Dynamic Pricing under Cost Reduction in the Presence of Myopic and Strategic Consumers

After release, a product usually suffers cost reductions during its whole lifespan. Compared to the myopic, strategic consumers may have stronger incentive to delay the purchase once they perceive that a significant cost reduction will result in a markdown. The strategic (compared to the myopic) properties influence the seller both quantitatively in terms of proportion of strategic consumers and qualitatively in terms of customer patience. To forecast the reaction of the whole market under cost reduction, it is necessary to acquire the strategic properties. In this paper, we study the impacts of proportion of strategic consumers, customer patience, and cost reduction on dynamic pricing strategy when cost reduction comes from technology advancement. The seller makes pricing strategies when facing unknown future cost, and the buyer makes purchase decisions when facing unknown future price. Our study shows that generally both higher strategic consumer proportion and customer patience contribute to a delay in sales. Further, profit diversion happens under great combination of strategic properties. In addition, with the increase of customer patience, not only strategic but also myopic consumers will buy less. Finally, the strategic properties moderate the pricing strategy in latter stage when there is a cost reduction. This indicates a threshold as combination of strategic properties, upon which seller tends to offer a smaller markdown to discourage strategic waiting, and under which seller tends to offer a greater markdown to divert strategic consumers to the latter period.

Managing Posterior Price Matching: The Role of Customer Boundedly Rational Expectations

The posterior price-matching policy, whereby a firm promises to reimburse the price difference to a customer who purchases a product before the firm marks it down, has been used in practice. The extensive literature has offered the following explanations for why posterior price matching is adopted: to reduce inventory, to soften competition, to price discriminate consumers, and to eliminate consumer strategic waiting incentives. In this paper, we provide a novel explanation and investigate the role of consumer bounded rationality in the sense of anecdotal reasoning. We adopt a simple model that allows us to isolate the role of customer bounded rationality on using posterior price matching. We demonstrate that while it is never optimal to adopt posterior price matching when consumers have rational expectations, it can be optimal when they have boundedly rational expectations. We show when and how a seller can intentionally mark down with some probability and adopt price matching to make a profit. Ignoring customer bounded rationality can result in a significant profit loss. Then, we build a dynamic programming model to investigate how the firm should dynamically manage its markdowns over the long run. We show that a cyclic policy switching between a high and low markdown probability is typically optimal for exploiting customer bounded rationality. We characterize the nature of the cyclic policy and the range in which it is optimal. Our findings underscore the importance of consumer bounded rationality and provide managerial and practical guidelines on how to manage price matching when customers are boundedly rational. The online supplement is available at https://doi.org/10.1287/msom.2016.0612 .