Nonlinear pricing for yield management and countering strategic consumer behavior

Many models assume that faced with excess inventory, retailers offer price discounts to increase sales. This discount is assumed to be a certain dollar amount or a certain percent of the regular price. However, many retailers use nonlinear pricing, e.g., Buy one, get one for 50% off, which we refer to as BOGO. We analyze BOGO within the newsvendor model and identify the reasons for its popularity. We describe the type of products for which BOGO is suitable, identify the optimal BOGO discount, and its effect on the retailer's profit. We compare BOGO to straight price reduction and analyze the newsvendor's optimal choice between them. We also examine the two promotions in the presence of strategic consumers. We find that for reasonable values of consumer marginal utility and a given order quantity, BOGO reduces strategic consumers' chances of obtaining a unit at a discount and their incentive to wait. Therefore, the newsvendor orders a larger quantity with BOGO than with a price reduction. Thus, BOGO can be used to counter strategic consumer behavior. Also, we find that in the presence of strategic consumers, there are cases where it is optimal for the retailer to wait and offer a straight discount at the end of the season. However, with BOGO, it is always optimal to offer a BOGO at the start of the season if realized demand is low. We examine the robustness of our results to different arrival rates and positive salvage value and find that they qualitatively hold.(c) 2022 Elsevier B.V. All rights reserved.

Automated summary

Many retailers use nonlinear pricing, such as Buy one, get one for 50% off (BOGO), to increase sales and counter strategic consumer behavior. This study analyzes the application of BOGO in the newsvendor model and determines its optimal discount and impact on the retailer's profit. The results show that BOGO reduces strategic consumers' chances of obtaining a discount and their incentive to wait, leading the retailer to order a larger quantity compared to a price reduction strategy. The study also highlights the optimal timing of offering BOGO and the robustness of the findings to different factors.