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Discount Pricing and Market Segmentation
for Source Reduction via Consumer Reuse
Tolga Aydinliyim
and
Michael Pangburn
Decision Sciences Department
Lundquist College of Business
University of Oregon
Eugene, OR
This research is supported by the Center for Sustainable Business Practices (CSBP)
of the Lundquist College of Business. http://lcb.uoregon.edu/csbp/
1/19/2011 1
Motivation
• Starbucks was honored for its recycled content cup and sleeve
by National Recycling Coalition (NRC), but…
"Starbucks white paper cups, used for hot beverages, are made of paper fiber and the
industry standard liner (low-density polyethylene plastic). The paper provides the rigidity
for the cup, while the plastic layer keeps the paper layer intact by protecting it from the hot
beverage. This plastic layer also makes the hot beverage cups unrecyclable in most paper
recycling systems.“
• Environmentally sensitive consumers push for more, but…
– 100% recycled cup content is economically infeasible.
– Possible reverse flow designs are far from effective.
• Impact of Starbucks’ Bring-Your-Own-Cup Incentive.
– 10-cents discount for consumers who provide their cups.
– 2.3 billion cups in circulation, but only 17 million customers reused.
• Our emphasis: We consider optimal discount pricing policies and
observe how the market is segmented, and what the effects of
this policy on the firm’s profit and environmental footprint are.
Tolga Aydinliyim and Michael Pangburn
1/19/2011 2
University of Oregon
Research Questions
• Under what conditions does a firm offer input reuse as an alternative
purchasing option – a segmenting policy; and what are the optimal
policy parameters – an optimal price and a discount?
– e.g., New printer cartridges and refills in a technology store.
• Under what conditions does a firm restrict its consumers only to the
input reuse option – a choice limiting policy; and what is the effective
price for this option?
– e.g., Refills only.
• Develop a solution procedure that identifies the right policy and its
parameters.
• How sensitive are these decisions to changes in critical parameters of
this model – costs and consumer attributes.
Tolga Aydinliyim and Michael Pangburn
1/19/2011 3
University of Oregon
Features of Our Model and Our Approach
• We consider a firm which provides its customers with a product
including an input that can be supplied by the consumer, i.e.,
consumer reuse, and hence can achieve source reduction.
• We propose discount pricing as an economic incentive to
encourage reuse.
• The policy choice segments the market into those who reuse
and those who do not. This is because the consumers have
differing valuations of the product itself, i.e., willingness to pay,
and the reuse option, i.e., transaction cost of reuse.
• We take a business view (Guide and van Wassenhove, 2001,
2003, 2009), consider and show the merits of a policy which has
a positive impact on the triple bottom line (Kleindorfer et al.,
2005) by focusing on the consumer behavior aspect of the
problem (Atasu et al., 2008a), and propose discount pricing as a
marketing strategy (Atasu et al., 2008b).
Tolga Aydinliyim and Michael Pangburn
1/19/2011 4
University of Oregon
Outline
• Motivation
• Research Questions
• Features of Our Model and Our Approach
• Input Reuse Model
– Fixed Reservation Value
– Varying Reservation Values
• Some Managerial Insights
• Conclusion
Tolga Aydinliyim and Michael Pangburn
1/19/2011 5
University of Oregon
Fixed Reservation Value
• Consider a single consumer segment.
– Segment defined by reservation value r.
– Permit transactional cost of reuse e, which can
differ across consumers.
• We define a feasible range for e.
• Assume constant density over [a,b], where a may be
negative.
• Firm decides both the selling price p and the
discount, d, for reuse.
• Assume single firm.
Tolga Aydinliyim and Michael Pangburn
1/19/2011 6
University of Oregon
Fixed Reservation Value
• Consider cost for both product and packaging.
– Denote unit product cost as k.
• Linear unit product costs, so w.l.o.g. assume k=0.
– Denote per-unit input cost (namely, a cup in the
case of Starbucks) as c.
• Demand is an endogenous function of both p
and d.
• Jointly optimize both p and d to maximize net
profit.
Tolga Aydinliyim and Michael Pangburn
1/19/2011 7
University of Oregon
Fixed Reservation Value
• Segmenting Policy Formulation: p ≤ r
– X1 : Reuse opting demand, customers using a reusable input.
– Y : Customers who require a new input.
Possible range for “e”
a d b
Participation: r – p ≥ 0
Self-selection: r – p + d – e ≥ r – p X1 Y
Participation: r – p ≥ 0
Self-selection: r – p + d – e < r – p
8
Fixed Reservation Value
• Choice Limiting Policy: p > r
– Intuition: With p > r, firm can induce demand via d, but
then all consumers will self-select reuse.
– Under certain conditions, this may be optimal.
Possible range for “e”
a r–p+d b
Participation: r – p < 0 Do not buy
X2
Reuse Invoked Demand: r – p + d – e ≥ 0 Participation: r – p < 0
Reuse
Invoked
Demand
9
Fixed Reservation Value
• Optimal p and d
– Segmenting Policy: p ≤ r
– Choice Limiting Policy: p > r
c
0 a 4b – 2a – r
Nobody re-uses! Consider the Consider the choice-
segmenting policy! limiting policy!
