Consumer driven demand and operations management models

Consumer-Driven Demand and Operations Management Models A Systematic Study of InformationTechnology-Enabled Sales Mechanisms INT SERIES IN OPERATIONS RESEARCH & MANAGEMENT SCIENCE Series Editor: Frederick S Hillier, Stanford University Special Editorial Consultant: Camille C Price, Stephen F Austin State University Titles with an asterisk (*) were recommended by Dr Price Netessine & Tang/ CONSUMER-DRIVEN DEMAND AND OPERATIONS MANAGEMENT MODELS: A Systematic Study of Information-Technology-Enabled Sales Mechanisms Saaty & Vargas/ DECISION MAKING WITH THE ANALYTIC NETWORK PROCESS: Economic, Political, Social & Technological Applications w Benefits, Opportunities, Costs & Risks Yu/ TECHNOLOGY PORTFOLIO PLANNING AND MANAGEMENT: Practical Concepts and Tools Kandiller/ PRINCIPLES OF MATHEMATICS IN OPERATIONS RESEARCH Lee & Lee/ BUILDING SUPPLY CHAIN EXCELLENCE IN EMERGING ECONOMIES Weintraub/ MANAGEMENT OF NATURAL RESOURCES: A Handbook of Operations Research Models, Algorithms, and Implementations Hooker/ INTEGRATED METHODS FOR OPTIMIZATION Dawande et al/ THROUGHPUT OPTIMIZATION IN ROBOTIC CELLS Friesz/ NETWORK SCIENCE, NONLINEAR SCIENCE and INFRASTRUCTURE SYSTEMS Cai, Sha & Wong/ TIME-VARYING NETWORK OPTIMIZATION Mamon & Elliott/ HIDDEN MARKOV MODELS IN FINANCE del Castillo/ PROCESS OPTIMIZATION: A Statistical Approach J´ozefowska/JUST-IN-TIME SCHEDULING: Models & Algorithms for Computer & Manufacturing Systems Yu, Wang & Lai/ FOREIGN-EXCHANGE-RATE FORECASTING WITH ARTIFICIAL NEURAL NETWORKS Beyer et al/ MARKOVIAN DEMAND INVENTORY MODELS Shi & Olafsson/ NESTED PARTITIONS OPTIMIZATION: Methodology and Applications Samaniego/ SYSTEM SIGNATURES AND THEIR APPLICATIONS IN ENGINEERING RELIABILITY Kleijnen/ DESIGN AND ANALYSIS OF SIMULATION EXPERIMENTS Førsund/ HYDROPOWER ECONOMICS Kogan & Tapiero/ SUPPLY CHAIN GAMES: Operations Management and Risk Valuation Vanderbei/ LINEAR PROGRAMMING: Foundations & Extensions, 3rd Edition Chhajed & Lowe/ BUILDING INTUITION: Insights from Basic Operations Mgmt Models and Principles Luenberger & Ye/ LINEAR AND NONLINEAR PROGRAMMING, 3rd Edition Drew et al/ COMPUTATIONAL PROBABILITY: Algorithms and Applications in the Mathematical Sciences* Chinneck/ FEASIBILITY AND INFEASIBILITY IN OPTIMIZATION: Algorithms and Computation Methods Tang, Teo & Wei/ SUPPLY CHAIN ANALYSIS: A Handbook on the Interaction of Information, System and Optimization Ozcan/ HEALTH CARE BENCHMARKING AND PERFORMANCE EVALUATION: An Assessment using Data Envelopment Analysis (DEA) Wierenga/ HANDBOOK OF MARKETING DECISION MODELS Agrawal & Smith/RETAIL SUPPLY CHAIN MANAGEMENT: Quantitative Models and Empirical Studies Brill/ LEVEL CROSSING METHODS IN STOCHASTIC MODELS Zsidisin & Ritchie/ SUPPLY CHAIN RISK: A Handbook of Assessment, Management & Performance Matsui/ MANUFACTURING AND SERVICE ENTERPRISE WITH RISKS: A Stochastic Management Approach Zhu/QUANTITATIVE MODELS FOR PERFORMANCE EVALUATION AND BENCHMARKING: Data Envelopment Analysis with Spreadsheets Kubiak/ PROPORTIONAL OPTIMIZATION AND FAIRNESS* Bier & Azaiez/ GAME THEORETIC RISK ANALYSIS OF SECURITY THREATS* ∼A list of the early publications in the series is found at the end of the book∼ Consumer-Driven Demand and Operations Management Models A Systematic Study of InformationTechnology-Enabled Sales Mechanisms Edited by Serguei Netessine Christopher S Tang 123 Editors Serguei Netessine The Wharton School University of Pennsylvania 3730 Walnut St Philadelphia, PA 19104-6340 USA netessine@wharton.upenn.edu Christopher S Tang UCLA Anderson School of Management Box 951481 Los Angeles, CA 90095–1481 ctang@anderson.ucla.edu Series Editor Frederick S Hillier Stanford University Stanford, CA, USA ISSN 0884-8289 ISBN 978-0-387-98018-8 e-ISBN 978-0-387-98026-3 DOI 10.1007/978-0-387-98026-3 Springer Dordrecht Heidelberg London New York Library of Congress Control Number: 2008944171 c Springer Science+Business Media, LLC 2009 All rights reserved This work may not be translated or copied in whole or in part without the written permission of the publisher (Springer Science+Business Media, LLC, 233 Spring Street, New York, NY 10013, USA), except for brief excerpts in connection with reviews or scholarly analysis Use in connection with any form of information storage and retrieval, electronic adaptation, computer software, or by similar or dissimilar methodology now known or hereafter developed is forbidden The use in this publication of trade names, trademarks, service marks, and similar terms, even if they are not identified as such, is not to be taken as an expression of opinion as to whether or not they are subject to proprietary rights Printed on acid-free paper Springer is part of Springer Science+Business