Why Markdown as a Pricing Modality?

Abstract

AboutSectionsView PDF ToolsAdd to favoritesDownload CitationsTrack CitationsPermissionsReprints ShareShare onFacebookTwitterLinked InEmail Go to Section HomeManagement ScienceVol. 65, No. 5 Why Markdown as a Pricing Modality?Elodie Adida , Özalp Özer Elodie Adida , Özalp Özer Published Online:20 Sep 2018https://doi.org/10.1287/mnsc.2018.3046AbstractMarkdown as a pricing modality is ubiquitous in retail whereas everyday low price (EDLP) remains relatively rare (despite its several advantages, such as simplicity). This paper explores whether and why retailers can use either of these pricing modalities as an effective defense against a competitor entering the market with the alternative pricing modality. Various studies have shown that consumers are strategic and heterogeneous in their valuation of a product. Consumers are also shown to be regret-prone, and anticipation of regret affects their purchase decisions. Consumers experience availability regret when they are unable to purchase products due to stockouts and high-price regret when they miss an opportunity to purchase products at low prices. Considering such factors, consumers decide whether, when, and from which retailer to purchase the product. In such a market environment, we find that the possible entry of a competitor should deter retailers from using the EDLP pricing modality but not markdown. We also identify a new reason for the markdown retailer to ration stock (in addition to the reason for discouraging consumers to wait for the markdown). In particular, we show that the markdown retailer can use inventory rationing to preclude a cutthroat competition and bankruptcy after the entry of an EDLP retailer. We also quantify how consumer regret affects both retailers’ decisions and resulting profits. In particular, in a competitive market, the EDLP retailer cannot simply disregard consumers’ availability and high-price regret (even when it stocks ample inventory and does not discount prices). We show that high-price regret and availability regret have complementary effects on the markdown retailer’s rationing strategy and the EDLP retailer’s price decision. Finally, using a proprietary price data set from a large department store, we show that ignoring regret factors causes the markdown retailer to leave up to 20% of its profits on the table. In addition, in a competitive market, the markdown retailer rations too aggressively when regret is ignored and, as a result, leaves some of the forgone profit to its competitor—the EDLP retailer. The retail industry is often characterized by its slim profit margins. In such an environment, the aforementioned results also suggest that retailers should seriously consider investing in developing the capacity to estimate and quantify the role of regret in consumers’ purchase decisions.Data and the online appendix are available at https://doi.org/10.1287/mnsc.2018.3046.This paper was accepted by Serguei Netessine, operations management. Previous Back to Top Next FiguresReferencesRelatedInformationCited byOptimizing mixed bundle pricing strategy: Advance selling and consumer regretOmega, Vol. 115Buy-One-Get-One Promotions in a Two-Echelon Supply ChainYuefeng Li, Moutaz J. Khouja, Jingming Pan, Jing Zhou13 December 2022 | Management Science, Vol. 0, No. 0High-Low Promotion Policies for Peak-End Demand ModelsTamar Cohen-Hillel, Kiran Panchamgam, Georgia Perakis8 August 2022 | Management Science, Vol. 0, No. 0Mapping the Ethicality of Algorithmic Pricing: A Review of Dynamic and Personalized Pricing10 December 2019 | Journal of Business Ethics, Vol. 170, No. 4 Volume 65, Issue 5May 2019Pages 1949-2443 Article Information Supplemental Materials Metrics Information Received:September 15, 2016Accepted:December 12, 2017Published Online:September 20, 2018 Copyright © 2018, INFORMSCite asElodie Adida, Özalp Özer (2018) Why Markdown as a Pricing Modality?. Management Science 65(5):2161-2178. https://doi.org/10.1287/mnsc.2018.3046 Keywordspricingmarkdowneveryday low pricecompetitionregretPDF download