What signal is Tesco giving by withdrawing ‘double the difference’?

(by Morten Hviid) Tesco has yet again rewritten its price guarantee.  In late February 2011, it announced a ‘double the difference’ guarantee , but by early April high take-up led it to cap at £20 the amount it would pay out. Now (end-April) they have further reduced the guarantee to simple price matching.  Price guarantees have many purposes, most of which are anti-competitive (see my summary of the academic literature).   There is, however, one theory known as signalling which can be pro-competitive.  This argues that a motive for firms to adopt a price guarantee is to signal to consumers that they have low prices.   What does Tesco’s action today suggest about this signalling theory?

ASDA started things off in January 2011 by advertising a guarantee to be 10% cheaper than rival supermarkets.   Tesco apparently believed that its image should be of a firm at least as inexpensive as ASDA and preferably cheaper, so it needed to respond.   In order to signal the credibility of its claim to be the cheapest, even to consumers who would not check, it needed to impose a considerable penalty on itself in the event that it turned out not to be the cheapest.  Refunding the differences plus another 100% [i.e. double the difference] certainly fits that bill. However, when consumers are very active in searching for low prices, to be credible, the claim to be cheapest also has to be true.  Otherwise, you can end up haemorrhaging profits by paying out on the guarantee. Tesco appears to have belatedly realised this problem.  It will be interesting to see how consumers react to this latest signal of an eroded guarantee.

This is not the first time Tesco has burned its fingers on a price guarantee. In 1998, Robin Young in the Times in an article entitled “Tesco Toes the Line in Sock Price War” [February 3, 1998, at page 5] recorded the following chain of events which we summarised in a 2004 paper on price guarantees:

“Tesco was selling a certain brand of sport socks at a package price of £8 and had a double the difference price guarantee. The owner of Essential Sports, a small sporting goods store, was unhappy with Tesco’s price and decided to sell the same brand of sports socks at a package price of 10p. When consumers arrived at his store, the owner met them and suggested that they buy their socks instead at the local Tesco store, where they could obtain a matching price plus a refund of £7.90. For its entire inventory of sport socks that day, Tesco’s incurred an out-of-pocket cost of £7.80 per package.” [See Arbatskaya, M., M. Hviid and G. Shaffer, , 2004, ‘On the Incidence and Variety of Low-Price Guarantees: A Case Study’  Journal of Law and Economics XLVII, 307-332 at page 317]

I suspect that the current story will also find its way into future academic research.