Media (www.springer.com) Preface To compete in today’s volatile market with rapidly changing consumer tastes and fierce competition, companies in the manufacturing and service industries are deploying new mechanisms to increase sales, market shares, and profits As an effective mechanism to segment a market comprising of consumers with different needs, preferences, and willingness-to-pay, many firms have used product (or service) variety with different price points to serve different segments of the market, see Ho (1998) Ideally, the price of each of these products (or services) targets a particular segment of customers For example, airlines often use different terms of sales (refundable/non-refundable, upgradable/non-upgradable, direct/connecting flight, etc.) to sell economy class tickets at different prices Likewise, retailers often sell the same product at different prices in different channels (company’s own web site, dealers’ web sites, or company’s physical stores) or at different times (before, during, and after the selling season), see Talluri and van Ryzin (2005) Ample academic literature in Operations Management and other areas considered these strategies However, as consumers become more knowledgeable about the product, pricing, organizational and operational policies that the companies deploy for products and services, their purchasing begins to change dramatically In the academic Operations Management literature, consumer demand is often assumed to be exogenous so that demand functions are usually modeled as well defined and exogenously specified functions of price and/or other product attributes such as quality This type of modeling approach captures the “macro” view of consumer demand and many OM models shed light on strategic and managerial issues ranging from revenue management to supply chain management Today, however, many companies are beginning to take the “micro” view by selling each product and service to a target segment by utilizing more sophisticated selling mechanisms enabled by information technologies (say, one-on-one marketing) Some of these sales mechanisms are the following: Mixed sales channels – To offer customers more options and price points, Amazon.com sells both new books (owned by Amazon) and used books (owned by independent used book sellers) which compete for demand from consumers v vi Preface Automatic markdown pricing – To clear overstocked items, Landsend.com pre-announces their price markdown schedule in advance so that consumers can time their purchases according to the markdown schedule Portals – To provide the one-stop shopping experience for their customers, Orbitz.com sells airline tickets for multiple airlines thus putting them in direct competition with each other Group buying – To provide each individual consumer with the buying power of the collective group, thebuyinggroup.com offers their members group discount prices on items ranging from cell phones to office supplies Auctions – To create an online market for consumers who want to buy or sell their items, ebay.com constructs different online auction mechanisms Anecdotal and empirical evidences suggest that, in these sales mechanisms, consumer purchasing behavior is fundamentally different from that arising in more traditional retailing environments For instance, there is plenty of anecdotal evidence suggesting that many consumers are becoming more strategic in the sense that they postpone their purchases due to an anticipation of future price decreases Besides strategic purchasing behavior, there is empirical evidence indicating that consumer’s purchasing decision is often affected by the purchasing decisions of other consumers For instance, Bikhchandani et al (1992) develop a theory to explain how information cascades can induce the herd behavior among customers If a consumer’s purchasing decision is affected by informational factors pertaining to pricing, product availability, product characteristics, and other consumers’ purchasing decisions, the consumer demand becomes endogenous in the sense that it now depends on the underlying sales mechanism as well as on the realized (total) price that the consumer actually pays As the demand pattern changes in response to firms’ actions, firms must manage their supply operations effectively and efficiently in order to meet these new challenges Thus, the study of different sales mechanisms and their implications for consumer demands and supply operations is very timely and is of immediate practical relevance This book contains a collection of state-of-the-art OM models that examine the implications of rational or strategic purchasing behavior under different retail formats These models provide new insights into how firms should operate in these