Markdown Policies for Demand Learning with Forward-looking Customers

70 Pages Posted: 15 Dec 2018 Last revised: 7 Aug 2019

See all articles by John R. Birge

John R. Birge

University of Chicago - Booth School of Business

Hongfan Chen

University of Chicago Booth School of Business

N. Bora Keskin

Duke University - Fuqua School of Business

Date Written: August 5, 2019

Abstract

We consider the markdown pricing problem of a firm that sells a product to a mixture of myopic and forward-looking customers. The firm faces an uncertainty about the customers' forward-looking behavior, arrival pattern, and valuations for the product, which we collectively refer to as the demand model. Over a multiperiod sales season, the firm sequentially marks down the product's price and makes demand observations to learn the underlying demand model. Because forward-looking customers create an intertemporal dependency, we identify that the keys to achieving good profit performance are: (i) judiciously accumulating information on the demand model, (ii) preserving the market size in early sales periods, and (iii) limiting the impact of the firm's learning on the forward-looking customers. Based on these, we construct and analyze markdown policies that exhibit near-optimal performance under a wide variety of forward-looking customer behaviors. Moreover, contrary to common intuition, we show that forward-looking customers can improve the performance of a learning policy: if the customers are forward-looking, the firm's profit loss due to demand model uncertainty can asymptotically vanish, whereas if the customers are myopic, the firm's profit loss is nonnegligible in the same asymptotic setting.

Keywords: markdown pricing, model uncertainty, Bayesian learning, exploration-exploitation, forward-looking customer behavior

Suggested Citation

Birge, John R. and Chen, Hongfan and Keskin, N. Bora, Markdown Policies for Demand Learning with Forward-looking Customers (August 5, 2019). Available at SSRN: https://ssrn.com/abstract=3299819 or http://dx.doi.org/10.2139/ssrn.3299819

John R. Birge

University of Chicago - Booth School of Business ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States

Hongfan Chen

University of Chicago Booth School of Business ( email )

N. Bora Keskin (Contact Author)

Duke University - Fuqua School of Business ( email )

100 Fuqua Drive
Durham, NC 27708-0120
United States

HOME PAGE: http://faculty.fuqua.duke.edu/~nk145/

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