Managing demand by upgrade programs and markdown pricing with a product rollover

Abstract

It has been challenging for firms to effectively manage demand when they release products of one generation after another one. Motivated by the observations from the smartphone industry, this paper investigates the effectiveness of two demand management strategies in the presence of a product rollover: the upgrade program and price markdown policy. Under an upgrade program, a firm allows customers to upgrade their on‐hand product to a new generation product that will be released in a future time. Under a markdown pricing policy, the firm offers a discount for the currently available product so as to induce waiting customers to make immediate purchases. The two demand management strategies target different groups of customers and have distinct impacts on customers' choices. Starting from the time‐varying choice behavior of a heterogeneous group of customers, we study the optimal pricing decisions involved in the two strategies. Specifically, when customers are myopic in the sense that they only make a one‐time purchasing decision upon arrival, we show that the firm should offer the upgrade program only when the innovation level of the new product is relatively high, and the firm's optimal upgrade price can increase over time. Generally, the firm should offer the upgrade program during the early selling period and adopt markdown pricing as the release date of the new product approaches. Numerical experiments reveal that the dynamic upgrade program and markdown pricing policies can help improve profit significantly. When customers are strategic in the sense that they can monitor the selling prices and make dynamic purchasing decisions until they buy a unit of product, we examine two coping strategies that a firm can adopt, and investigate how the strategic monitoring behavior may influence a firm's optimal selling decisions and profit.