Demand-based pricing versus past-price dependence: The role of retailer category objectives, costs and benefits of pricing tactics

Recent research has found that retailers’ dynamic pricing practices often fall short of sophisticated demand-based pricing models, and has demonstrated that much money is left on the table in the process. Why then would a retailer not engage in demand-based pricing for each category and brand? We examine the circumstances under which demand-based pricing versus past-price dependence is more prominent in dynamic retail pricing. We develop a conceptual framework of the strategic objectives and costs and benefits to retailers of changing prices over time. First, we argue that the strategic role of the category in the retailer’s portfolio matters in terms of retailer overall profit objectives: Staples (high penetration and frequency) are more important than fill-ins (low penetration and low frequency). Second, the costs of demand-based pricing are likely to be higher for categories with many SKUs. Third, we expect that retailer benefits of demand-based pricing are higher for growing categories, for storable products, for brands with broader product lines, for high-share brands, in categories where private labels have a strong position, and when consumer demand is very sensitive to price. In contrast, past-price dependence offers benefits for expensive products, but is costly when manufacturers offer frequent discounts. We use metrics of demand-based pricing and past-price dependence and relate these to the variables in our conceptual framework. We show that category purchase frequency is the strongest positive determinant of demand-based pricing, followed by price sensitivity of brand demand and brand product-line breadth. In contrast, category SKU proliferation strongly reduces the retailer’s propensity to use demand-based pricing. Past-price dependence is most prominent for expensive products, and least prominent for storable products. Understanding and formalizing the antecedents of the price drivers will allow manufacturers to use trade deals strategically and will allow retailers to identify problem areas and re-allocate scarce marketing resources in order to get the biggest bang for their buck. Moreover, understanding the supply-side benefits and costs of retail-price changes adds to the rich marketing literature on consumer effects of purchase frequency, product storability, and assortment complexity.