Dynamic Pricing Through Discounts for Optimizing Multiple-Class Demand Fulfillment

Authors:
Qing Ding;Panos Kouvelis;Joseph M. Milner
Affiliations:
School of Business, Singapore Management University, 469 Bukit Timah Road, Singapore 259756;John M. Olin School of Business, Washington University, St. Louis, Missouri 63130;Joseph L. Rotman School of Management, University of Toronto, 105 St. George Street, Toronto, Ontario, Canada M5S 3E6
Venue:
Operations Research
Year:
2006

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Abstract

In a multiple-customer-class model of demand fulfillment for a single item, we consider the use of dynamic price discounts to encourage backlogging of demand for customer classes denied immediate service. Customers are assumed to arrive over several stages in a period, and customer classes are distinguished by their contractual price and sensitivity to discounts. Through dynamic programming we determine the optimal discounts to offer, assuming a linear model for the sensitivity of customers to such inducements. We show that customers are served in class order, and allocation of inventory to demand is determined by considering the current number of customers backlogged, as well as the current inventory position. Through comparison to a naive supplier allocating inventory first come/first served with no discounting, we show that profits are primarily influenced by the allocation of capacity, and the use of price discounts primarily benefits the second-class customers overall fill rate. Heuristics for implementation of the solution in real-time settings are given.