Randomized Assortment Optimization

54 Pages Posted: 21 Oct 2020

See all articles by Zhengchao Wang

Zhengchao Wang

Imperial College London

Heikki Peura

Imperial College Business School

Wolfram Wiesemann

Imperial College Business School

Date Written: September 3, 2020

Abstract

When a firm selects an assortment of products to offer to customers, it uses a choice model to anticipate their probability of purchasing each product. In practice, the estimation of these models is subject to statistical errors, which may lead to significantly suboptimal assortment decisions. Recent work has addressed this issue using robust optimization, where the true parameter values are assumed unknown and the firm chooses an assortment that maximizes its worst-case expected revenues over an uncertainty set of likely parameter values, thus mitigating estimation errors. In this paper, we introduce the concept of randomization into the robust assortment optimization literature. We show that the standard approach of deterministically selecting a single assortment to offer is not always optimal in the robust assortment optimization problem. Instead, the firm can improve its worst-case expected revenues by selecting an assortment randomly according to a prudently designed probability distribution. We demonstrate this potential benefit of randomization across three popular choice models: the multinomial logit model, the Markov chain model, and the preference ranking model. We show how an optimal randomization strategy can be determined exactly and heuristically. Besides the superior in-sample performance of randomized assortments, we demonstrate improved out-of-sample performance in a data-driven setting that combines estimation with optimization. Our results suggest that more general versions of the assortment optimization problem—incorporating business constraints, more flexible choice models and/or more general uncertainty sets—tend to be more receptive to the benefits of randomization.

Suggested Citation

Wang, Zhengchao and Peura, Heikki and Wiesemann, Wolfram, Randomized Assortment Optimization (September 3, 2020). Available at SSRN: https://ssrn.com/abstract=3685695 or http://dx.doi.org/10.2139/ssrn.3685695

Zhengchao Wang

Imperial College London ( email )

South Kensington Campus
Exhibition Road
London, Greater London SW7 2AZ
United Kingdom

Heikki Peura (Contact Author)

Imperial College Business School ( email )

South Kensington Campus
Exhibition Road
London SW7 2AZ, SW7 2AZ
United Kingdom

Wolfram Wiesemann

Imperial College Business School ( email )

South Kensington Campus
Exhibition Road
London SW7 2AZ, SW7 2AZ
United Kingdom

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