Cross-Category Retailing Management: Substitution and Complementarity

Abstract

This paper studies pricing and assortment management for cross-category products, a common practice in brick-and-mortar retailing and e-tailing. We investigate the complementarity effects between the main products and the secondary products, in addition to the substitution effects for products in the same category. In this paper, we develop a multi-stage sequential choice model, under which a consumer first chooses a main product and then selects a secondary product. The new model can alleviate the restriction of the independence of irrelevant alternatives (IIA) property, and allows more flexible substitution patterns and also takes into account complementarity effects.
We characterize the impact of the magnitude of complementarity effects on pricing and assortment management. For the problems that are hard to solve optimally, we propose simple heuristics and establish performance guarantee. In addition, we develop easy-to-implement estimation algorithms to calibrate the proposed sequential choice model by using sales data. We show that ignoring or mis-specifying complementarity effects may lead to substantial losses. The methodologies on modeling, optimization and estimation have potential to make impact on cross-category retailing management.

Keywords: Main Products and Secondary Products, Substitution Effects, Complementarity Effects, Sequential Choice Model, Assortment Planning and Pricing