A model of consumer regime switching in retail grocery expenditure: The impact of store price image

This research considers the problem of a retailer setting everyday shelf prices on the items that he offers. Empirical estimates of category level price elasticities imply substantially higher profit maximizing prices than the ones that we observe in retail stores today. However, these elasticity estimates do not account for the critical problem of the retailer, the potential loss of customers to competing retail destinations. I employ the notion of consumer regime switching to model the potential loss of customers a retailer faces over the long run. I utilize Stigler's Information Theory to develop priors on the types of retail categories that influence store price image for retailers and thus would tend to drive consumer regime switching. Further, I test a set of these categories in an empirical model of monthly household retail grocery expenditure. My results provide evidence that consumer regime switching is driven in part by retail prices in a subset of categories, while prices in other categories are exogenous to the regime switching process. Consequently, the optimizing retailer should continue to price competitively in those categories which drive regime switching but should make attempts to raise prices and take profits in categories that are less predictive of long run consumer store choice behavior.