Price Promotions in Choice Models
58 Pages Posted: 13 Jun 2013
Date Written: May 28, 2013
Promotions are commonly used in marketing to increase sales and drive profits by temporarily decreasing the price per unit of a good. Some price promotions apply to all quantities (20% off), some have limits on the number of units that can be purchased at a reduced price, and others only offer the discount if the volume purchased is sufficiently high. We develop a model of price promotions in the context of a direct utility model where its effects are incorporated through the budget constraint. Price promotions complicate the estimation and analysis of direct utility models because they induce kinks and points of discontinuity in the budget set. We propose a Bayesian approach to dealing with these irregularities, and demonstrate the ability of direct utility models to engage in counter-factual analyses of price promotions given a consumer’s utility function. We investigate the stability of utility function estimates for consumers under alternative price promotions, and find evidence supporting the assumption that price promotions only affect consumer choices through the budget constraint. We then explore the benefits of customization and show that firm profits can significantly increase by offering different types of promotions to different people.
Keywords: Utility theory, Bayesian estimation, nonlinear pricing, irregular budget sets
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