Dynamic Pricing for Heterogeneous Time-Sensitive Customers

Abstract

Problem definition: A core problem in the area of revenue management is pricing goods in the presence of strategic customers. We study this problem when customers are heterogeneous with respect to their initial valuations for the good and their time sensitivities—that is, the customers differ in both their initial valuations and the rates at which their initial valuation decreases with a delay in the purchase. Academic/practical relevance: In many settings, especially in fashion and electronic retail, a customer’s valuation for the product is time-sensitive and decreases over time. In these situations, customers are not only different in terms of their initial willingness to pay for these products when they are first introduced to the market, but they are also different in terms of how rapidly they lose interest in these products. We show that when a firm sells products in such settings, it can realize significant benefits by incorporating dynamic pricing, even in the absence of demand uncertainty. Methodology: Dynamic mechanism design. Results: We characterize the optimal mechanism for selling durable goods when the customers differ in both their initial valuations and the rates at which their initial valuation decreases. We show that delayed allocation and dynamic pricing can be effective screening tools for maximizing firm profit and can also increase social welfare. We also investigate the impact of production and holding costs on the optimal mechanism. Managerial implications: Our work shows how firms can exploit scenarios in which their customers have time-sensitive valuations and are forward-looking to achieve a win–win, by both generating additional revenue and improving social welfare.