This content relates to : MARKETING INNOVATION
It can be beneficial for retailers to give customers the option to receive a discount if they let the retailer pick which product they will receive.
• Increase its profit margins on transparent products
• Increase total sales by attracting price-sensitive consumers to the opaque product
• Balance demand more evenly across its product mix, which can help it avoid stockouts and excess inventory
This strategy is effective when those customers who most strongly prefer one particular product over the other products offered by that retailer are also the ones who have the highest value for that product.
Retailers must not allow returns or exchanges on purchases of opaque products (except in cases where the product is defective or was damaged during shipping).
Pricing is a notoriously challenging decision for retailers because a product is worth more to some customers than to other. High prices allow for large profit margins but sacrifice sales; Low prices attract price-sensitive customers but reduce revenue from customers who highly value one’s product. An innovative selling strategy, Probabilistic Selling, can address this dilemma. Under this strategy, in addition to offering regular “transparent” products, the retailer also offers “opaque” products for which consumers are not told which product they will get prior to purchase. The retailer can charge high prices for the transparent products and low prices for the opaque ones, thus maintaining high unit sales while also allowing for high margins on a substantial portion of its sales.
Probabilistic Selling works by allowing the price paid by a customer to depend on how strongly that customer prefers her favorite product to the next-best option. Consider the following example of a retailer who sells red and blue sweaters. Some consumers like red sweaters much more than blue ones, others strongly prefer the blue sweaters, others may only weakly prefer one color over the other one, and some may even be completely indifferent about the two options – they just want a sweater, regardless of the color. Under Probabilistic Selling, the retailer would charge a relatively high “full price” for red sweaters, a relatively high “full price” for blue sweaters, and a lower “discounted price” for an opaque sweater. If a customer buys the opaque sweater, she will get either a red sweater or a blue one. Customers who strongly prefer one color will not want to chance getting their less preferred color and thus will buy their preferred color at the full price. But, customers with weaker preferences will opt for the opaque sweater as long as the discount is large enough.
Probabilistic Selling will boost a retailer’s profit as long as several conditions are met. Customers must differ in how much products are worth to them and in how strongly they prefer one product to the next-best alternative. Furthermore, customers with stronger preferences must, on average, value their preferred transparent good more than customers with weaker preferences do. Finally, there must be some customers who value the opaque good more than it costs the retailer to acquire a unit of the product. It would seem that these conditions are met in a wide range of market settings and thus the potential applications of Probabilistic Selling are nearly limitless.
In implementing Probabilistic Selling, it is best if each product has the same probability of being assigned as the opaque good (and the retailer informs customers that each option is equally likely). Equal assignments create maximum differentiation between the opaque and transparent products, thus enabling the market to be segmented as much as possible. Equal assignments also imply that Probabilistic Selling can help a retailer address its own uncertainty about demand. Specifically, since demand for the opaque good is spread equally across the products, a retailer who doesn’t know which item will be more popular with customers can benefit from demand being more evenly distributed than it would have been if only transparent items were sold.
Professor, Whitman School of Management, Syracuse University
To learn more, read:
Probabilistic Goods: A Creative Way of Selling Products and Services (2008). Marketing Science 27.4 (July – August): pp. 674-690. Scott Fay and Jinhong Xie.