Competition for Context-Sensitive Consumers

When preferences are sensitive to context, firms may try to influence purchase decisions by designing the environment of consumption choices. Confirming anecdotal evidence on retailer marketing tricks, we show that competitive retailers exploit context-sensitivity by designing environments that drive a wedge between preferences before and after entering a store. This wedge induces naive consumers to switch preference from a loss-leader product that attracts consumers into the store to a more profitable product. Depending on the quality preferences and budget of consumers, markets are either in an "up-selling" or "down-selling" equilibrium. In the former, firms attract consumers with low-quality products, compete on prices, and design context to ultimately sell a product of higher price. In the latter, firms attract consumers with high-price products, compete on quality, and design context to ultimately sell a product of lower quality. When modeling context-sensitivity according to the theories of Salience, Focusing, or Relative Thinking, designing context comes down to the introduction of a single decoy product. This decoy draws consumer attention at the store to the favorable attributes of the product the firm aims to sell.