Optimal depth and timing of price promotions in a vertically differentiated product line

Abstract

When a monopoly consumer packaged goods seller contemplates a temporary price decrease to promote a particular product, the decision is complicated, due to the potential impacts on demand for its other products. Yet limited research details how a monopoly seller should promote its offerings of different quality. This article proposes a model in which consumers switch from a low- to a high-quality offering in the product line when the latter's price is temporarily reduced. According to this model, the price promotion offers consumers a chance to learn about the high-end option, and some trials will lead to sufficient liking of the high-quality offering that they will continue purchasing it, even after it reverts to its regular (non-promotional) price. However, the quality expectations of these repeat buyers increase, which narrows the positive disconfirmation gap. Eventually, these consumers return to the low-quality option. With these assumptions, the current study determines a dynamically optimal (profit-maximizing) product line pricing and promotion strategy for a seller, which in turn has implications for consumer surplus. Contrary to conventional wisdom, overall consumer surplus decreases over the optimal price promotion cycle. A model extension also investigates a periodical promotion strategy for low-end products, in an effort to induce non-buyers to consume; the seller's profit also improves with this strategy.