Online-offline competitive pricing with reference price effect

Nowadays, consumers can easily compare the prices of the online and offline channels before making purchase decisions, which might arouse the reference price effect among consumers. Considering the reference price effect, how should online and offline retailers set prices? To answer it, we incorporate the reference price effect into a Hotelling model to formulate the online-offline price competition. We find that, when the reference price effect is low (high), the offline (online) retailer monopolizes the market; when the reference price effect is moderate, the retailers co-exist. Interestingly, a first mover disadvantage and a second mover advantage exist in terms of market share, but they do not necessarily exist in terms of profit. However, both the online and offline retailers can be better off by negotiating on the game sequence. Furthermore, we find that each retailer prefers its own price to be regarded as the reference price. A lower reference price, although benefiting the e-retailing in the short run, might compromise the product image and hurt both retailers in the long run.