Managing Competition: Promotions that Reduce Pricing Pressure

37 Pages Posted: 17 Oct 2014 Last revised: 4 Nov 2014

See all articles by David Richardson

David Richardson

Stuart School of Business, IIT

Ram C. Rao

The University of Texas at Dallas, Naveen Jindal School of Management

Date Written: October 14, 2014

Abstract

Firms that must choose capacity in advance of observing uncertain or time varying demand sometimes have more inventory than their full price customers will consume. By pricing a limited quantity at below market clearing rates, “rationed promotions” allow sellers to recruit enough excess demand to clear excess inventory while effectively excluding high value customers from purchasing at the discount price. Examples include airlines’ release of limited blocks of seats for discount fare classes, and “Black Friday” offerings of limited quantities of toys, and electronics.

We show that competition weakly increases prices above the monopoly level, but lowers revenues because the higher prices fail to achieve optimal segmentation of heterogeneous consumers. Nonetheless, by clearing excess inventory, yield managing firms avoid direct competition for their most profitable customers and retain most of the revenues available to the monopolist. This has important consequences for capacity choice in these markets. Since rationed promotions dramatically improve profitability in low demand states, firms using them elect significantly higher capacities when facing variable or uncertain demand. This leads to substantial social welfare gains in these markets. While in the monopoly case most of this gain goes to consumers, under duopoly competition firms gain all the benefits.

Keywords: Competition, Promotions, Capacity, Revenue Management, Game Theory, Pricing, Inventory

JEL Classification: C72, D43, D45, L13, M31

Suggested Citation

Richardson, David and Rao, Ram C., Managing Competition: Promotions that Reduce Pricing Pressure (October 14, 2014). Available at SSRN: https://ssrn.com/abstract=2510390 or http://dx.doi.org/10.2139/ssrn.2510390

David Richardson

Stuart School of Business, IIT ( email )

Ram C. Rao (Contact Author)

The University of Texas at Dallas, Naveen Jindal School of Management ( email )

Dallas, TX
United States
972-883-2580 (Phone)
972-883-6727 (Fax)

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