new channels using different sales mechanisms The chapters in this book are written by leading scholars who have initiated the quest for a deeper understanding of consumer’s rational purchasing behavior under various sales mechanisms Moreover, these scholars have continued their efforts in developing innovative ways for companies to respond to this rational purchasing behavior We enjoyed the experience of working on this book and we sincerely hope that this book will stimulate researchers in Operations Management and other areas to explore further this exciting emerging area of research Preface vii References Bikhchandani S, Hirshleifer D, Welch I (1992) A theory of fads, fashion, custom, and cultural change as informational cascades Journal of Political Economy 100(5):992–1026 Ho TH, Tang CS (1998) Product variety management: Research advances Kluwer Publishers, Massachusetts Talluri K, van Ryzin G (2005) The theory and practice of revenue management Springer, New York Fontainebleau, France, November 2008 Los Angeles, November 2008 Serguei Netessine Christopher S Tang Introduction One primary focus of research in Operations Management field is to find ways to make supply meet consumer demand For decades, many OM researchers have developed various production planning and inventory control models and mathematical solution techniques with the intent of helping companies meet consumer demand effectively and at a low cost These models have certainly helped many companies improve their internal operations Our field continues to develop more sophisticated solution techniques for solving various classical Operations Management problems However, another item on the agenda of our field is to broaden the scope of Operations Management, which is the key goal of this book In most Operations Management models consumer demand is assumed to be exogenous so that demand is usually taken to be a well-defined and pre-specified function of price and/or other product attributes such as quality This modeling assumption is quite reasonable for capturing the consumer demand on an aggregate level For example, there are many existing models explaining how firms can use product (or service) variety with different price points to serve different segments of the market (Ho and Tang 1998) However, to compete for market share, companies in the manufacturing and service industries are now deploying other novel mechanisms to segment a market comprising of consumers with different needs, preferences, and willingness-to-pay When buying different variants of a basic product (or service) at different prices with different terms of sales, consumers often need to process information about product characteristics and make their choices in a rational manner Hence, each consumer’s purchasing decision is affected by the way information is being conveyed to them, by the way information is being analyzed by the consumer, and by other consumers’ decisions (such as the herding effect in Bikhchandani et al 1992) In addition, organizational factors such as the choice of sales channels, marketing factors pertaining to product assortments (such as horizontal competition, see Hotelling 1929) and vertical competition (see Lilien et al 1992), different sales mechanisms such as auctions (cf., Krishna 2002), and pricing (see Coase 1972 and Besanko and Winston 1990) as well as operational factors related to product availability can have direct impact on consumers’ purchasing behavior If these factors ix x Introduction are considered by consumers, the consumer demand becomes endogenous in the sense that it depends on the underlying sales mechanism as well as on the realized price that the consumer actually pays To address these recent developments, this book presents a collection of stateof-the-art Operations Management models with consumer-driven demand This is an emerging research area that focuses on the evaluation of different innovative product, services, and sales initiatives, and in all of these chapters it is critical to obtain a deeper understanding of consumer purchasing behavior first and then to develop efficient response to this behavior Not only is each chapter motivated by various innovative service/product delivery mechanisms found in practice, but also the models presented in each chapter are based on various well-established theories in economics, marketing, operations management, and psychology that deal with consumer purchasing behavior Overall Structure This book is comprised of 18 chapters that are divided into parts The first part (Chapters 1, 2, 3, and 4) examines consumers’ rational or strategic purchasing behavior under different business environments Anticipating consumers’ behavior, firms in these chapters use different response