Managing Competition: Promotions that Reduce Pricing Pressure

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