Markdown Pricing with Quality Perception
37 Pages Posted: 7 Aug 2020 Last revised: 11 Sep 2020
Date Written: June 23, 2020
Problem Deﬁnition: Consumers often perceive higher-priced products to have higher quality. Less is known on how quality perception is aﬀected by price markdowns. In addition, it is an open question whether and how consumers’ ex-ante expectation on a future markdown aﬀects their quality perception as well as purchase decisions. We answer these questions in a markdown setting under a ﬁxed inventory.
Academic/Practical Relevance: This paper adds to the growing literature that incorporates consumers’ behavioral regularities in revenue management by studying the new dimension of quality perception and generates new insights absent in the current literature. Our results oﬀer insights on how retailers should adapt their markdown strategy in the presence of price-based quality perception.
Methodology: We develop a consumer model that incorporates quality perception and emotional loss when the expected markdown is too optimistic as compared to the actual markdown. We embed this model into the retailer’s markdown optimization and examine the impact of consumers’ behavioral factors on the retailer’s optimal strategy. Finally, we design and conduct a consumer study to calibrate our model and validate the functional relationships among key factors.
Results: Consumers’ quality perception increases with the products full price while it decreases with the (expected) markdown. We show that the retailer’s optimal markdown is nonmonotone in these quality perception parameters. The nonmonotonicity is driven by the nontrivial tradeoﬀ of trying to maintain a higher perceived quality by the consumers while controlling potential loss emotion that could arise if consumers observe a smaller-than-expected markdown, particularly when total market demand is not very large. Furthermore, we ﬁnd that it is beneﬁcial for the retailer to pre-announce and commit to a markdown strategy to prevent a mismatch between consumers’ expectation and the actual markdown. This approach beneﬁts the retailer by eliminating the negative eﬀect on sales of the consumers’ loss emotion due to an optimistic expectation.
Managerial Implications: Ignoring these behavioral factors can substantially hurt the retailer’s payoﬀ. When inventory is tight, it is critical to correctly capture consumers quality perception (38% average loss in payoﬀ if ignored). When instead inventory is suﬃcient, the retailer should be mindful of the potential emotional loss that its markdown could create among its consumers.
Keywords: Markdown pricing, quality perception, loss emotion, forward-looking consumers, behavioral operations
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