The Impact of Product Substitution and Retail Capacity on the Timing and Depth of Price Promotions : Theory and Evidence

We investigate the impact of store capacity and extent of inter-product substitution in a retailer's assortment on the optimal timing and depth of price promotions using a two step approach. First, a survey of price promotions within the shampoo and detergent assortments of four mass-market retailers yields three motivating observations: (i) Stores that devote more capacity to stock a product category offer deeper discounts compared to stores that devote comparatively less aisle space to a category; (ii) stores offer deeper (shallower) discounts on expensive products, compared to inexpensive products within a category, if the extent of inter-product substitution in their assortment is low (high); and (iii) stores sequentially (simultaneously) promote products within the same category, if the extent of inter-product substitution in their assortment is low (high). Next, to generate insights into this retailer behaviour, we develop a normative model of a monopolistic retailer selling two substitutable products over a finite number of time-periods in a market where consumers are heterogeneous in terms of brand preference and loyalty, as well as in term of time sensitivity. In our analysis of the model, we present closed-form solutions to limiting cases of the model, and use these solutions to develop insight into our empirical observations