Optimal Markdown Pricing: Implications of Inventory Display Formats in the Presence of Strategic Customers

Abstract

Consider a retailer announces both the regular price and the post-season clearance price at the beginning of the selling season. Throughout the season, customers arrive in accord with a Poisson process. In this paper we analyze the impact of two types of customer purchasing behavior and two common in-store display formats on the retailer’s optimal expected profit and optimal order quantity. We consider the case when all customers are either myopic (purchase immediately upon arrival) or strategic (either purchase at the regular price upon arrival or attempt to purchase at the clearance price after the season ends). In addition, we consider the case when the retailer would display either all available units or one unit at a time on the sales floor. When all customers have identical valuation, we show that, in equilibrium, each strategic customer’s purchasing decision is based on a threshold policy that depends on the inventory level at the time of arrival. We prove analytically that the retailer would obtain a higher expected profit and would order more when the customers are myopic. Also, we show analytically that the retailer would earn a higher expected profit and would order more under the display one unit format when the customers are strategic. We illustrate numerically the penalty when the retailer mistakenly assumes that the strategic customers are myopic. We extend our analysis to the case in which customers belong to multiple classes, each of which has a class-specific valuation, and also to the case in which the post-season clearance price depends on the actual end-of-season inventory level.

Keywords: Retailing, Purchasing Behavior, In-Store Display Formats, Ordering Decision