Markdown or Everyday-Low-Price? The Role of Behavioral Motives

Forthcoming in Management Science

41 Pages Posted: 7 Feb 2013 Last revised: 21 Dec 2014

Özalp Özer

University of Texas at Dallas - Jindal School of Management

Yanchong Zheng

Massachusetts Institute of Technology (MIT) - Sloan School of Management

Date Written: December 19, 2014

Abstract

We study a seller's optimal pricing and inventory strategies when behavioral (non-pecuniary) motives affect consumers' purchase decisions. In particular, the seller chooses between two pricing strategies, markdown or everyday-low-price, and determines the optimal prices and inventory level at the beginning of a two-period selling season. Two salient behavioral motives that impact consumers' purchase decisions and the seller's optimal strategies are anticipated regret and misperception of product availability. Regret arises when a consumer initially chooses to wait but encounters stockout later, or when the consumer buys the product at the high price but realizes that the product is still available at the markdown price. In addition, consumers often perceive the product's future availability to be different than its actual availability. We determine and quantify that both regret and availability misperception have significant operational and profit implications for the seller. For example, ignoring these behavioral factors can result in up to 10% profit losses. We contrast the roles of consumers' strategic (pecuniary) motives with their behavioral (non-pecuniary) motives in affecting purchase, pricing, and inventory decisions. The presence of the behavioral motives reinstates the profitability of markdown over everyday-low-price, in sharp contrast to prior studies of only strategic motives which suggest the contrary. We characterize how and why strategic versus behavioral motives affect decisions in distinctive manners. In doing so, this paper also introduces and determines the behavioral benefits of pricing in leveraging consumers' behavioral regularities. We advocate that tactics which may intensify consumers' misperception of availability, such as intentionally disclosing low inventory levels, can have a far-reaching impact on improving the seller's profit.

Keywords: Regret, availability misperception, markdown, everyday-low-price, inventory rationing, revenue management, consumer model, behavioral economics

Suggested Citation

Özer, Özalp and Zheng, Yanchong, Markdown or Everyday-Low-Price? The Role of Behavioral Motives (December 19, 2014). Forthcoming in Management Science. Available at SSRN: https://ssrn.com/abstract=2212888 or http://dx.doi.org/10.2139/ssrn.2212888

Özalp Özer

University of Texas at Dallas - Jindal School of Management ( email )

Jindal School of Management
800 W. Campbell Road
Richardson, TX 75080
United States

Yanchong Zheng (Contact Author)

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

77 Massachusetts Ave.
E62-416
Cambridge, MA 02142
United States

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