Demand management using responsive pricing and product variety to counter supply chain disruptions

Abstract

We consider a retailer that offers multiple variants of two brands, all of which are substitutable, within a single product category. Due to supply disruptions, the retailer may not be able to always offer either or both brands. To mitigate potential loss in demand due to unavailability of one brand, the retailer may choose the product variety strategically and/or adjust the price of the available brand. The goal of this paper is to compare the relative impact of these two levers of demand management in the face of supply disruptions. To that end, we develop and analyze a model of a retailer buying from two brands (suppliers) subject to random supply disruptions. The retailer’s customer demand depends on price and product variety, and their impact on customer choice is captured through the nested logit model. The model also takes into account fixed design and operational costs associated with product variety. Our analysis reveals that strategic choice of product variety yields most of the benefit; price is a largely ineffective lever. We also show that when the supply of one brand is disrupted, the optimal price for the other brand is lower than when both brands are available, provided the outside option is equally or less affected by the disruption. However, even if the outside option is affected more, this result may not necessarily reverse. Finally, even though responsive pricing does not improve the profit substantially, it may reduce safety stock requirements.