Robust Pricing and Production with Information Partitioning and Adaptation

Abstract

We introduce a new distributionally robust optimization model to address a two-period, multiitem joint pricing and production problem, which can be implemented in a data-driven setting using historical demand and side information pertinent to the prediction of demands. Starting from an additive demand model, we introduce a new partitioned-moment-based ambiguity set to characterize its residuals, which also determines how the second-period demand would evolve from the first-period information in a data-driven setting. We investigate the joint pricing and production problem by proposing a cluster-adapted markdown policy and an affine recourse adaptation, which allow us to reformulate the problem as a mixed-integer linear optimization problem that we can solve to optimality using commercial solvers. We also extend our framework to ensemble methods using a set of ambiguity sets constructed from different clustering approaches. Both the numerical experiments and case study demonstrate the benefits of the cluster-adapted markdown policy and the partitioned moment-based ambiguity set in improving the mean profit over the empirical model—when applied to most out-of-sample tests.This paper was accepted by J. George Shanthikumar, data science.Funding: The research of Q. Tang was supported by Nanyang Technological University [Start-Up Grant 020022-00001] and partly financed by a NUS Business School FY2018 Ph.D. Exchange Fellowship. The research of M. Sim and P. Xiong was supported by the Ministry of Education, Singapore, under its 2019 Academic Research Fund Tier 3 grant call [GrantMOE-2019-T3-1-010].Supplemental Material: Data and the online appendix are available at https://doi.org/10.1287/mnsc.2022.4446 .