Could Tesco’s “Price Promise” be anti-competitive?

For a few years, Tesco has been operating what it calls its “Price Promise”, in which it states that “[w]hen you shop at Tesco, we’ll check your basket against the prices at Asda, Sainsbury’s and Morrisons. If your comparable grocery shopping would have been cheaper there, we’ll give you a voucher for the difference (up to £10)” (see Tesco’s website).

In other words, Tesco is promising to match any lower price charged by a rival. This is precisely what the economic literature refers to as a “price-matching guarantee” (PMG) – one firm promises to match the price of a rival firm should it transpire that the customer could have obtained a lower price at that rival firm.

At first glance, this appears to be uncontroversially beneficial to consumers – they are guaranteed to receive the best possible price wherever they shop, such that they can save on “search costs” (essentially, time and money spent searching for the cheapest price) while at the same time obtaining the cheapest price.

However, this simple assessment fails to take into account the incentive of PMGs on the retailers themselves. If one retailer is considering decreasing its price, it will determine whether or not doing so would be profitable by weighing the decrease in margin per unit sold it would obtain against the increase in sales it would make (via enticing additional customers to purchase the product at the lower price). If its rivals do not have a PMG in place, then the price cut would result in consumers switching from rival retailers such that the price cut might be profitable. On the other hand, if rivals have PMGs in place, then the price cut might not be profitable as consumers have no incentive to switch to the cheaper retailer – they can just tell their current retailer that they have found a cheaper price elsewhere and be refunded the difference. Hence, if rivals have PMGs, then an individual retailer would experience a reduced increase in sales subsequent to a price cut, thereby decreasing that retailer’s incentives to cut prices in the first place. As such, PMGs could harm consumers by maintaining an “artificially” high level of retail prices.

Indeed, the findings in economic literature are generally inconclusive (An excellent non-technical summary of the literature is available here). Some results (see here) suggest that PMGs can act as a credible commitment by a retailer to keep prices low – a retailer making a price guarantee is effectively signalling to consumers that they will do everything they can to keep prices low because they know that if they do not, then consumers will be able to claim money back from them. In this way, PMGs could help competition by making consumers aware of alternatives that charge a lower price than their current provider.

However, other findings (see here) suggest that the incentive effect described above outweighs all other factors, such that the presence of PMGs leads to higher retail prices. In this way, PMGs could hinder competition because they reduce the potential profitability of a price cut by any one retailer (since, if a single retailer were to decrease price, it knows that its rival with a PMG will automatically match it anyway, so the retailer contemplating a price cut would gain fewer customers than it would if its rival did not match its price).

As such, there is a potential that Tesco’s Price Promise is anti-competitive, but it is difficult to reach a definitive conclusion.

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