Journal of the Korean Operations Research and Management Science Society (한국경영과학회지)

The Korean Operations Research and Management Science Society (한국경영과학회)
권호 표지

A Deterministic Model for Optimal Pricing Decisions with Price-Driven Substitution

가격차에 의해 발생하는 수요대체효과를 고려한 정태적 최적가격결정 모형 수립

  • Published : 2008.03.31
Download PDF
⟨ Previous Next ⟩

Abstract

Market segmentation is a key strategic factor in increasing the expected profits, especially in the practice of revenue management. A manufacturing firm should manage both manufacturing quantities and pricing decisions over its segmented markets to maximize the expected profits, setting different price for each different segment. Also, market segments should be kept separate in order to prevent demand leakages between different market segments. In fact, even though the markets for different products are firmly segmented, it is not easy to keep separate segmentation because many products might be substitutable by customer buying behavior. That is, customers respond to price changes by purchasing other market's products instead of purchasing the originally requested products, which causes demand substitution effect ; This kind of substitution is referred to as price-driven substitution. Therefore, decisions on optimal prices should take into account the differences in customers' valuation of the different products. We consider a deterministic model for deciding optimal prices in the presence of price-driven substitution, and we compare both symmetrical-and asymmetrical-type demand substitutions between two segmented markets. The objective of this study is to develop analytical and numerical models to examine the impact of price-driven substitution on the optimal price levels and the total expected profits.

Keywords

References

  1. Bassok, Y., R. Anupindi, and R Akella., Infinite horizon multi-product inventory models with substitution. Operations Research Vol.40, No.5(1993), pp.999-1017 https://doi.org/10.1287/opre.40.5.999
  2. Bassok, Y., R. Anupindi, and R Akella., Single-period multiproduct inventory models with substitution. Operations Research Vol.47, No.4 (1999), pp.632-642 https://doi.org/10.1287/opre.47.4.632
  3. Birge, J., Drogosz, J., and Duenyas, I., Setting single-period optimal capacity levels and prices for substitutable products. International Journal of Flexible Manufacturing Systems Vol.10, 1998, pp.407-430 https://doi.org/10.1023/A:1008061605260
  4. Bitran, G., Caldentry, C., and Vial R., Pricing policies for perishable products with demand substitution. Working paper, MIT, Cambridge, USA, 2005
  5. Gerchak, Y., A. Tripathy, and K. Wang, Coproduction models with random functionality yields. IIE Transactions Vol.328, No.5(1996), pp.2391-403
  6. Heath, T.B, and S.C. Chatterjee, Asymmetrical decoy effects on lower-quality versus higherquality brands. Journal of Consumer Research Vol.22, No.3(1995), p.268 https://doi.org/10.1086/209449
  7. Hsu, A. and Y. Bassok, Single period substitution problems with single raw material input. Operations Research Vol.3, 1996, pp.267- 275
  8. Khouza, M., A. Mehrez, and G. Raibinowitz, A two-item newsboy problem with substitutability," International Journal of Production Economics Vol.44, 1996, pp.267-275 https://doi.org/10.1016/0925-5273(96)80002-V
  9. Kuyumcu, H.A. and I. Popescu, Deterministic price-inventory management for substitutable products. Journal of Revenue and Pricing Management Vol.4, No.4(2006), pp.354-367 https://doi.org/10.1057/palgrave.rpm.5170158
  10. Mulhern, F.J. and R.P. Leone, Implicit price bundling of retail products：A multi-product approach to maximizing store profitability. Journal of Marketing Vol.55, No.4(1991), p.63 https://doi.org/10.2307/1251957
  11. asternack, B. and Z. Drezner, Optimal inventory policies for substitutable commodities with stochastic demand. Naval Research Logistics Vol.38, 1991, pp.221-240 https://doi.org/10.1002/1520-6750(199104)38:2<221::AID-NAV3220380208>3.0.CO;2-7
  12. Paul, K., Fuel, Switching, gasoline price controls, and the leaded-unleaded gasoline price differential. Journal of Environmental Economics and Management Vol.8, No.3 (1981), pp.287-305 https://doi.org/10.1016/0095-0696(81)90042-5
  13. Rao, U.S., Swaminathan, J.M., and Zhang, J., Multi-product inventory planning with downward substitution, stochastic demand and setup costs. IIE Transactions Vol.36, No.1(2005), p.59 https://doi.org/10.1080/07408170490247304
  14. Rajaram, K. and Tang, C.S., The impact of product substitution on retail merchandising. European Journal of Operational Research Vol.135, 2001, pp.582-601 https://doi.org/10.1016/S0377-2217(01)00021-2
  15. Schmidt, G.M. and Druehl, C.T., Changes in product attributes and costs as drivers of new product diffusion and substitution. Production and Operations Management Vol.14 No.3(2005), pp.272-286 https://doi.org/10.1111/j.1937-5956.2005.tb00024.x
  16. Sen, A. and Zhang, A., The Newsboy problem with multiple demand classes. IIE Transactions Vol.31, 1999, pp.431-444
  17. Smith, S. and Agrawal, N., Management of multi-item retail inventory systems with demand substitution Vol.48 No.1(2000), p.50 https://doi.org/10.1287/opre.48.1.50.12443
  18. Taheri, A. A., Oil shocks and the dynamics of substitution adjustments of industrial fuels in the US. Applied Economics Vol.26 No.8(1994), pp.751-757 https://doi.org/10.1080/00036849400000089
  19. Xu, X. and Hopp, W.J., Dynamic pricing and inventory control with demand substitution ：The value of pricing flexibility. Working paper, Department of Industrial Engineering, Northwestern University, Evanston, IL USA, 2004