An Integrated Approach to Pricing, Inventory, and Market Segmentation Decisions with Demand Leakage

Abstract

Differentiated pricing is among the widely practised Revenue Management (RM) tactics in which a firm offers its products/services at differentiated prices to distinct markets. Earlier researches have shown that the benefits from differentiated pricing are evident when the market segmentation is assumed perfect which are regarded as distinct markets with deterministic demands. In perfect market segmentation customers associated with a market segment do not cannibalize (move) between market segments. However, it is not uncommon to notice that the market segmentation a firm exercises is seldom perfect, and due to imperfect segmentation customers cannibalize between market segments which is also referred as demand leakage. In addition to this, the demand is often uncertain, and thus a firm also experiences short sales and leftovers due to uncertain demand. This research addresses the issue of establishing an integrated framework to optimize price differentiation strategy, pricing, and order quantity for a firm that experiences demand leakage. The models to determine the optimal market segmentation strategy, pricing, and order quantities for a firm are developed facing price dependent deterministic demand, stochastic demand, and when the demand is stochastic, yet the distribution is unknown. The models are analyzed to identify the optimal pricing, order quantities, and price differentiation strategy. Numerical experimentation show that optimizing the price differentiation strategy (market segmentation) along with optimizing the joint pricing and order quantity decisions price significantly improve the revenue to a firm although it experiences customer cannibalization. This paper, however, only highlights the deterministic model and its analysis.