The benefit of Demand Learning in the Presence of Strategic Consumer Behavior

Learning consumer demand from early sales is a complex but a potentially rewarding practice for retailers of fashion products. With learning capability, a retailer can adjust prices during a sales season in response to sales observations; i.e., the retailer can benefit from the ability to act upon updated information. The potential value of demand learning under dynamic pricing could be significant and has been the preeminent motivation for retailers to acquire such capability.  Nonetheless, in fashion retail environments, consumers may be cognizant of a retailer’s learn-and-price strategy; as a result, they may strategically adjust their purchase timing in anticipation of price changes driven by the dynamics of the retailer’s learning process.  This gives rise to an important question: Is the adoption of learning technology truly beneficial for a retailer that sells fashion goods to strategic consumers?  In the paper “Responsive Pricing of Fashion Products: The Effects of Demand Learning and Strategic Consumer Behavior”, Yossi Aviv, Mike Mingcheng Wei, and Fuqiang Zhang address this question.

The authors propose an integrative model that incorporates both demand learning and strategic consumer behavior. A monopolist retailer sells a finite quantity of fashion product over a two-period horizon with significant demand uncertainty. The retailer selects a price for the first period, based on limited demand information; then, the retailer adjusts the price in the second period, based on the sales made in the first period. A Bayesian learning mechanism is utilized to model the demand learning process, through which the retailer’s belief about the market size for the product evolves. Consumers in the market are strategic and decide on whether to buy in the first period or wait for a possible discount. A market equilibrium – which provides a prediction of how demand learning and consumers’ behavior interact – is then identified.

The authors demonstrate that the benefits of learning depend critically on the nature of the consumers. With strategic consumers, the benefits of learning tend to worsen when there is a higher potential to learn. This is in stark contrast to the case with non-strategic (myopic) consumers, where learning is more beneficial when there is a higher potential to learn. This counter-intuitive outcome is explained by pointing to a phenomenon called “information shaping” – the collective conscious attempts of the strategic consumers to influence the retailer’s interpretation of the demand. The authors argue that retailers of fashion products that consider upgrading their responsive pricing systems to incorporate "accurate response" strategies (i.e., integrating learning into dynamic pricing) should be aware of the possibility that such endeavor might lead them to a new and potentially worse equilibrium, particularly when there is a greater opportunity to learn.  Further, the authors suggest that despite the fact that a price-commitment strategy completely eliminates the seller’s ability to learn, it appears to increasingly dominate the responsive pricing as more strategic consumers are present in the market. Finally, the authors explain how an option to replenish inventory during the season can serve as an effective implicit threat by the retailer to the consumers in a way that discourages strategic waiting.

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Aviv Y, Wei M, and Zhang F (2019). Responsive Pricing of Fashion Products: The Effects of Demand Learning and Strategic Consumer Behavior. Management Science 65(7):2982-3000.