The impact of heterogeneity in purchase timing and price responsiveness onestimates of sticker shock effects

The notion that individuals have an internal reference price against which they compare observed prices is well supported by several psychological the ories. Empirically, several papers in the marketing literature, employing s canner panel data, have modeled the impact of reference prices on brand cho ice via the sticker shock formulation, in which consumers evaluate choice a lternatives using differences between shelf prices and reference prices. Mo st of the studies reported thus far have not accounted for heterogeneity in price response among consumers and have typically imputed reference prices from the shelf prices of brands that a consumer is supposed to have "obser ved" on previous purchases in the category. Since category marketing activi ty can differentially affect the purchase timing of households, we argue th at this measure of reference price may follow certain systematic patterns a cross consumers and, when combined with unaccounted for price response hete rogeneity, may result in a spurious sticker shock effect. Specifically, we show that estimates of sticker shock are biased upward if households that a re price-sensitive in the brand choice decision are also more responsive to category promotion activity in their purchase timing decision. We discuss some general conditions under which the bias occurs and conduct a simulation experiment to confirm our specific hypotheses. Our simulation results show that changes in purchase timing are a critical determinant of the bias in the sticker shock effect. We also show that unaccounted for pri ce response heterogeneity can in itself result in a biased sticker shock pa rameter; however, this requires very large differences in price sensitiviti es across consumers, far greater than what is normally observed. We develop a hierarchical Bayes version of the nested legit model, which mo dels heterogeneity via individual-level parameters in a continuous random e ffects framework. We estimate the model on scanner panel data from the yogu rt and ketchup categories. We find, in both categories, that the 95% probab ility interval of the posterior distribution of the mean sticker shock coef ficient contains the value zero. Therefore, at least for the data used in t his study, there is no evidence for the sticker shock effect at the aggrega te level. In contrast, the corresponding coefficient from a standard model (which ignores this heterogeneity) is highly significant and supports the e xistence of a (possibly spurious) sticker shock effect. Consistent with our explanation of the underlying cause of the bias, households that are more price-sensitive in the choice decision are also found to be more responsive to category promotion activity in their decision to purchase in the catego ry. The results highlight the measurement problems associated with imputing ref erence prices from past prices. Since the frequency, duration, and price le vel of a retailer's promotional program depend on its size and prevalence, accurate estimates of the sticker shock effect are essential for formulatin g optimal promotion strategies. An adequate accounting of consumer heteroge neity is critical to this effort.