Dynamic Pricing of Substitutable Products in the Presence of Capacity Flexibility

Abstract

F irms that offer multiple products are often susceptible to periods of inventory mismatches where one product may face shortages while the other has excess inventories. In this paper, we study a joint implementation of price-and capacity-based substitution mechanisms to alleviate the level of such inventory disparities. We consider a firm producing substitutable products via a capacity portfolio consisting of both product-dedicated and flexible resources and characterize the structure of the optimal production and pricing decisions. We then explore how changes in various problem parameters affect the optimal policy structure. We show that the availability of a flexible resource helps maintain stable price differences across products over time even though the price of each product may fluctuate over time. This result has favorable ramifications from a marketing standpoint because it suggests that even when a firm applies a dynamic pricing strategy, it may still establish consistent price positioning among multiple products if it can employ a flexible replenishment resource. We provide numerical examples for the price stabilization effect and discuss extensions of our results to a more general multiple product setting.

Pricing and Production Flexibility: An Empirical Analysis of the U.S. Automotive Industry

“…To the best of our knowledge, this paper provides the first piece of empirical evidence complementing the theoretical literature on production flexibility with endogenous pricing (e.g., Van Mieghem and Dada 1999, Chod and Rudi 2005, Goyal and Netessine 2007, Ceryan et al 2013). …”

“…The exact magnitude of the effect of mix flexibility will depend on the shape of the cost and demand curves, as demonstrated in the recent modeling work by Ceryan et al (2013).…”

“…For example, Van Mieghem and Dada (1999) study how the timing of decisions -in particular production and pricing-with respect to the demand uncertainty affects the strategic investment decision of the firm and its value. Other recent papers that analyze flexibility in presence of responsive or dynamic pricing are Chod and Rudi (2005), Goyal and Netessine (2007), and Ceryan et al (2013). Despite these careful analytical studies of dynamic pricing and production flexibility, the empirical evidence in this area remains scarce, which is one of the main motivations of the present study.…”

Joint pricing and inventory decisions under resource constraints and price-based substitution

“…Our work differs from these two papers by considering stochastic demand. Most closely related to our model, Bertsimas and de Boer (2002), Song and Xue (2008) and Ceryan et al (2013) examine joint pricing-inventory decision under both demand uncertainty and resource constraints. Nevertheless, Bertsimas and de Boer (2002) ignore the demand substitution among products, which is considered in our article.…”

Dedicated vs product flexible production technology: Strategic capacity investment choice

“…Firms have to determine the optimal investment type (flexible/dedicated), the optimal (lumpy/incremental) capacity to invest in, and/or the utilization rate of the capacity. Papers that discuss the value of flexibility of a monopolist are Fine and Freud (1990), Van Mieghem (1998), Bish and Wang (2004), Chod and Rudi (2005), Tomlin and Wang (2005) and Ceryan, Sahin, and Duenyas (2012). Fine and Freud (1990) consider a n-product firm that assembles an optimal mix of flexible and dedicated capacities, where uncertainty is modeled through a revenue function with a discrete set of possible scenarios.…”