To Bargain or Not to Bargain: The Role of Fixed Costs in Price Negotiations

Abstract

Retailers routinely allow consumers to negotiate a discount off the posted price for big-ticket items such as home appliances and automobiles, and on online platforms such as Amazon and eBay. The profitability of such a strategy, relative to selling only at posted prices, depends on consumers’ willingness to initiate a negotiation and ability to negotiate a discount. In this article, the authors incorporate consumers’ decision of whether to negotiate into a demand model. The decision to negotiate hinges on how the expected discount from negotiation compares with the magnitude of a nonpecuniary cost that the consumer incurs by initiating the negotiation. The current study shows how this cost can be nonparametrically identified, separately from consumers’ ability to get a discount and marginal utility of income. The application of this model to individual-level data on refrigerator transactions reveals that, conditional on negotiating, consumers get, on average, 41% of the available surplus and incur an average cost of $28 to initiate a negotiation. The magnitude of these nonpecuniary costs’ not only affects retailer profits but also has implications for pricing strategy and consumer surplus. Ignoring these costs results in biased estimates of consumers’ willingness to pay, translating to annual losses of $1.6 million in the current study setting.