can be rationalized in terms of differences in the number of semi-loyal customers across the categories.
For example, as shown in Table 3 in §4, ketchup is a category with very low consumer state dependence.
As such, our model predicts low correlation in promotion timing, which is consistent with the empirical
findings of Rao et al (1995).
These results also offer some insight into results from Kopalle et al (1999). For symmetric
brands, our model predicts negative contemporaneous correlation if there are sufficient semi-loyal
consumers (θ) and the degree of loyalty is strong (c >>0). In Table 1, all the significant coefficients are
negative for symmetrically positioned brands. In contrast, for asymmetric brands our model predicts
positive contemporaneous correlation. In Table 1, 8 of the 11 significant coefficients are positive for
asymmetrically positioned brands.
While our model is consistent with these stylized facts, this evidence is not a direct test of our
theory. In the next section, we present and test a series of hypotheses, which offers further support for our
model.

4. EMPIRICAL VALIDATION

In this section, we offer preliminary evidence in support of some of the testable implications of
the proposed framework. We begin by outlining the key predictions of our model (§ 4.1). In §4.2, we
discuss the data and variable definitions and in §4.3, we briefly outline the econometric methodology
used in the analysis (details are offered in the Technical Appendix). Finally, in §4.4 we discuss our
empirical findings.

4.1 Key Testable Implications of the Proposed Model

Based on the analysis in §3, we classify our predictions into two groups: those relating to the “speed
of response” (i.e., the likelihood of price promotion) and the other relating to the “magnitude of response”

15
It should be noted that according to Consumer Reports (March 1988), in certain markets Coke and Pepsi bottlers
negotiated contracts which allocated alternating weeks in a supermarket to each brand. Whether or not explicit
contracts are currently written, the de-facto practice today is for alternating promotion in many of these same
markets. The intuition in this model suggests that even in the absence of a contract, Coke and Pepsi have incentive
to alternate promotions.

- 24 -
(i.e., the depth of promotional discount). Our hypotheses and the propositions and results they are based on
are summarized in Table 2.
[INSERT TABLE 2 ABOUT HERE]
A key parameter in our model that moderates promotion frequency and the promoted price is the
size of the consumer segment that exhibits state dependence (θ). As θ increases, promotions are less
frequent (H1) and the promoted price increases (H4). Our model also offers predictions on how variation in
θ affects how a brand responds to competitor’s actions (H2 and H5) and own past actions (H3 and H6). We
focus our hypotheses on θ as we did not have suitable measures to operationalize l (size of loyal customers)
and γ (size of switchers).

4.1.1 Data Description and Variable Definition

Our empirical analysis focuses on the impact of differences in the size of the consumer segment
exhibiting state dependence (θ) across product categories on the speed and the magnitude of competitive
response in these categories. To conduct such a cross-category analysis, we use the ERIM data sets from
A.C. Nielsen for the following product categories: ketchup, canned tuna, peanut butter, stick margarine
and toilet tissue. By design these five categories are identical to those used in Seetharaman et al (1999),
who investigate household state dependence effects across categories. For each product category,
Seetharaman et al (1999) estimate the fraction of households that exhibit significant inertia (state
16
dependence) as well as the mean value of this effect. We use these estimates as proxies for the segment
size exhibiting state dependence (θ) and the premium that the semi-loyal customers are willing to pay for
their preferred brand (c) respectively.
The ERIM data set tracks information for each UPC at several stores in two markets. Our
analysis is performed at the brand level by aggregating UPC items as in Seetharaman et al (1999). The
brands included in our analysis for ketchup, peanut butter and toilet tissue categories are identical to those
used in Seetharaman et al (1999). For stick margarine and tuna categories, we excluded the lowest share
brands (viz., Fleischmann's and the store brand, respectively) so that we consistently analyze four brands
in each of the five categories. Thus, the data accounts for 96% of all 32-ounce ketchup, 89% of all 18-
ounce peanut butter, 66% of all four-stick packs of stick margarine and 87% of all 6.5-ounce canned tuna.
Please refer to Seetharaman et al (1999), Table 1, page 492 for additional details.

