Tuesday, April 7, 2015

The Operational Advantages of Threshold Discounting Offers

Read the working paper
INSEAD Working Paper 2015/26/TOM revised version of 2013/90/TOM

We study the use of threshold discounting, the practice of offering a discounted price service only if at least a given number of customers show interest in it, pioneered by Groupon in the multi-billion-dollar online deals industry. We model a capacity-constrained firm servicing a randomsized population of strategic customers in two representative time periods, a desirable hot period and a less desirable slow period. A comparison with traditional approaches (slow period discounting and closure) reveals that threshold discounting boosts the firm's operational performance on account of two advantages. First, the contingent discount incentivizes slow period consumption when the market for the service is large and reduces supply of the service when the market is small, in effect allowing the firm to respond to the service's unobserved market potential. Second, activation of the threshold discount signals the market state to strategic customers, giving them with information on service availability, and inducing them into self-selecting the consumption period to one that improves the firm's capacity utilization and profit. Unlike in typical settings with strategic customers, strategic customer behavior in our setting is often beneficial for the firm. Threshold discounting delivers most value in situations with high demand seasonality but it can be harmful in situations with low market uncertainty, chronically low demand, or when customers have high transaction costs. Further, when threshold discounts are offered through an intermediary, we find that the arrangements most used in practice distort the incentives of the intermediary, which can severely diminish the advantages of threshold discounting.