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The Dynamic Effect of Discounting on Sales: Empirical Analysis and Normative Pricing Implications

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Author Info

  • Praveen K. Kopalle

    (Amos Tuck School of Business Administration, Dartmouth College, Hanover, New Hampshire 03755)

  • Carl F. Mela

    (Fugua School of Business, Duke University, Durham, North Carolina, 27708)

  • Lawrence Marsh

    (Department of Economics, University of Notre Dame, Notre Dame, Indiana 46556)

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    Abstract

    Baseline sales measure what retail sales would be in the absence of a promotion (Abraham and Lodish 1993), and models that measure baseline sales are widely used by managers to assess the profitability of promotions (Bucklin and Gupta 1999–this issue). Estimates of baseline sales and promotional response are typically independent of past promotional activity, even though there is evidence to suggest that increased discounting reduces off-promotion sales and increases the percentage of purchases made on deal (e.g., Krishna 1994). As a result, models that do not consider dynamic promotional effects can mislead managers to overpromote. Given the widespread use of “static” models to evaluate the efficacy of promotions, it is particularly desirable to calibrate a dynamic brand sales model and use it to establish an optimal course of action. Accordingly, we develop a descriptive dynamic brand sales model and use it to determine normative price promotion strategies. Our descriptive approach consists of estimating a varying-parameter sales response model. Letting model parameters vary with past discounting activity accommodates the possibility that market response changes with firms' discounting policies. In the normative model, we use the estimates obtained in the descriptive model to determine optimal retailer and manufacturer prices over time. The results of the descriptive model indicate that promotions have positive contemporaneous effects on sales accompanied by negative future effects on baseline sales. The results of the normative model suggest that the higher-share brands in our data tend to overpromote while the lower-share brands do not promote frequently enough. We project that the use of our model could improve manufacturers' profits by as much as 7% to 31%. More generally, the normative results indicate that i) if deals become more effective in the current period, i.e., if consumers are more price sensitive, promotions should be used more frequently; and ii) as the negative dynamic effect of discounts on sales increases, the optimal level of discounting should go down. Without our approach, it would be difficult to make this trade-off exact. Finally, we demonstrate that these dynamic effects provide another perspective to the marketing literature regarding the existence of promotions.

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    File URL: http://dx.doi.org/10.1287/mksc.18.3.317
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    Bibliographic Info

    Article provided by INFORMS in its journal Marketing Science.

    Volume (Year): 18 (1999)
    Issue (Month): 3 ()
    Pages: 317-332

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    Handle: RePEc:inm:ormksc:v:18:y:1999:i:3:p:317-332

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    Related research

    Keywords: Price Promotions; Baseline Sales; Price Sensitivity; Scanner Data; Channel Dynamics;

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    Cited by:
    1. Benchekroun, Hassan & Martín-Herrán, Guiomar & Taboubi, Sihem, 2009. "Could myopic pricing be a strategic choice in marketing channels? A game theoretic analysis," Journal of Economic Dynamics and Control, Elsevier, vol. 33(9), pages 1699-1718, September.
    2. Tülin Erdem & Susumu Imai & Michael Keane, 2003. "Brand and Quantity Choice Dynamics Under Price Uncertainty," Quantitative Marketing and Economics, Springer, vol. 1(1), pages 5-64, March.
    3. Sheu, Jiuh-Biing, 2011. "Marketing-driven channel coordination with revenue-sharing contracts under price promotion to end-customers," European Journal of Operational Research, Elsevier, vol. 214(2), pages 246-255, October.
    4. Fleischmann, M. & Hall, J.M. & Pyke, D.F., 2003. "Smart Pricing: Linking Pricing Decisions with Operational Insights," ERIM Report Series Research in Management ERS-2004-001-LIS, Erasmus Research Institute of Management (ERIM), ERIM is the joint research institute of the Rotterdam School of Management, Erasmus University and the Erasmus School of Economics (ESE) at Erasmus Uni.
    5. Srinivasan, S. & Pauwels, K.H. & Hanssens, D.M. & Dekimpe, M.G., 2002. "Do Promotions Benefit Manufacturers, Retailers or Both?," ERIM Report Series Research in Management ERS-2002-21-MKT, Erasmus Research Institute of Management (ERIM), ERIM is the joint research institute of the Rotterdam School of Management, Erasmus University and the Erasmus School of Economics (ESE) at Erasmus Uni.
    6. Reinaldo Guerreiro & Beng Soo Ong & Ariovaldo dos Santos, 2004. "Bonus pack promotions:Perceptions of Controllers and CommercialManagers," Brazilian Business Review, Fucape Business School, vol. 1(2), pages 103-117, June.
    7. Fleischmann, M. & Hall, J.M. & Pyke, D.F., 2005. "A Dynamic Pricing Model for Coordinated Sales and Operations," ERIM Report Series Research in Management ERS-2005-074-LIS, Erasmus Research Institute of Management (ERIM), ERIM is the joint research institute of the Rotterdam School of Management, Erasmus University and the Erasmus School of Economics (ESE) at Erasmus Uni.
    8. Eric Anderson & Nanda Kumar, 2007. "Price competition with repeat, loyal buyers," Quantitative Marketing and Economics, Springer, vol. 5(4), pages 333-359, December.

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