16
Seetharaman et al (1999) allow for unobserved heterogeneity across consumers in the magnitude of state dependence
effects and report the mean and variance of this effect for the five categories analyzed.

- 25 -
4.1.2 Variable Operationalization

a) Occurrence of Price Promotion (SALE): This is a dummy variable such that SALEjkrt = 1 if brand j in
product category k is on “sale” in week t at retail store r; SALEjkrt = 0, otherwise. In determining whether
or not a brand is on sale in any given week, we recognize that while remote, there is a possibility that
not all UPC's that comprise a brand may be on promotion at the same time. In this case, we set SALEjkrt
= 1 if more than 50% of the UPC's that comprise brand j are price promoted in that week.
b) Depth of Promotional Discount (DEPTH): DEPTHjkrl represents the percentage price reduction offered
on brand j in category k in retail store r, during the lth sale event. The percentage reduction off regular
price is first computed at the UPC level. DEPTHjkrl is then simply the sales-weighted average of the
depth of discount offered on the individual UPC's comprising brand j.
c) Consumer State Dependence (STATEDEP): STATEDEPk represents the percentage of consumers in
product category k that exhibit state dependence and corresponds to the parameter θ (size of the semi-
loyal customers) in the model. This measure is based on Seetharaman et al (1999), who estimate the
percentage of households that exhibit significant state dependence effects across the 5 categories used in
our analysis. Their estimates for these categories are as follows: Tuna=0, Ketchup=3, Tissue=16, Peanut
Butter=13 and Margarine=21 (Seetharaman et al 1999, p. 497).
d) Own Past Promotion (OPSALE): The variable OPSALEjkrt represents whether or not brand j in category
k was on sale in retail store r in week t-1 and is simply the lagged value of SALEjkrt. Thus, OPSALEjkrt =
1 if SALEjkr,t-1 = 1 and = 0, otherwise.
e) Past Competitive Sale (CSALE): The variable CSALEjkrt captures the impact of price promotions by the
competing brands in category k in week t-1 on brand j's price promotion in week t. Unlike the stylized
duopoly model, there are 4 competing brands in each product in our data set. We recognize that a
competitive sale by a large market share brand has a greater impact than a low market share competitor.
Therefore, we define CSALEjkrt as follows:

CSALE jkrt = ∑ i ,i ≠ j  SALEikr ,t −1 × SHAREikr  ∑ SHAREirs

i ,i ≠ j

Here SALEikr,t-1 is as defined above and SHAREikr denotes the market share of brand i in category k at
store r. Thus, CSALEjkrt represents the market share weighted number of competing brands that were on
sale in week t-1 at store r.
f) Past Promotional Depth (PDEPTH): PDEPTHjkrl represents the depth of discount offered on brand j in
category k at store r on the previous sale (i.e., l-1th sale event). In constructing this measure, we
recognize that a deep discount offered on a sale offered in the recent past is likely to have a greater
impact than an identical discount offered on a sale in the more distant past. We control for this effect by

- 26 -
 adjusting for the time elapsed (in number of weeks) since the previous sale (i.e., the interval between lth
and l-1th sale events) for brand j in category k at store r. Specifically, we use the following measure:
PDEPTHjkrl = DEPTHjkr,l-1 / TIMELAPjkrl
Here DEPTHjkrl is as defined above and TIMELAPjkrl is the interval between lth and l-1th sale events.
g) Competitive Promotional Depth (CDEPTH): The variable CDEPTHjkrl captures the impact of deep
discount offered by the competing brands i, i ≠ j, in category k on their previous sale (i.e., their li-1th sale
events) on the price discount that brand j offers on the lth sale event. In constructing this measure, we
control for the time (elapsed) effect as well as the size of the competitor. In particular, we use the
following measure:

∑ ( DEPTH
i ,i ≠ j
ikr ,l j −1 )
× SHAREikr / TIMELAPikrl j 

CDEPTH jkrl =
∑ SHARE
i ,i ≠ j
ikr

Here DEPTH ikr ,l j −1 denotes the depth of discount offered by brand i during its previous promotion

(i.e., li-1th sale event). Similarly, TIMELAPjkrl is the interval between brand j's lth promotion and brand i's
li-1th sale event.

