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

Kim, Sang-Won (울산대학교 경영학과)
Publication Information
Journal of the Korean Operations Research and Management Science Society / v.33, no.1, 2008 , pp. 1-17 More about this Journal
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
Price-driven Substitution; Pricing; Market Segmentation; Customer Buying Behavior;
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