mechanisms to mitigate the negative effect caused by the consumers’ rational/strategic purchasing behavior As a response to strategic customers, the second part (Chapters 5, 6, and 7) examines how different organizational strategies (such as sales channels and customer selection processes) can be deployed to increase profits Chapters in the third part (Chapters 8, 9, 10, and 11) examine how companies can use product strategies to increase profits when consumers are strategic To counteract the strategic customers’ purchasing behavior, the fourth part (Chapters 12, 13, 14, and 15) examines how companies can use certain operational strategies (such as capacity/inventory/product availability and inventory display formats) to increase profits Finally, in the fifth part (Chapters 16, 17, and 18) the book describes how different pricing strategies can enable firms to improve profits in the presence of strategic consumers Chapter Highlights Part I: Rational Consumer Behavior: Endogenous Decision Making Mechanisms In Chapter 1, Gad Allon and Achal Bassamboo set the stage for the book by examining situations in which consumers treat information provided by the sellers regarding product/service availability as unreliable Thus, customers are strategic Introduction xi in the way they treat information and use it in decisions that they make regarding buying/waiting While it is often assumed that consumers’ purchasing behavior is purely driven by utility optimization, in Chapter 2, Matulya Bansal and Costis Maglaras examine a situation in which customers are “satisficers” instead of “optimizers” Specifically, the authors consider the case in which the customers seek to buy the cheapest product with quality above a certain customer-specific threshold which may reflect, for example, bounded rationality of consumers In the same vein, in Chapter 3, Felipe Caro and Victor Marinez-de-Albeniz consider the case when customers are insatiable so that companies can increase sales by frequent new product introduction, and they determine how often the company should rotate its assortment Laurens Debo and Senthil Veeraraghavan in Chapter study consumer behavior in queues In particular, they consider the issue of how customers might be able to infer product quality from the length of the queue and they endogenize customers’ decision to select the queue to join Part sets the stage by proposing that consumers are either rational (e.g., optimizers, satisficers, insatiable) or strategic Specifically, consumers are strategic when they rationally anticipate and respond to future conditions For example, anticipating future price drops, a strategic consumer may delay his/her purchasing decision Therefore, dealing with rational/strategic consumers can be costly As such, companies need to develop effective mechanisms to mitigate the negative effects of rational/strategic customers This is the focus of the remainder of this book Part II: Organizational Strategies for Managing Rational/Strategic Consumer Behavior Motivated by proliferation of multiple channels that target multiple customer segments, Barchi Gillai and Hau Lee examine in Chapter the use of a secondary (e.g., Internet) market that can enable retailers to clear inventories unsold in the primary market They demonstrate benefits of such strategies for retailers, manufacturers, and consumers In Chapter 6, Basak Kalkanci and Jin Whang highlight the fact that it can be very costly to satisfy rational consumers (clients in a supply chain) in a heterogeneous market since their aggregate orders may induce the bullwhip effect Instead, they suggest that a supplier can improve profitability by focusing on an optimal portfolio of clients that maximizes supplier’s long-run expected profit Considering situations when consumers are strategic and rationally respond to future market conditions, Xuanming Su and Fuqiang Zhang review several existing papers that demonstrate how decentralization can be beneficial to supply chain performance in Chapter Interestingly, they find that, when customers are strategic, decentralized systems can outperform a centralized organization ... a-bassamboo@kellogg.northwestern.edu S Netessine, C.S Tang (eds.), Consumer- Driven Demand and Operations Management Models, International Series in Operations Research & Management Science 131, DOI 10.1007/978-0-387-98026-3... approach captures the “macro” view of consumer demand and many OM models shed light on strategic and managerial issues ranging from revenue management to supply chain management Today, however, many... supply operations effectively and efficiently in order to meet these new challenges Thus, the study of different sales mechanisms and their implications for consumer demands and supply operations