4.1.3 Covariates Operationalization

Note that the ERIM panel data tracks retail prices and not manufacturers’ wholesale prices.
Consequently, in testing our predictions derived from a model of inter-brand promotional competition, we
need to control for other factors exogenous to our theoretical model that might influence the retailer’s price
promotion decisions on frequency and depth of discount. We used the following four covariates in our
analysis.

a) Intensity of Inter-Brand Competition (CONC): The stylized model is a symmetric duopoly. However,
the data set contains multiple brands; further, the competitive structure differs across the categories. We
control for differences across product categories in their intensity of competition and their potential
impact on the frequency of promotion and depth of discount through a market concentration index.
CONCk is defined as the sum of the square of market share of the top four brands (selected for our
4
analysis) in category k: CONC k = ∑ SHARE ik 2 .
i =1

b) Loss Leader Pricing (PROMO): Retailers typically use certain product categories (that display large
category volume elasticity) as loss leaders and offer more frequent “sale” in these categories
accompanied by deeper discounts. We control for any potential confound through the variable
PROMOkr that denotes the responsiveness of category sales to price promotion for category k at retail

- 27 -
 store r. We compute PROMOkr, the price elasticity, by regressing ln(qkrt) on ln(pkrt), where qkrt is volume
sold in category k, at store r in week t and pkrt is sales weighted price index computed across all brands
in category k, at store r in week t.
c) Feature Advertisement (FEAT): Retailers may be more likely to offer a higher depth of discount on
price promotions supported by in-store activities such as feature and display. To control for these
effects, we include an indicator variable, FEAT, with FEATjkrl = 1 if brand j in category k at retail store
r, is feature advertised during the lth sale event; FEATjkrl = 0, otherwise.
d) Display (DISP): This is an indicator variable such that DISPjkrl = 1 if brand j in category k at retail store
r, is displayed during the lth sale event; DISPjkrl = 0, otherwise.
The summary statistics for the sample used in the analysis are reported in Table 3
[INSERT TABLE 3 ABOUT HERE]

4.2 Model Specifications

4.2.1 Empirical Model for the Likelihood of a “Sale”

Hypotheses 1-3B relate the dependent variable – the likelihood of a brand being on “sale” i.e.,
Pr ( SALE = 1) – to 3 explanatory variables viz., size of the consumer segment exhibiting state dependence

(θ), own previous sale (OPSALE) and past competitive sale (CSALE). The unit of analysis here is the
weekly observation on promotional activity (sale/no sale) for a brand, pooled across the 5 product categories
and across 5 randomly selected stores. Pooling observations across product categories and across stores
(while controlling for store-specific heterogeneity) helps us improve the statistical efficiency of the
parameter estimates.
In our analysis, we use a binary logit model and specify the probability that brand j in category k is
on “sale” in week t at store r as:

−1
  α 0+α 1× STATEDEPk +α 2×CSALE jkrt +α 3×OPSALE jkrt  
  
  +α 4×CSALE jkrt × STATEDEPk +α 5×OPSALE jkrt 
Pr ( SALE jkrt = 1) = 1+ exp  (10)
  ×STATEDEPk +α 6×CONC k +α 7× PROMO kr +α8 −10 
  × BRAND j +α11−14 × STORE r 
   

We adopt a fixed effects formulation to account for brand and store heterogeneity. Consequently,
BRAND and STORE are dummy variables included to account for idiosyncratic brand- and store-level
effects, respectively.

- 28 -
 Hypotheses H1-H3 imply that we expect α1>0 (H1); α2<0 (H2A); α3>0 (H3A); α4<0 (H2B); and,
17
α5>0 (H3B). Based on the discussion in §4.1.2, we expect α6<0 and α7<0, respectively. As noted earlier,
extant static models of price promotion model the phenomenon as a memory-less process so that prior
sale events have no impact on a brand’s current promotional decisions. This corresponds to α2 = α3 = 0.
Further, since these models do not incorporate consumer choice dynamics (e.g., Guadagni and Little,
1983; Papatla and Krishnamurthi, 1996), they offer no predictions on α1, α4 and α5.

