Free Shipping or Not? Retail Platform Operations Considering Reference Effect and Loyal Consumers

Abstract

Consumer behaviors profoundly affect platform competition. This study incorporates consumers' reference effect and loyalty into a Hotelling model, examining competition between two online retail platforms: an incumbent platform and an intrusive platform. The intrusive platform can introduce a free shipping service to gain market penetration. Consumers in the market are divided into two types: loyal and disloyal. The former remains insensitive to the incumbent platform's pricing, while the latter exhibits reference behaviors in their purchase decisions. Our primary objective is to investigate the intricate interactions between free shipping and consumer behaviors under two pricing settings. The findings indicate that the higher the proportion of loyal consumers or the stronger the reference effect of disloyal consumers, the more likely the incumbent platform is to set a lower price to capture the market. Moreover, free shipping only affects the operational decisions of the platforms when the reference effect is considered, and it strengthens (weakens) the impact of consumer loyalty (reference effect) on the platforms. The reference behaviors of disloyal consumers will amplify the impact of loyalty on the platforms. Interestingly, platforms always choose sequential pricing, which leads to a Pareto-improvement in their profits. Additionally, while the adoption of free shipping by the intrusive platform intensifies competition between the two platforms, it can result in a Pareto-improvement of their profits.

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