Advance selling of new products considering retailers’ learning

• Published date: 01 September 2020
• DOI: http://doi.org/10.1111/ijet.12193
• Date: 01 September 2020
• Author: Chenhang Zeng

doi: 10.1111/ijet.12193

Advance selling of new products considering

retailers’ learning

Chenhang Zeng∗

Whena retailer launches a new product, the lack of information on market size and consumer val-

uation lead to yield uncertainty for the retailer concerning demand and therefore lead to risks in

production. Under advance selling, the pre-ordersmay signal the future demand for the retailer,

which helps to reduce demand uncertainty. This paper studies the retailer’s optimal advance

selling price and production quantity in a two-period model where the demand uncertainty

comes from both the market size and the distribution of consumer valuations. We characterize

the conditions under which the retailer adopts advance selling and perform comparative statics

analysis of the equilibrium.

Key wor ds pre-order, advance selling, newsvendor problem, learning, demand uncertainty,

consumer valuation

Accepted 19 February 2018

1 Introduction

Advance selling is a sale strategy by a retailer which allows consumers to submit pre-orders before

the release of a new product. It is often implemented when the retailer (or producer) faces demand

uncertainty and needs to decide how much to produce before the regular selling season. Since

consumers are uncertain about their valuations for the product in advance of the regular selling

season, advance selling is usually carried out with a discount to induce consumers to pre-order,

guaranteeing that pre-orders will be fulfilled promptly after release. With remarkable developments

in the internet and information technology,advance selling is widely used in many product categories,

such as books, compact discs, video games, smartphones, software, fashion products, and travel

services.

There are three major benefits associated with advance selling. First, it helps the retailer to reduce

the demand uncertainty because he can capture some of the market demand in advance through

pre-orders. Second, it provides the retailer with opportunities to better forecast the future demand.

In particular, pre-order information may work as a signal for the retailer to update the forecast of

market size. Third, it helps the retailer to utilize consumers’ uncertainty of valuations and increase

the overall demand. In the regular selling season, consumers with valuations below the selling price

∗WenlanSchool of Business, Zhongnan University of Economics and Law, Wuhan,China. Email: cz sdu@163.com

Financial support from the Social Science Youth Foundation of the Ministry of Education of China (grant no.

15YJC790138), the key program of the National Social Science Foundation of China (program no. 17ZDA038), and

the National Natural Science Foundationof China (g rant no.71773063) are gratefully acknowledged. The author would

also like to thank the editor, an anonymous referee, X. Henry Wang and Oksana Loginova for their helpful comments

and suggestions.

International Journal of Economic Theory xx (2018) 1–23 © IAET 1

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Advance selling of new products Chenhang Zeng

will not make purchases. However, they may be attracted to pre-order at a discount because they do

not know their valuations in the advance selling season.

This paper studies the optimal selling strategy for completely new products.1The motivation

for the present study comes from two observations. First, some retailers adjust the pre-order prices

in the advance selling season. while some refund early adopters in the regular selling season.2The

paper points out that retailers are most likely uncertain about consumers’ valuation distribution for

new products. Thus it is very interesting to take this into consideration in the advanceselling model.

Second, some retailers adopt advance selling for their new products with pre-order discounts, but

some others do not.3Toexplain the second observation, we mainly address the following questions in

this paper. Fora new product, when should a retailer implement advance selling? What should be the

optimal advance selling price? How does the retailer’s optimal choice change with some important

parameters in the model, such as salvage value, profit margin in the regular selling season, uncertainty

of market size, and some consumer characteristics?

Weconsider a two-period dynamic model, in which the first period is the advance selling season,

and the second period is the regular selling season. Consumers in the model are heterogeneous in

their valuations, which are assumed to follow a normal distribution. Consumers do not know their

own valuations in the advance selling season since they will not have had the chance to try the new

product or to browseproduct reviews online. Based on the available product information, consumers

form expectations for valuations in the first period and make purchases in advance by comparing the

expected payoffs from pre-orders and otherwise. If they decide to wait, consumers with valuations

above the regular selling price will make purchases in the regular selling season. However, they will

face the risk of not being able to get the product. With regard to the retailer, he is uncertain about

the market size and the mean of the consumer valuation distribution. To reduce the uncertainty

caused by these two factors, the retailer decides whether to adopt advance selling after considering

consumers’ decision-making process. If he decides to adopt, he chooses the advance selling price at

the same time and makes the quantity decision at the end of the advance selling season.

Wefind that there are three types of advance selling strategies for the retailer: advance selling at a

deep discount; advance selling at a moderate discount; and no advance selling. In addition, we show

that the retailer will implement advance selling if and only if marginal cost is below the threshold on

it. Numerical tests are also presented toshow how these parameters in the model impact the retailer’s

optimal advance selling strategy.

This paper contains several contributions to the literature on advance selling. First, most studies

on advance selling assume the consumer valuation distribution is known to the retailer. They only

consider the demand uncertainty from the randomness of the market size. However, this paper

includes the uncertainty of the consumer valuation distribution in the model and studies how it affects

the retailer’s optimal advanceselling strateg y.Second, rather than build up a correlation between the

demands in these two periods and forecast the second-period demand with the realized first-period

demand, this paper studies the retailer’s active learning of the consumer valuation distribution or

the market size, with which he updates the forecast of the future demand. Finally, most studies

1For serial products, it focuses on the first generation.

2For example, Appleadopted advance selling without a discount for its first-generation iPhone in 2007, but later gave $100

rebates to early adopters after the release. Amazon started taking pre-orders for the Nokia N900 at $649 in September

2009, but later dropped the pre-order price to $589.

3For example, retailers did not take pre-orders for the first Harry Potterbook or the first-generation iPhone, iPod Touch,

and Amazon Kindle. But for products such as Gears of Warand Nintendo Wii Fit, pre-orders were taken with reasonable

discounts.

2International Journal of Economic Theory xx (2018) 1–23 © IAET

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