4.2.2 Empirical Model for the Expected Depth of Promotional Discounts

Hypotheses 4-6B relate the dependent variable – the expected depth of discount offered by a
brand during a “sale” (DEPTH) – to 3 explanatory variables viz., size of the consumer segment exhibiting
state dependence (θ), discount offered during own previous sale (PDEPTH) and discount offered during
past competitive sale (CDEPTH). The unit of analysis here is price discount offered during sale events.
Since the variable DEPTH can only take values between 0 and 1, we use the two-limit probit
approach (e.g., Datar, Jordan, Kekre, Rajiv and Srinivasan, 1997). We further recognize that PDEPTH
and CDEPTH impact DEPTH only if the premium that the semi-loyal customers are willing to pay for
their preferred brand is not “too large” i.e., c rk ≤ c*rk , where crk denote the premium that semi-loyal
customers are willing to pay for their preferred brand in category k at retail store r. In addition note that
the impact of θ on the magnitude of response is positive when θ≤ θˆ but negative when θ> θˆ (Hypotheses
H5B and H6B). We incorporate this non-linearity by including interaction terms of PDEPTH (CDEPTH)
and STATEDEP squared in the model.
We specify the (latent) depth of discount offered by brand j in category k during the lth sale event
at store r as:

y jkrl = β 0 + β 1×STATEDEP k + β 2 × PDEPTH jkrl + β 3 × CDEPTH jkrl

*


+ β 4 × PDEPTH jkrl×STATEDEP k + β 5 × CDEPTH jkrl×STATEDEP k 

+ β 6 × PDEPTH jkrl×STATEDEP k 2 + β 7 × CDEPTH jkrl×STATEDEP k 2  if c kr ≤ c*kr
+ β 8 × DISP jkrl + β 9 × FEAT jkrl + β 10 × CONC k + β 11×PROMO kr 

+ β 12 −14 × BRAND j + β 15−18 × STORE r + ε jkrl 


17
It is easy to show that the marginal impact of any explanatory variable, Xi, on the likelihood of sale, i.e.,
∂ Pr ( SALE = 1) ∂X i = − α i e X α (1 + e X α ) .
−2

- 29 -
 y jkrl = β 0 + β 1×STATEDEP k + β 8 × DISP jkrl + β 9 × FEAT jkrl 
*


+ β 10 × CONC k + β 11×PROMO kr + β 12 −14 × BRAND j  if c kr > c kr
*
(11)
+ β 15−18 × STORE r + ε jkrl 

As before, BRAND and STORE are dummy variables included to account for idiosyncratic brand-
and store-level effects, respectively.
Hypotheses H4-H6B imply that we expect: β 1<0 (H4); β2<0 (H6A); β 3>0 (H5A); β 4<0, β 6>0 (H6B);
18
and, β 5>0, β 7<0 (H5B). Based on the discussion in § 4.1.2, we expect β 6>0; β 7>0; β 8>0and β 7>0,
respectively. As noted earlier, extant static models suggest that β 2 = β 3 = 0. In the next section we present
the estimation results and discuss the findings as they relate to our hypotheses.

