How Does the Reference Price Mechanism Affect Competition?

This paper proposes an operational strategy based on the theory of transaction utility, aiming to mitigate the negative impact of customers' free-riding behaviour. This operational strategy is named the reference price mechanism (RPM), in which the retailer gives a reference price that may be different from the retail price, and the customer's purchase decision is affected by the reference price. Based on the Hotelling model, we develop a duopoly game by considering the free-riding cost to systematically discuss the effectiveness of the RPM. The results show that the brick-and-mortar/online retailer can benefit from implementing the RPM separately, vice versa. If both retailers implement the RPM, only the retailer with the higher reference price can attain more profits. In addition, there is a threshold of the free-riding cost that can affect whether the retailers implement the RPM.