Smart Pricing

The past decade has seen a virtual explosion of information about customers and their preferences. Many companies have the ability to gauge customers’ willingness to pay for their products and can determine with some accuracy the effect of price changes on sales volumes. With Internet shopping, it is possible to effect such price changes at minimal cost for different customer segments and even for individual customers. Perhaps more enticing is the development of electronic shelf-labeling systems, which open the door to a remarkable array of possibilities for dynamic pricing in brick-and-mortar stores. The potential for increased revenue is huge.

At the same time, companies have taken major strides in understanding and managing the dynamics of the supply chain. Internally, many companies have implemented the tools and concepts of lean manufacturing. And externally, they have aggressively pursued supply chain initiatives, such as electronic procurement; vendor-managed inventory and collaborative planning; forecasting; and replenishment. The potential for cost reduction and service improvement is great.

Yet despite these potential benefits, there is a persistent dilemma. Pricing decisions have a direct, and sometimes dramatic, effect on operations and vice versa. This is vividly illustrated by the bullwhip effect, which can be initiated by price promotions (a classic 1997 paper by Lee et al. explains this effect). A more recent paper by Macé and Neslin (2000) provides new insight into consumer stockpiling in response to a promotion and deceleration (their willingness to reduce inventories in anticipation of a promotion). This insight has led many to suggest that firms should eliminate promotions in favor of “everyday low pricing” — evoking the disdain of their marketing colleagues. Also, the operations community has recently identified drivers for dynamic pricing, inspired by the widely acclaimed successes of revenue management in the airline industry (McCartney, 2000). These developments call for thorough integration of marketing and operations insights — which today still appears to be lacking. Conversations with a significant number of managers indicate that this integration is no more complete in industry than it is in academia.

Nevertheless, the linkage between pricing and operations is increasingly being scrutinized by academics and managers alike. For an extensive discussion of the literature, including technical aspects, see Rao (1993); Radjou et al. (2003); Chan et al. (in press); and Elmaghraby and Keskinocak (2003).