4.3 Results and Discussion

The results for the ML estimation of the logit model specifying the likelihood of “sale” are
reported in the second column of Table 4. The parameters α1 (impact of θ), α2 (impact of past
competitive promotion) and α3 (impact of own past promotion) are all significant and in the expected
direction lending support to hypotheses H1, H2A, and H3A. While only marginally significant, the
parameter α5 (interaction of θ and own past promotion) is in the predicted direction, thus supporting
hypothesis H3B. Due to multi-collinearity, we did not include the interaction term STATEDEP × CSALE
and hence could not test for hypothesis H2B.
[INSERT TABLE 4 ABOUT HERE]
To help interpret our empirical findings of likelihood-of-sale model, we focus on peanut butter
categories where θ (fraction of customers who exhibit state-dependence) is relatively high (θ = 0.13).
The four brands in this category are: Skippy (market share 36%), Peter Pan (26%), Jif (19%) and Store
Brand (19%). At the sample average values of the control variables (CONC = 0.27; PROMO = 3.44), the
likelihood that Peter Pan offers a “sale” in any given week is 0.13 in the absence of any promotional
activity in the previous week (OPSALE = 0; CSALE = 0). However, if Peter Pan had promoted last week
(i.e., OPSALE = 1), the probability that it promotes again this week reduces to 0.05. To understand the
impact of past competitive promotions, we need to recognize the differential market shares of the
competing brands. If a low share brand such as Jif promoted last time (i.e., CSALE = 0.19), the likelihood
that Peter Pan offers a “sale” in the following goes up to 0.20. However, if it was the high market share

- 30 -
brand Skippy that had promoted last week (i.e., CSALE = 0.36), the likelihood of Peter Pan offering a
retaliatory promotion this week is 0.33.
The results for the two-limit model of depth of promotional discount are reported in the third column
of Table 4. The parameters β 1 (impact of θ) is in the expected direction and is significant while the
parameters β 2 (impact of own past promotional depth) and β 3 (impact of past competitive promotional
depth) are not statically significant though they are in the expected direction. Thus, we find support for
hypothesis H4 but no direct support for hypotheses H5A and H6A (we need to recognize that PDEPTH and
CDEPTH still impact current promotional discount through the interaction effect). The parameters β 4
(interaction of θ and PDEPTH) and β 5 (interaction of θ and CDEPTH) are statistically significant and in
the predicted direction, thus supporting hypothesis H5B and H6B. The parameters corresponding to the
quadratic interaction effect (β 6 and β 7) are both statistically insignificant, indicative of the fact that the
size of consumers exhibiting state dependence in all five categories may be less than θˆ .
Based on these results, the data appears to offer preliminary support to all but two of our
hypotheses related to the speed (likelihood of promotion) and magnitude of competitive response (depth
of promotional discounts).

5. CONCLUSIONS AND MANAGERI AL INSI GHTS

An integral part of planning sales promotions is the development of promotion calendars that
provides guidelines on how to allocate promotional budgets over “sale” events. In addition, managers
need to update this promotion schedule in light of competitor’s actions. To develop an effective
promotion schedule, managers need to understand how their own previous promotions affect the timing of
the next sale and the price discount to be offered. Further, managers need to understand whether
adjusting the timing of the next “sale” of the future discount is a more effective competitive response. To
answer these questions, managers must relate their promotional strategy to the product market
characteristics.
In this paper, we extend static promotion models to incorporate consumer choice dynamics that
are well documented in the empirical scanner data models (e.g. Guadagni-Little, 1983). This dependence
of consumers’ current preference on past purchases induces long-term effects of temporary price
reductions. Our analysis indicates that the magnitude of this long-term effect depends on both the number

18
Because dynamics are relevant only when the size of the semi-loyal segment is larger than zero (θ>0) it is
reasonable to wonder why coefficients of CSALE and OPSALE are non-zero. Since the estimates are computed
using the entire sample where sample average θ > 0, the parameters should be interpreted in a conditional sense, i.e.,
the hypothesized sign of the parameter estimates conditional on the sample average θ.

