Abstract Rationed Promotions

Managing Competition: Promotions that Reduce Pricing Pressure

David W. Richardson and Ram C. Rao

October 2014

Abstract

When firms have more capacity than their full price customers will consume in the short term, and have access to a pool of very price elastic customers, they can use deep promotions to clear the excess inventory without cannibalizing their high margin demand and so avoid directly competing for high value customers. Examples include airlines’ release of limited blocks of seats for discount fare classes, and “Black Friday” offerings of limited quantities of toys, electronics and other consumer durables at the beginning of the Christmas selling season. By pricing a limited quantity at below market clearing rates, these “rationed promotions” allow firms to recruit enough excess demand to clear excess inventory while effectively excluding high value customers from purchasing at the discount price.

We show that competition weakly increases prices above the optimal monopoly level, but lowers revenues because the higher prices fail to achieve optimal segmentation of heterogeneous consumers. Nonetheless, by clearing excess inventory, yield managing firms avoid direct competition for their most profitable customers and retain most of the revenues available to the monopolist. This has important consequences for capacity choice in these markets. Since rationed promotions dramatically improve profitability in low demand states, firms using them elect significantly higher capacities when facing variable or uncertain demand. This leads to substantial social welfare gains in these markets. While in the monopoly case most of this gain goes to consumers, under duopoly competition firms gain all the benefits. We extend these results to situations of asymmetric competition and horizontally differentiated products and find that in these contexts competition can lead to either higher or lower prices depending on the degree and nature of preference heterogeneity.

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