Executive Summary
It is well known that store-level sales respond positively to short-term price promotions. Under the assumption of constant consumption rate, prior literature has identified that the sources for the increase are brand switching, purchase acceleration, and stockpiling. However, recent research has shown that households’ consumption is also affected positively by price promotions. It is important to model the flexible consumption in household behavior to identify correctly the drivers of the increase in sales due to a temporary price promotion because their impacts on profits of manufacturers and retailers are potentially different.
In this article, the authors develop a dynamic structural model of a household that decides when, what, and how much to buy, as well as how much to consume, to maximize its expected utility over an infinite horizon. Consumption in each period is endogenous and is based on current marketing mix, inventory levels, preferences, and the household’s expectations about future prices. In deciding whether to buy today, a household trades off inventory cost against the opportunity cost of buying the product in the future at a possibly higher price. The model incorporates heterogeneity across households in inventory cost, price sensitivity, and underlying preferences. The authors propose a solution to overcome the dimensionality problem in the dynamic optimization model by imposing some simplifying assumptions. They estimate the proposed model using household purchase data in canned tuna and paper towel categories. Then, they run simulations using the estimates from the model to decompose the total effect of a price promotion into its components of increase in consumption, brand switching in current and future periods, and stockpiling.
The analysis reveals several notable insights: (1) Contrary to what is shown in most previous literature, brand switching is not the dominant effect; (2) for larger share brands, the majority of promotion induced sales increase is attributed to stockpiling; and (3) for smaller share brands, the consumption effect is greater. The authors further show that a household’s brand preference has a significant impact on its stockpiling and flexible consumption behavior; brand loyals mainly respond to a price promotion by stockpiling, whereas brand switchers do not stockpile. The authors also find that heavy users stockpile more for future consumption, whereas light users have larger consumption increase under the price promotion. These findings have important implications for pricing and promotion strategies for manufacturers and retailers. For example, they could help managers make inferences about which brand’s sales are more responsive to stockpiling or increase in consumption expansion and how temporary price cuts affect future sales.
Biography
Tat Chan is Associate Professor of Marketing in the Olin Business School at Washington University in St. Louis. He received a PhD in Economics at Yale University in 2001. His research interests are in modeling consumer demand and firms strategies using econometric methodologies. His recent research also includes evaluating the impact of effectiveness and side effects on prescription decisions, analyzing the optimal nonlinear pricing strategies (e.g., three-part tariff, product bundling) for firms, and identifying the impacts of pre- and postprice expectations on consumer purchase decisions.
Chakravarthi Narasimhan is Philip L. Siteman Professor of Marketing and Director of the PhD Program in the Olin Business School at Washington University. He received his PhD in Business from the University of Rochester. His current research interests are in supply chain strategies especially under uncertainty, choice models, product bundling and nonlinear tariffs, and the interaction between advertising positioning and quality choices. His articles have appeared in Marketing Science, Management Science, Journal of Marketing Research, Journal of Marketing, Journal of Business, and Harvard Business Review, among others. He is an associate editor of Marketing Science and Management Science.
Qin Zhang is Assistant Professor of Marketing in the School of Management at the University of Texas at Dallas. She received her MSBA and PhD in Marketing from Washington University at St. Louis, and she holds a BS in International Finance from Tsinghua University, China. Her research interests include dynamic choice modeling, retailing, database marketing, and models of customer profitability and lifetime values.
Journal of Marketing Research, Volume 45, Number 4, August 2008
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