- 31 -
of consumers who exhibit state dependence and the degree of state dependence. Further, because these
long-term effects may be brand specific, manager’s need to understand the ability of competing brands to
generate future loyal customers.
We find that when both competing brands can generate a significant degree of consumer loyalty,
they respond “very aggressively” to competitor’s actions by advancing the next planned sale. That is,
response speed (i.e., promotion timing) is the primary mode of reaction. However in product markets
with less purchase event feedback, brands shift attention from response speed to response magnitude and
respond less aggressively. That is, brands respond to competitive past price cuts by decreasing the
promoted price without significantly altering promotion timing. The overall response is more muted as
both brands are relatively weak.
In product markets in which brands differ in their ability to generate purchase event feedback, we
find that the strong brand behaves as a leader while the weak brand behaves as a follower. As the leader,
the strong brand adopts a “passive” posture and tempers its reaction to the weaker brand. When the
strong brand does react, the primary reaction is to adjust the promoted price (Result 2b). In contrast, the
weak brand adopts an “accommodative” posture primarily by avoiding fierce price competition. When
the weak brand responds, it is primarily by changing the timing of a future “sale” event (Result 2a). We
summarize these implications in Table 5.
[INSERT TABLE 5 ABOUT HERE]
We note that our model predictions are consistent with several stylized facts highlighted in the
introduction. We find that when similarly positioned brands compete, prices exhibiting negative
contemporaneous correlation (i.e., the competing brands “take turns” in offering sales). Further, we find
that when one brand is dominant, the competitive prices exhibit positive contemporaneous correlation
(i.e., the competing brands are likely to offer a “sale” concurrently). These results allow us to reconcile
the conflicting empirical evidence on the timing of price promotions. A more direct test of the model is
obtained from a series of testable hypotheses on the likelihood of promotion and the expected depth of
discount. We investigate these hypotheses on an ERIM dataset from 5 different product categories and
find broad support for our model.
We consider this paper as an important attempt to study the dynamic aspects of competitive price
promotions. Having said that, we realize the limitations of our analysis. For instance, for analytical
simplicity we assume that consumer state dependence persists for one period alone. However,
Seetharaman et al (1999) finds a much more varied pattern of state dependence. It would be interesting to
investigate the implications of such generalized long-term effects on dynamic promotional strategies. We
also recognize the shortcomings of our empirical analysis, primarily due to data limitations. We did not

- 32 -
have suitable measures to operationalize parameters such as l (size of loyal customers) and γ (size of
switchers) and hence could not test comparative static implications based on these parameters.

- 33 -
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Figure 1: Demand curves for each brand assuming brand A charged a lower price in the previous
period

Demand for Brand A Demand for Brand B

r r
Price of Brand A

Price of Brand B
p2+c
p2 p1

p1-c

θ (1+γ) (1+γ) θ
hard-core semi- switchers hard-core switchers semi-
loyal loyal loyal loyal

Quantity of Brand A Quantity of Brand B

Figure 2 Asymmetry of Price Distributions is Increasing in θ

f1(p) f1(p)
f2(p) f2(p)

note: f2(p=r) = 0.125

note: f2(p=r) = 0.364

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 Figure 3 Support of the Price Distributions in States 1 & 2
Region I
F1(p)
F2(p)

p p p1 p2
1 2
Region II
F1(p)

F2(p)

p r-c p p1 p2 =r
1 2
Region III
F (p)
1
F (p)
2
r-c p p1 = p2 =r

Figure 4: Difference in Promoted Price (D) vs. Number of Semi-Loyals (θ)

0.60

0.50

0.40

0.30
D

0.20

0.10

0.00
0.00 0.20 0.40 0.60 0.80 1.00
θ

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 Table 1: Price Reaction Coefficients from Kopalle et al (1999)

Effect of
Strong Brands Weak Brands
(High Share Brands) (Low Share Brands)
4 negative 2 negative
Strong Brands 0 positive 4 positive
(High Share Brands) 2 not significant 3 not significant
Effect
On
1 negative 1 negative
Weak Brands 4 positive 0 positive
(Low Share Brands) 4 not significant 5 not significant

Table 2a: Testable Implications

Speed of Response Hypotheses

Description Based on:

H1 The likelihood that a brand offers a price promotion is decreasing the size of the Lemma 2b
consumer segment exhibiting state dependence (θ).

H2A The likelihood that a brand offers a price promotion is higher if a competing brand was Prop. 1
on “sale” in the previous period.

H2B The likelihood that a brand offers a price promotion in response to a competitive price Result 1a
cut is increasing in the size of the consumer segment exhibiting state dependence (θ).

H3A The likelihood that a brand offers a price promotion is lower if it was on “sale” in the Prop. 3
previous period.

