Structural Models of Demand to Study Consistent Pricing During Sales Promotions

Abstract:     
Marketing researchers have traditionally modeled sales promotions by introducing a sales promotion dummy variable (sometimes accompanied by its interaction with prices) in the indirect utility specification. This approach has been useful in reproducing consumers’ response to sales promotions but fails when the focus is on modeling pricing by retailers or manufacturers. This specification usually prescribes increases in prices, which is exactly the opposite of what we empirically observe (sales promotions paradox). We model sales promotions as deviations of the promoted price with respect to the regular price (“value of the deal”). During sales promotions, this specification not only captures increases in demand but also makes it optimal for firms to always decrease prices. To account for other effects observed during sales promotions (i.e., increase in sales across the category) without affecting our demand specification, we incorporate structure to the potential market. We test the model in the oatmeal category and find that it outperforms others when predicting demand and margins. Additionally, we find that promotions attract 50% more consumers to the category as a whole. Sales promotions increase profits of not only the promoted but also all brands in the category.

Number of Pages in PDF File: 51

Keywords: Structural Models, NEIO, Pricing, Sales Promotion, Sales Promotion Paradox

JEL Classification: C50, D40, L00, M31

working papers series