Potential additional profits of selling a perishable product due to implementing price discrimination versus implementation costs

• Author: Avi Herbon
• Published date: 01 July 2019
• Date: 01 July 2019
• DOI: http://doi.org/10.1111/itor.12426

Intl. Trans. in Op. Res. 26 (2019) 1402–1421

DOI: 10.1111/itor.12426

INTERNATIONAL

TRANSACTIONS

IN OPERATIONAL

RESEARCH

Potential additional profits of selling a perishable product due

to implementing price discrimination versus implementation

costs

Avi Herbon

Department of Management, Bar-Ilan University, Ramat-Gan, Israel

E-mail: avher@bezeqint.net [Herbon]

Received 27 November2016; received in revised form 20 April 2017; accepted 24 April 2017

Abstract

Firms that seek to undertake the course of price discrimination may face obstacles. Answering the question

as to whether the implementation of price discrimination for perishables is beneficial from the perspective

of the seller depends on the total costs of acquiring both consumption information and the technology. We

analyze two models. The first model assumes that sufficient consumer information (e.g., purchasing history)

and the technology for applyingprice discrimination are availableto the decision maker (i.e., the retailer). The

second represents the common situation where the price is identical to all, that is, price discrimination is not

carried out. The optimal prices are derived. Our modeling indicates that even under deterministic demand

mode, lost sales or surplus can be observed due to the absence of consumer information about sensitivity to

a product’s remaining time until expiration. Simulations for evaluating the effect of random demand noise

on the relative profits obtained byboth models surprisingly show that the gap between them decreases under

demand noise. Numerical illustration indicates that the subjective prediction made by the retailer, who has

no accurate consumer information about demand sensitivity, has a significant impact both on the proportion

of the consumer population that benefits from possible price discrimination and on the retailer’s expected

profits.

Keywords:optimization; retailing; price discrimination; consumer information; perishable inventory

1. Introduction

Enormous amounts of wasted inventories, such as unsold fresh produce, as well as increasing

competition are lowering the levels of marginal profits gained by retailers selling perishables. In

the food industry, for example, weight loss, microbial rots, diseases, and insect damage are possible

accelerators of food loss (Hertog et al., 2014). As a result, these retailers are motivated to research

and carry out atypical pricing strategies. One of the suggested pricing strategies for minimizing

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2017 International Federation ofOperational Research Societies

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A. Herbon / Intl. Trans. in Op. Res. 26 (2019) 1402–1421 1403

these drawbacks is price discrimination. According to this approach, each consumer (or group of

consumers) is assigned a different price. Accordingto the Forrester report, out of 30 online retailers

interviewed in 2000, 57% had plans to try some form of personalized pricing (Johnson et al.,

2000). Radhakrishnan et al.’s (2008) study finds empirical support for the differential business value

created by IT along a numberof process-oriented dimensions. Other examples of utilizing consumer

information are credit-reporting companies that provide businesses with monetary information

about a consumer’s past behavior, or motor insurance companies thatexamine a consumer’s driving

record prior to determining their price. These findings set an optimistic tone forIT as a major causal

driver of differentiation.According to Aydin and Ziya(2009), many sellers have the abilityto identify

individual customers, collect information about them, and track their purchasing behavior (e.g.,

catalog retailers, online retailers, and stores that issue loyalty cards to their customers). Possessing

and analyzing such information may act as a basis for determining more customized pricing.

Fay and Xie (2008) who suggest a selling strategy termed probabilistic selling (PS) find that

probabilistic goods have the fundamental advantage of allowing the seller to benefit from a special

type of buyer heterogeneity. Such a strategy takes advantage of selling probabilistic products (or

opaque selling) to consumers with weak preferences,that is, applying a form of price discrimination.

Different from Fay and Xie (2008) who assume consumers are homogeneous in their evaluations

of the probabilistic product, Huang and Yu (2014) model opaque selling under different levels

of consumer rationality. Compared to online retailers who have a wealth of information about

registered customers, retailers selling perishables (e.g., food and drugs) might face bigger challenges

in the implementation of price discrimination, that is, offering each customer her/his own price.

The expected additional profit and expected cost associated with the implementation of price

discrimination are keyfactors in the decision-making process about whether to apply such a strategy.

Examples of characteristics that affect a customer’s purchasing decision are price, taste, location,

texture, product color and appearance, brand, and shelf life. Although expiration date is openly

presented to consumers (i.e., the duration of time until the expiration date can be easily computed),

different consumers are likely to assign different qualities to the same product and, accordingly,

are likely to have different willingness to pay depending on their personal perspective and their

required duration of utilization of the item (e.g., two days remaining until expiration may be more

than enough for one consumer but unsatisfactory for another). The perceived quality (see Zeithaml,

1988) strongly depends on the prior knowledge of a given individual about the product, as well

as on that individual’s subjective impression of the deterioration in product quality over time. The

remaining shelf life is the only “objective” information regarding the quality of a given product

relative to a fresh one that is available to consumers; therefore, it makes sense that shelf life is

the origin of the heterogeneity of consumers regarding their estimation of a product’s quality. In

order to exemplify consumer information associated with perishables, we consider in this paper

consumer sensitivity to remaining time until expiration of a perishable product. According to

Liu and Serfes (2004), several sources are available to firms in collecting information about the

heterogeneity of their consumers: past transactions, telemarketing or mail surveys, and credit cards

reports. In this research,we address a special case of the general, open question concerning whether

service providers and retailers who implement price discrimination can benefit economically from

heterogeneity in customer willingness to pay for the same product.

This paper draws from the extensive literature on perishable inventory. The literature that focuses

on the price and inventory control of perishables appears in the reviews of Gallego and Van Ryzin

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2017 The Authors.

International Transactionsin Operational Research C

2017 International Federation of OperationalResearch Societies