H3B The likelihood that a brand offers price promotions in successive periods is decreasing in Prop. 3,
the size of the consumer segment exhibiting state dependence (θ). Lemma 4

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 Table 2b: Testable Implications

Magnitude of Response Hypotheses

Description Based on:

H4 The expected depth of discount that a brand offers during a price promotion is Lemma 3b
decreasing the size of the consumer segment exhibiting state dependence (θ).

H5A The expected depth of discount that a brand offers in response to a competitive Prop. 2b
promotion is increasing in the depth of discount offered by the competitor. This holds
**
provided state dependence effects are not “too large” (i.e., c < c ).

H5B The change in the expected discounted price in response to a deeper competitive price Result 1b
cut is increasing in the size of the consumer segment exhibiting state dependence (θ)
forθ ≤ θˆ and is decreasing forθ > θˆ .

H6A The expected depth of discount that a brand offers in the current period is decreasing in Prop. 4b
the depth of discount offered by it during the previous promotion. This holds provided
**
state dependence effects are not “too large” (i.e., c < c ).

H6B The change in the expected discounted price in response to a brand’s own previous Prop. 4 ,
price cut is increasing in the size of the consumer segment exhibiting state dependence Lemma 4
(θ) forθ ≤ θˆ and is decreasing forθ > θˆ .

Table 3: Summary Statistics

Category Variable Ketchup Margarine Peanut Toilet Tuna

Butter Tissue
Mean of SALE 0.08 0.18 0.07 0.09 0.17
Mean of DEPTH 0.20 0.25 0.13 0.15 0.29
Value of STATEDEP (θ) 0.03 0.21 0.13 0.16 0
Mean CSALE 0.04 0.07 0.03 0.06 0.11
Mean of PDEPTH 0.05 0.08 0.03 0.04 0.08
Mean of CDEPTH 0.02 0.06 0.02 0.03 0.07
Mean of FEAT 0.62 0.77 0.37 0.58 0.81
Mean of DISP 0.12 0.09 0.05 0.25 0.11
Value of CONC 0.38 0.26 0.27 0.33 0.30
Value of PROMO -0.58 -2.75 -1.19 -2.50 -1.88
Value of Strength of State 0.15 0.53 0.42 0.46 0
Dependence Effect (c)

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 Table 4: Sale and Depth Model Results

Parameter Estimates (t-ratio)

Explanatory Variable SALE DEPTH
STATEDEP α1 = 2.7144 (2.47) **
β 1 = -0.3132 (2.09) **
CSALE α2 = -2.6632 (-4.84) ** –
OPSALE α3 = 0.8078 (3.84) ** –
OPSALE × STATEDEP α5 = 1.2678 (1.72) *** –
PDEPTH – β2 = -0.4134 (0.642)
CDEPTH – β3 = 0.01324 (-0.23)
PDEPTH × STATEDEP – β4 = -2.2427 (-3.72) **
CDEPTH × STATEDEP – β 5 = 2.6873 (2.19) **
PDEPTH × STATEDEP2 – β6 = 1.3829 (0.55)
CDEPTH × STATEDEP2 – β7 = -1.2762 (-0.73)
DISP – β8 = -0.0673 (-3.23) **
FEAT – β9 = 0.0787 (7.43) **
CONC α6 = 4.268 (5.03) ** β10 = 0.4216 (1.54)
PROMO α7 = -0.1747 (-12.39) ** β11 = 0.0213 (1.75) ***
Log Likelihood -2035.63 589.72
**
: significant at α = 0.05
***
: significant at α = 0.10
NOTE: In the SALE model (equation), we dropped the interaction term CSALE × STATEDEP
because of multi-collinearity.

Table 5: Nature and Mode of Response to Competition

Competitive Response of
Strong Brand Weak Brand

Nature of “Very Aggressive” Nature of

“Accommodative”
Promotion by Response Response
Strong Brand
Mode of Response Promotion Timing Mode of Response Promotion Timing

Nature of Nature of
“Passive” “Aggressive”
Promotion by Response Response
Weak Brand
Mode of Response Promoted Price Mode of Response Promoted Price

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