Competition-Based Dynamic Pricing in Online Retailing: A Methodology Validated with Field Experiments

Forthcoming at Management Science

Ross School of Business Paper No. 1265

43 Pages Posted: 11 Jan 2015 Last revised: 26 Jan 2017

See all articles by Marshall Fisher

Marshall Fisher

University of Pennsylvania - Operations & Information Management Department

Santiago Gallino

University of Pennsylvania - Operations, Information and Decisions Department

Jun Li

University of Michigan, Stephen M. Ross School of Business

Date Written: January 15, 2017

Abstract

A retailer following a competition-based dynamic pricing strategy tracks competitors' price changes and then must answer the following questions: (1) Should we respond? (2) If so, respond to whom? (3) How much of a response? (4) And on which products? The answers require unbiased measures of price elasticity as well as accurate estimates of competitor significance and the extent to which consumers compare prices across retailers. There are two key challenges to quantify these factors empirically: first, the endogeneity associated with almost any type of observational data, where prices are correlated with demand shocks observable to pricing managers but not to researchers, and second, the absence of competitor sales information, which prevents efficient estimation of a full consumer-choice model. We address the first issue by conducting a field experiment with randomized prices. We resolve the second issue by exploiting the retailer's own and competitors' stockouts as a source of variation to the consumer choice set, in addition to variations in competitors' prices. We estimate an empirical model capturing consumer choices among substitutable products from multiple retailers. Based on the estimates, we propose and test a best-response pricing strategy through a carefully controlled live experiment that lasts five weeks. The experiment documents an 11 percent revenue increase while maintaining a margin above a retailer-specified target.

Keywords: Online Retailing, Field Experiments, Competition-Based Dynamic Pricing, Stock-outs, Consumer Choice

Suggested Citation

Fisher, Marshall and Gallino, Santiago and Li, Jun, Competition-Based Dynamic Pricing in Online Retailing: A Methodology Validated with Field Experiments (January 15, 2017). Forthcoming at Management Science; Ross School of Business Paper No. 1265. Available at SSRN: https://ssrn.com/abstract=2547793 or http://dx.doi.org/10.2139/ssrn.2547793

Marshall Fisher

University of Pennsylvania - Operations & Information Management Department ( email )

Philadelphia, PA 19104
United States

Santiago Gallino

University of Pennsylvania - Operations, Information and Decisions Department ( email )

3730 Walnut Street
558 & 559 Jon M. Huntsman Hall
Philadelphia, PA 19104-5340
United States

Jun Li (Contact Author)

University of Michigan, Stephen M. Ross School of Business ( email )

701 Tappan Street
Ann Arbor, MI MI 48109
United States

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