The Exponomial Choice Model: A New Alternative for Assortment and Price Optimization

Forthcoming in Operations Research

50 Pages Posted: 3 Feb 2013 Last revised: 30 Oct 2015

See all articles by Aydin Alptekinoglu

Aydin Alptekinoglu

Smeal College of Business, Pennsylvania State University

John H. Semple

Southern Methodist University (SMU) - Information Technology and Operations Management Department (ITOM)

Date Written: October 29, 2015

Abstract

We investigate the use of a canonical version of a discrete choice model due to Daganzo (1979) in optimal pricing and assortment planning. In contrast to multinomial and nested logit (the prevailing choice models used for optimizing prices and assortments), this model assumes a negatively skewed distribution of consumer utilities, an assumption we motivate by conceptual arguments as well as published work. The choice probabilities in this model can be derived in closed-form as an exponomial (a linear function of exponential terms). The pricing and assortment planning insights we obtain from the Exponomial Choice (EC) model differ from the literature in two important ways. First, the EC model allows variable markups in optimal prices that increase with expected utilities. Second, when prices are exogenous, the optimal assortment may exhibit leapfrogging in prices, i.e., a product can be skipped in favor of a lower-priced one depending on the utility positions of neighboring products. These two plausible pricing and assortment patterns are ruled out by multinomial logit (and by nested logit within each nest). We provide structural results on optimal pricing for monopoly and oligopoly cases, and on the optimal assortments for both exogenous and endogenous prices. We also demonstrate how the EC model can be easily estimated---by establishing that the loglikelihood function is concave in model parameters and detailing an estimation example using real data.

Keywords: Discrete choice theory, willingness to pay, assortment planning, pricing, revenue management, multinomial logit, nested logit.

Suggested Citation

Alptekinoglu, Aydin and Semple, John H., The Exponomial Choice Model: A New Alternative for Assortment and Price Optimization (October 29, 2015). Forthcoming in Operations Research. Available at SSRN: https://ssrn.com/abstract=2210478 or http://dx.doi.org/10.2139/ssrn.2210478

Aydin Alptekinoglu

Smeal College of Business, Pennsylvania State University ( email )

University Park, PA 16802
United States

John H. Semple (Contact Author)

Southern Methodist University (SMU) - Information Technology and Operations Management Department (ITOM) ( email )

Dallas, TX 75275
United States
214-768-2546 (Phone)
214-768-4099 (Fax)

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