An Empirical Test of the Theory of Sales: Do Household Storage Costs Affect Consumer and Store Behavior?

Price variation is a fundamental characteristic of many homogenous goods markets and the extent to which it is driven by consumer characteristics and the equilibrium behavior of firms has received considerable attention. Implicit in most empirical marketing studies of consumables is the notion that consumers are largely unconstrained in their response to price variation – that is, consumer response is predominantly a function of observed prices. A deeper investigation suggests that storage costs may play a significant role in the behavior of consumers, and also influence the equilibrium price-setting of firms. We revisit the model of Salop and Stiglitz (1982) which shows that ex ante identical retailers may be induced to charge different prices in equilibrium when consumers are willing stockpile at low prices. Three testable predictions of the theory are as follows. An increase in consumer storage costs leads to: (1) an increase in average prices, (2) a reduction in the probability of promotion, and (3) a decrease in promotion depth. Empirical estimates of storage cost are developed for approximately 1,000 households in the Chicago region who shop at nine different stores over a two-year period. Information from the American Housing Survey (1989), United States Census (1990) and Stanford Market Basket Database (1991-1993) are used to construct the data. We find consumers with higher storage costs shop more often and purchase smaller quantities per visit. In addition, all three predictions of Salop and Stiglitz are supported by the data. Furthermore, the estimated effects are quantitatively quite important. For example, a consumer who moves from a large but inexpensive housing unit in the urban fringe to a small and expensive downtown unit increases the number of shopping trips by about 20 percent. Similarly, downtown stores are about 20 percent less likely to promote any given item compared to their counterparts in the urban fringe.