Strategic pricing with reference effects in a competitive supply chain

• We consider a supply chain consisting of a manufacturer and a retailer in a bilateral monopoly setting in the presence of reference-price effects.
• We derive the equilibrium pricing strategies.
• The pricing strategy that the manufacturer and retailer take (price skimming or price penetration) depends on consumers’ initial reference price.
• The reference-price effects decrease products’ steady-state retail price.
• Managers would benefit more if consumers have higher initial reference price, more sensitive to the reference price and more loyal to their product.

The reference-price effect refers to the demand deviation caused by consumers’ perceived losses or gains when the current market price of a product differs from a cognitive benchmark (known as a reference price) formed by the customers based on past prices. The impact of such a reference effect on the dynamic pricing policy of a monopolist has been widely studied in the literature. However, despite the importance of the topic due to the growing transparency of price information in the Internet era, its relevance in the context of a distribution channel has never been explored. In this study, we consider a supply chain consisting of a manufacturer and a retailer in a bilateral monopoly setting. The two channel members independently choose their pricing strategies to optimize their own benefits in the presence of consumers’ reference-price effects. Based on a deterministic demand function, we derive the equilibrium prices and analyze the resulting profit sensitivity with respect to various factors that crucially shape the reference effects. We conclude that both the centralized and decentralized channels should want consumers to have a higher initial reference price, be more sensitive to the reference-price effect, and be more loyal to their product.