Pricing and composition of multiple vertically differentiated bundles considering demand uncertainty1

Abstract

The aim of this paper is to investigate a profit-maximization firm how to determine the composition and prices of multiple bundles. Bundles are sets of components that must meet some technical constraints; furthermore, customers differ in their quality valuations and choose the bundle that maximizes their utility. A mixed integer non-linear program is proposed to solve this problem. First, a two-step approach is employed to obtain the firm’s optimal decision. The result indicates that when the firm faces deterministic demand, the optimal set of bundles it offers is independent of the distribution of customer valuations and does not contain any dominated bundle. In addition, dominated components cannot be used to construct the optimal bundles. Second, the impact of demand uncertainty on the firm’s performance is explored. The results suggest that disregarding the demand risk may result in broader assortment and suboptimal prices. Finally, numerical experiments and sensitive analysis are conducted to provide managerial insights for the pricing and composition of multiple bundles.