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Fulton, Food Marketing Policy Center Modeling Coupon Values for Ready-To-Eat Breakfast Cereals by Gregory K. Price and John M. Connor Food Marketing Policy Center Research Report No. 54 January 2001 Research Report Series http://www.are.uconn.edu/FMKTC.html University of Connecticut Department of Agricultural and Resource Economics FOOD MARKETING POLICY CENTER RESEARCH REPORT SERIES This series includes final reports for contract research conducted by Policy Center Staff. The series also contains research direction and policy analysis papers. Some of these reports have been commissioned by the Center and are authored by especially qualified individuals from other institutions. (A list of previous reports in the series is given on the inside back cover.) Other publications distributed by the Policy Center are the Working Paper Series, Journal Reprint Series for Regional Research Project NE-165: Private Strategies, Public Policies, and Food System Performance, and the Food Marketing Issue Paper Series. Food Marketing Policy Center staff contribute to these series. Individuals may receive a list of publications in these series and paper copies of older Research Reports are available for $20.00 each, $5.00 for students. Call or mail your request at the number or address below. Please make all checks payable to the University of Connecticut. Research Reports can be downloaded free of charge from our website given below. Food Marketing Policy Center 1376 Storrs Road, U-21 University of Connecticut Storrs, CT 06269-4021 Tel: (860) 486-1927 FAX: (860) 486-2461 email: [email protected] http://www.are.uconn.edu/fmktc.html Modeling Coupon Values for Ready-To-Eat Breakfast Cereal by Gregory K. Price and John M. Connor Food Marketing Policy Center Research Report No. 54 January 2001 Department of Agricultural and Resource Economics University of Connecticut Contents Tables and Figures .................................................................................................................................................. ii Acknowledgement .................................................................................................................................................. iii Affiliation ................................................................................................................................................................ iii Preface..................................................................................................................................................................... iii 1. Introduction ..................................................................................................................................................... 1 2. Functions of Coupons ...................................................................................................................................... 1 3. Background on the RTE Cereal Industry ........................................................................................................ 2 4. Theoretical Model ........................................................................................................................................... 3 5. Application to the RTE Breakfast Cereal Industry ......................................................................................... 5 6. Empirical Model and Data .............................................................................................................................. 6 7. Results ............................................................................................................................................................. 8 8. Summary and Implications .............................................................................................................................. 10 References ............................................................................................................................................................... 10 Food Marketing Policy Center Research Report Series Ordering Information ...................................................... 34 Tables and Figures Table 1. Regression Results Explaining RTE Cereal Coupon Discounts from 1992-1997 ................................... 12 Table 2. Regression Results Explaining RTE Cereal Prices from 1992-1997 ....................................................... 12 Figure 1. Competing Brands Offered by Two Firms in Different Demand Segments ........................................... 13 Figure 2. Demand Curves of a Single Loyal and Nonloyal Consumer for Brand i. ............................................... 14 Figure 3. Demand Curves of a Single Nonloyal Consumer with Different Levels of Loyalty to Brand i .............. 14 Figure 4. Effect of Lowering Competing Products= Prices or Increasing Rival Brands= Discounts on a Nonloyal Consumer=s Demand Curve ................................................................................................................... 15 Appendix Appendix Figure 1. Price-Cost Margin of the Cereal Breakfast Foods Industry: 1973 –1996. ............................. 15 Appendix Table 1. Annual Price-Cost Margins of the Cereal Breakfast Foods Industry:1973 – 1996 ................. 16 Appendix Table 2. Summary of Hypotheses and Expected Influences on Brand Prices and Discount Levels ..... 17 Appendix Table 3. Correlation Between RTE Cereal Prices and the Prices of Rival Brands, Within and Cross Demand Segments. ................................................................................................................................. 18 Appendix Table 4. Description of Variables in the Coupon Value Equation ........................................................ 18 Appendix Table 5. Summary Statistics for Variables in the Coupon Value Equation .......................................... 19 Appendix Table 6. Description of Selected Variables in the Brand Price Equation .............................................. 19 Appendix Table 7. Summary Statistics for Selected Variables in the Brand Price Equation ................................ 20 Appendix Table 8. Food Ingredient Percentages and Use of Packaging Materials by Brand of RTE Cereal ....... 21 Appendix Table 9. First-Stage Estimation Results. ............................................................................................... 25 Appendix Table 10. Regression Results for the Brand-Specific Effects in the Coupon Value Equation After Accounting for the Endogeneity of RIVREDEMPi ................................................................................ 26 Appendix Table 11 Regressions Results for the Brand-Specific Effects in the Brand Price Equation After Accounting for Endogeneity of RIVREDEMPi ...................................................................................... 30 ii Acknowledgement The authors would like to thank Janet Wetz, Jay Akridge, and Jame Eales at Purdue University for providing helpful comments and suggestions. Affiliation Gregory K. Price is an agricultural economist with the Economic Research Service, USDA. John M. Connor is Professor of agricultural economics at Purdue University. Preface This paper is a synopsis of the lead author’s Ph.D. dissertation. This study evolved from the authors’ mutual interest in the effects of industry concentration and market power on retail food marketing. iii Modeling Coupon Values for Ready-To-Eat Breakfast Cereals Price and Connor discount levels must be identified and quantified with the 1. Introduction appropriate data. Researchers in the field of marketing consider coupons 2. Functions of Coupons to be promotional devices that aim to increase brand market share, strengthen brand loyalty, and expand a Coupons can increase brand sales because they are product=s market by attracting consumers with low price-discounting mechanisms, and the discounts expand reservation prices. Economists provide a complementary demand by attracting price-sensitive consumers (Schindler, perspective by modeling coupons as tools to exploit Ward and Davis). Unlike general price reductions, which unilateral market power through price discrimination. can be taken advantage of by all consumers, couponing While both research traditions demonstrate interest in the enables firms to target certain demand segments, in functions of coupons and their performance implications, particular consumers with relatively low reservation prices. the determinants of coupon values have been largely As a result, the issuers of coupons price discriminate and unexplored. Reasons for this deficiency in the literature maximize profit (Houston and Howe, Narasimhan). include a lack of sufficiently detailed transaction data and Companies cannot prevent consumers with a high the proprietary nature of coupon information. willingness to pay from using coupons, so discount levels The objective of this study is to develop and test a are set such that leakage is minimized (Larson). model that explains the determinants of coupon values at Manufacturers also issue coupons to encourage the brand level. The theoretical framework is derived from consumers to try new or unfamiliar products. The price discrimination theory and the principles of demand. discounts compensate individuals for assuming risk and In order to test the hypotheses of the model, the framework may reward firms with loyal purchasers (Levedahl). is operationalized with a simultaneous, two-equation, Coupons increase the probability of purchase through their fixed-effects, panel-data