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Optimal pricing and production decisions in the presence of symmetrical and asymmetrical substitution

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  • Kim, Sang-Won
  • Bell, Peter C.
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    Abstract

    Firms may produce a variety of generally similar products or may practice "scientific pricing" or revenue management where the firm will offer similar or somewhat differentiated products in multiple market segments at different prices. Whenever generally similar products are available, the demand for the products is linked through the ability of the customer to substitute one product for another. One widely known type of demand substitution is referred to as inventory-driven substitution where a customer will substitute for a product that is out of stock by buying a similar product. A second type of substitution occurs as a response to price-differences when a customer substitutes a less expensive product for a similar higher priced product. As firms use dynamic pricing to match demand with inventory or capacity while maximizing revenue or contribution, there is a need to take into account the fact that the creation of price differences between market segments will motivate customers to try to switch from higher priced segments to lower priced segments leading to price-driven product substitution. If the firms' price behavior leads to stockouts, inventory-driven product substitution may also occur. Both these effects will impact the firms' price and production capacity decisions. In this paper, we consider the impact of price-driven substitution on a firm's pricing and production capacity decisions for a single period, when the firm sells to multiple market segments. We show that revenue managers and supply chain coordinators should adapt product prices in each market segment and order quantities to take into account substitution by customers and the costs of supplying product to each market. We develop both deterministic and stochastic models with substitution as a result of price-differences. We investigate the impact of the symmetrical and asymmetrical demand substitution on optimal prices, production levels and revenue or contribution and the impact of changes in the production cost on the optimal solutions.

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    Bibliographic Info

    Article provided by Elsevier in its journal Omega.

    Volume (Year): 39 (2011)
    Issue (Month): 5 (October)
    Pages: 528-538

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    Handle: RePEc:eee:jomega:v:39:y:2011:i:5:p:528-538

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    Related research

    Keywords: Revenue management Pricing Demand substitution Production capacity decision Symmetrical and asymmetrical demand;

    References

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    17. Yücel, Eda & Karaesmen, Fikri & Salman, F. Sibel & Türkay, Metin, 2009. "Optimizing product assortment under customer-driven demand substitution," European Journal of Operational Research, Elsevier, vol. 199(3), pages 759-768, December.
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    Citations

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    Cited by:
    1. Zhao, Li & Tian, Peng & Xiangyong Li, 2012. "Dynamic pricing in the presence of consumer inertia," Omega, Elsevier, vol. 40(2), pages 137-148, April.
    2. Shah, Nita H & Soni, Hardik N & Patel, Kamlesh A, 2013. "Optimizing inventory and marketing policy for non-instantaneous deteriorating items with generalized type deterioration and holding cost rates," Omega, Elsevier, vol. 41(2), pages 421-430.
    3. Zhang, Juan & Gou, Qinglong & Liang, Liang & Huang, Zhimin, 2013. "Supply chain coordination through cooperative advertising with reference price effect," Omega, Elsevier, vol. 41(2), pages 345-353.
    4. Li, Deng-Feng, 2011. "Linear programming approach to solve interval-valued matrix games," Omega, Elsevier, vol. 39(6), pages 655-666, December.
    5. Lim, Sungmook, 2013. "A joint optimal pricing and order quantity model under parameter uncertainty and its practical implementation," Omega, Elsevier, vol. 41(6), pages 998-1007.

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