Price Commitments with Strategic Consumers: Why it Can Be Optimal to Discount More Frequently ... Than Optimal

39 Pages Posted: 20 Jul 2013

See all articles by Gerard P Cachon

Gerard P Cachon

The Wharton School - Operations, Information and Decisions Department

Pnina Feldman

Questrom School of Business, Boston University

Date Written: July 18, 2013

Abstract

In many markets consumers incur search costs and firms must choose a pricing strategy that determines how their pricing responds to market conditions. A pricing strategy may involve commitments to take actions that are not optimal given the information the firm knowns about demand. Two types of commitments that have been discussed in the literature and implemented in practice apply in our setting: (i) the firm may choose a static-pricing strategy with a single price no matter whether demand is strong or weak ; or (ii) the firm commits to always discount (i.e., never markup even if demand is strong). We introduce a third type: the firm begins with a high (non-discounted) price but commits to discount frequently even if discounting lowers revenue. These commitments provide the enticement needed to get strategic consumers to visit the firm. But which is best? For a fixed capacity, we show that discount-frequently is the best among the three, and in many reasonable situations it is the best over all possible policies. We provide an upper bound on revenue and show that when discount-frequently is not provably optimal, it nevertheless performs very well (on average within 1% of the bound). If the firm can choose its capacity, then we show that (i) discount-frequently can be the only profitable strategy and (ii) without a price commitment, overinvesting in capacity to attract consumers is a poor strategy. In the debate regarding pricing strategies, our results provide strong support for a strategy that not only embraces deep discounting, but offers consumers those discounts even more frequently than is optimal given market conditions.

Suggested Citation

Cachon, Gerard P and Feldman, Pnina, Price Commitments with Strategic Consumers: Why it Can Be Optimal to Discount More Frequently ... Than Optimal (July 18, 2013). Available at SSRN: https://ssrn.com/abstract=2296154 or http://dx.doi.org/10.2139/ssrn.2296154

Gerard P Cachon (Contact Author)

The Wharton School - Operations, Information and Decisions Department ( email )

Philadelphia, PA 19104
United States

Pnina Feldman

Questrom School of Business, Boston University ( email )

Boston, MA
United States

HOME PAGE: http://https://www.bu.edu/questrom/faculty-research/faculty-directory/pnina-feldman/

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