The Effect of Most-Favored Customer Clauses on Prices

Abstract

We study the effects of introducing a Most-Favored Customer (MFC) clause on price competition among major consumer electronics retailers. Our data spans the periods before and after the introduction of an MFC clause by Best Buy, which occurred between April 1, 2003 and March 31, 2004. After controlling for various factors (including product life-cycle and seasonality effects), we find that, on average, Best Buy lowered its prices by 1.6% after introducing the MFC clause. Its competitors responded by cutting prices further: Buy.com by 3.5%, Circuit City by 2.2%, CompUSA by 3.2%, and Sears by 0.4%. Our empirical results are robust to a variety of measures and estimation methods. We conclude that Best Buy's MFC adoption reduced prices in the consumer electronics retail industry.

Keywords: Most-favored customer clauses; Low-price guarantee; Price discrimination

JEL Classification: D43, L13, L81