Let them stay or let them go? Online retailer pricing strategy for managing stockouts

Abstract

A challenge for online retail firms is managing stockouts of products when substitutes are available. We develop a game-theoretic model to analyze the competition between multiple-product online firms and characterize the scenarios when they can use prices as stockout recovery mechanisms. Depending on the consumer costs of searching for unfamiliar substitute products on their sites and the consumer mismatch costs of shopping at backup compared to favorite firms, in our primary analysis, we demonstrate that the equilibrium of a pricing game can be one of three possible types: following stockouts the firms retain their customers, the firms release their customers, or all consumers turn to one of the firms. We also examine a firm’s combined use of prices and product recommender systems to manage stockouts. Results in the primary section of the analysis and a first extension combine to demonstrate a firm’s strategic marketing complementarity of its prices and quality of its product recommender system. That is, when a firm uses a better product recommender system to retain consumers following stockouts, we show that it also raises prices. In our primary section, we also show that by implementing a better product recommender system, surprisingly a firm’s sales may fall. However, implementing higher-quality recommender systems may not be jointly optimal for the firms. In the first extension’s game, depending on the cost of better product recommender systems, the firms, when choosing recommender systems, may engage in a prisoner’s dilemma, where the price increase associated cannot fully compensate the implementation cost. In a second extension, we show that positively (negatively) correlated stockouts of a product between the competitors reduces (raises) each firm’s profit and prices because the positive (negative) correlation reduces (raises) each consumer’s expected utility of shopping experience.

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