Using Opaque Selling to Better Match Supply and Demand

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Author Information : Zhengping Wu (Whitman School of Management, Syracuse University)
Jianghua Wu (School of Business, Renmin University of China)

Year of Publication : Decision Support System (2015)

Summary of Findings : In today's business world, information technology advancements allow firms to take reservations in advance, which enables them to collect demand information and develop innovative and effective selling strategies such as advance selling and opaque selling (Xie and Shugan [11]). Motivated by observations from the travel industry, we develop a firm's opaque selling strategy in this paper. The firm faces two classes of random demand—the advance demand class and the spot demand class. Some advance customers are flexible in terms of their order fulfillment timing, and can be enticed to have their demand met in the postponement period. The firm uses a price discount to induce flexible customers to agree to demand postponement, effectively creating an opaque product. We formulate a two-stage stochastic program and characterize the optimal capacity and price discount the firm should offer to maximize its expected profit.

Our analysis shows that the driver of the demand postponement strategy is that the firm's option to satisfy early orders at a later time enables it to use less safety stock to hedge against uncertainties in the spot demand. The firm benefits from both stockout cost reduction and capacity waste decrease. Additionally, the firm may also benefit from the lower capacity cost brought by the second ordering chance, if the unit capacity cost in the postponement period is lower. Furthermore, when advance demand and spot demand are correlated, the firm can derive additional benefit from information updating. Through illustrative numerical examples, we demonstrate that demand postponement may present a good opportunity to noticeably improve the firm's bottom line.

Research Questions : Can opaque selling improve profit?

What we know : Matching supply and demand has been a constant challenge faced by business executives, largely due to the uncertain nature of demand. The Chinese tourism industry, for instance, experiences very volatile demand during peak seasons. Many tourists typically book group tours organized by travel agencies, who reserve nonrefundable capacity, such as hotel rooms, in advance. The large fluctuations in tourism demand make the capacity decision of travel agencies a difficult one: if they do not reserve enough, they will lose the opportunity to capitalize on the high traffic and high markups during the peak season; if they reserve too much, however, they may get hit by the large swings commonly observed in tourism demand.

Tourism demand usually consists of two classes – the price-sensitive but relatively less consumption time-sensitive advance demand, and the spot demand that exhibits little flexibility. An effective strategy to help travel agencies hedge against demand uncertainties is to use opaque selling to exploit heterogeneity in the advance demand, as some of the advance customers, such as retirees and students, have flexible schedules and are willing to postpone their vacations to a later time, if given appropriate incentives.

Novel Findings : Our analysis shows that the driver of the demand postponement strategy is that the firm's option to satisfy early orders at a later time enables it to use less safety stock to hedge against uncertainties in the spot demand. The firm benefits from both stockout cost reduction and capacity waste decrease. Additionally, the firm may also benefit from the lower capacity cost brought by the second ordering chance, if the unit capacity cost in the postponement period is lower. Furthermore, when advance demand and spot demand are correlated, the firm can derive additional benefit from information updating. Through illustrative numerical examples, we demonstrate that demand postponement may present a good opportunity to noticeably improve the firm's bottom line.

Implications for Practice : The paper uses an analytical model to explore the optimal design of price discount and capacity decisions, and shows that opaque selling can noticeably improve the profit.

Full Citations : Zhengping Wu, “Price discount and capacity planning under demand postponement with opaque selling" (with Wu, J.), Decision Support Systems, 2015.

Abstract : In this paper, we consider the opaque selling strategy of a firm that uses a price discount to induce demand postponement. Under demand postponement, the firm offers a price discount to advance customers in exchange for the option to fulfill their orders after the spot demand has been satisfied. Advance customers who take the discount commit their orders early, but the actual delivery time is chosen by the firm. In effect, the price discount enables the firm to create a capacity buffer for the spot demand. We formulate a two-stage stochastic program, and characterize the firm's optimal capacity and price discount decisions to maximize its expected profit. We find that the driver of demand postponement is that the option to postpone allows the firm to not only use less safety stock to hedge against the risk in the spot demand, but also reduce capacity waste. In addition, the firm might gain from the potentially lower capacity cost for postponed demand. In the event that the advance demand information can be utilized to update the regular demand distribution, the firm can garner additional benefits from information updating through the early orders. Through numerical experiments, we demonstrate the significance of the value of demand postponement and information updating, and assess the impact of market conditions on the firm's optimal capacity and price discount decisions.

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Zhengping Wu

Zhengping Wu

Zhengping Wu is an associate professor of supply chain management whose research interests include supply chain coordination and contracting, operations and marketing interfaces, pricing and inventory management.
Zhengping Wu

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