Dynamic pricing for revenue maximization in supply chains
The exchange of goods and services is affected by pricing policies, of which there are two broad categories: posted-price mechanisms (take-it-or-leave-it pricing), and price-discovery mechanisms (auction pricing). In the past, companies fixed prices of a product for a relatively long time period; i.e., prices were considered static. The reason for this strategy is found in the absence of accurate demand information, high transaction costs associated with changing prices, and huge investment in software and hardware to implement a dynamic pricing strategy. Although dynamically posted prices are also take-it-or-leave-it prices, the seller can dynamically change prices over time. The goal here is to balance demand and supply via dynamic pricing. Early adopters of dynamic pricing methods are commonly found in industries where the short-term capacity is difficult to change such as airlines, and hotels. Most of these industries operate in a centralized fashion, which allows prices to be changed at little or no cost. Contrasting to the former are retail-like industries, for whom short-term supply is more flexible but price changes are costly.
The primary focus of this research is on the latter type industry. We consider a two-echelon supply chain with a single retailer and a single supplier for whom we develop a dynamic pricing policy, which optimizes the net profit in the presence of costly price changes. Besides that cost, we consider that under a dynamic pricing policy costs for buyers are uncertain. This uncertainty is addressed in an optimal order policy. In addition, repeated buyer seller interaction in a dynamic pricing setting requires the incorporation of buyer behavior and, therefore, it is included in the dynamic pricing policy.
The results we obtain are twofold. First, we show that the use of dynamic pricing is beneficial to the individual node, but when applied to multiple nodes in a supply chain environment results in price amplification, or price bullwhip. Second, we observe that the cost for changing price is the unique contributor to "sticky prices", prices that remain fixed for a certain period of time.