Should a retailer disclose its unit variable costs in monopoly and duopoly markets

Abstract

Should a retailer disclose its variable costs to consumers? While disclosing variable costs (e.g., material cost, production cost, and shipping cost) can build consumer trust through transparency, it may also lead to resentment if the actual gross profit margin, deduced from the disclosed costs, is perceived as excessively high. By incorporating key findings from behavioral experiments in the literature, we present an exploratory model to examine if and when a firm should disclose its variable costs in both monopoly and duopoly markets. Assuming that consumers use the concept of rational expectation equilibrium to infer the firm’s actual variable costs when they are not disclosed, our equilibrium analysis yields the following results that provide insights when a retailer should adopt cost disclosure. Specifically, in a monopoly model, we find that consumers tend to overestimate the firm’s true variable costs when the firm does not disclose them. This occurs because consumers use the observed price as a “signal” about the undisclosed true cost, and believe that the firm would set its price closer to the true cost. Also, a monopoly should not disclose its true variable costs to prevent pressure to lower its gross profit margin, especially when consumers are highly concerned about the firm’s gross profit margin. This behavior persists in a duopoly model. In a duopoly model, we find two additional results: as competition intensifies, both firms are more likely to disclose their true variable costs in equilibrium to gain additional trust from consumers. However, when competition is moderate but the cost differential between firms is sufficiently high, only one firm would disclose its true costs in equilibrium.