Pre-Orders for New To-Be-Released Products Considering Consumer Loss Aversion

Abstract

Advance selling through pre-orders is a strategy to transfer inventory risk from a retailer to consumers. A newsvendor retailer can have three strategies to choose from: no advance selling allowed (NAS), moderate advance selling with a moderate discount for pre-orders (MAS), and deep advance selling with a deep discount for pre-orders (DAS). MAS allows for intermediate allocations of inventory risk: The retailer bears the risk on inventory carried for the selling season because of demand uncertainty while consumers bear the risk on products purchased in advance because of consumer valuation uncertainty. DAS completely transfers inventory risk from a retailer to consumers. This research studies how a retailer could design an advance selling strategy to maximize her own profits.We find some interesting results. For example, there exist two thresholds for the selling season profit margin and also two thresholds for consumer's expected valuation. For products with higher profit margin than the high threshold on profit margin, a retailer should always use a DAS strategy. For products with medium profit margin within the two thresholds, a retailer should adopt a MAS strategy if consumer's expected valuation is lower than the high threshold on expected valuation and use a DAS strategy otherwise. For products with lower profit margin than the low threshold on profit margin, a retailer should not encourage pre-order at all if consumer's expected valuation is lower than the low threshold on expected valuation, use a DAS strategy if consumer's expected valuation is higher than the high threshold, and use a MAS strategy if consumer's expected valuation is between the two thresholds. Through analytically comparing deep discount and moderate discount strategies, we also find that a strong correlation between the number of rational and loss averse consumers favors MAS more than DAS. An increase in consumer loss averse degree makes DAS less attractive to a retailer than MAS. An increase in the number of rational consumers hurts DAS more than MAS. An increase in the standard deviation of the number of loss averse consumers benefits DAS but hurts MAS.