1/19/2011 10
Fixed Reservation Value
• Segmenting vs. Choice-limiting policy
Effective price for a
Effective price for reuse purchase with a new cup
for a segmenting policy for a segmenting policy
Effective price for a choice-
limiting policy
– When cup costs are too high, it is beneficial to restrict
consumers’ choices, i.e., enforcing reuse, by choosing an
effective price between the two prices in the base case
which eliminates the demand for new cups.
– A segmenting policy (further) rewards re-using customers
and penalize others.
Tolga Aydinliyim and Michael Pangburn
1/19/2011 11
University of Oregon
Varying Reservation Values
• Reservation value r differs across consumers.
– We define a feasible range for r.
– Assume constant density for r over [0, R].
• For simplicity, assume a=0, b=E.
– i.e., constant density for e over [0, E].
• Firm decides both the selling price p and the
discount, d, for reuse which creates three types
of demand.
– X1 : Input reuse demand.
– Y : Customers who require input.
– X2 : Input revoked demand, i.e., r – p < 0, but r – p + d – e ≥ 0.
Tolga Aydinliyim and Michael Pangburn
1/19/2011 12
University of Oregon
r r r
r–p+d–e=0 r–p+d–e=0 r–p+d–e=0
p
p
R R R
X1 Y
X2 X2
p
X2
45 45 45
o o o
p–d p–d p–d
d E e R–p+d E d e E R–p+d d e
(a) (b – i ) (b – ii)
r
r–p+d–e=0
d
R
X1 Y c
p
X2
45
o
p–d
c/3
d E e
(a)
p
r r r
r–p+d–e=0 r–p+d–e=0 r–p+d–e=0
p
p
R R R
X1 Y
X2 X2
p
X2
45 45 45
o o o
p–d p–d p–d
d E e R–p+d E d e E R–p+d d e
(a) (b – i ) (b – ii)
Finding the optimal policy
d
Optimal segmenting
policy parameters
p
Finding the optimal policy
Changes in the Composition of Demand
(a) Reuse opting demand as a (b) Reuse invoked demand as a (c) Total reuse demand as a
percentage of the customer base percentage of the customer base percentage of the customer base
14% 30% 30%
12% 25% 25%
10%
20% 20%
c c
8%
15% 15%
6%
10% 10%
4%
2% 5% 5%
0% 0%
0%
0.0
0.2
0.4
0.6
0.8
1.0
1.2
1.4
1.6
1.8
2.0
2.2
2.4
2.6
2.8
3.0
3.2
3.4
3.6
3.8
4.0
0.0
0.2
0.4
0.6
0.8
1.0
1.2
1.4
1.6
1.8
2.0
2.2
2.4
2.6
2.8
3.0
3.2
3.4
3.6
3.8
4.0
0.0
0.2
0.4
0.6
0.8
1.0
1.2
1.4
1.6
1.8
2.0
2.2
2.4
2.6
2.8
3.0
3.2
3.4
3.6
3.8
4.0
E = 3.00 E = 5.00 E = 7.00 E = 9.00 E = 3.00 E = 5.00 E = 7.00 E = 9.00 E = 3.00 E = 5.00 E = 7.00 E = 9.00
• As the input cost, c, increases, reuse demand composition shifts strongly towards the
reuse-invoked type. Total reuse demand increases at a decreasing rate as the input cost
approaches R.
• For lower c values, the benefits of discount pricing to the firm are mostly based on a
partial cost shift from the non-reuse segment to the reuse-opting segment (a savings
of c-d* for every consumer switching from Y to X1).
• At higher c values, the discount pricing incentive is mostly used as a marketing tool
to attract reuse-invoked consumers (to increase X2).
Benefits of Joint Discount Pricing
(a) Input used with joint discount (b) Loss in profit with no discount (c) Consumer surplus forgone with no
pricing as a percentage of inputs as a percentage of profit with joint discount as a percentage of consumer
used with no discount discount pricing surplus with joint discount pricing
100% 100% 100%
90% 90% 90%
80% 80% 80%
70% 70% 70%
60% 60% 60%
50% 50% 50%
40% 40% 40%
30% 30% 30%
20% 20% 20%
10% 10% 10%
0% 0% 0%
0.0
0.2
0.4
0.6
0.8
1.0
1.2
1.4
1.6
1.8
2.0
2.2
2.4
2.6
2.8
3.0
3.2
3.4
3.6
3.8
4.0
0.0
0.2
0.4
0.6
0.8
1.0
1.2
1.4
1.6
1.8
2.0
2.2
2.4
2.6
2.8
3.0
3.2
3.4
3.6
3.8
4.0
0.0
0.2
0.4
0.6
0.8
1.0
1.2
1.4
1.6
1.8
2.0
2.2
2.4
2.6
2.8
3.0
3.2
3.4
3.6
3.8
4.0
E = 3.00 E = 5.00 E = 7.00 E = 9.00 E = 3.00 E = 5.00 E = 7.00 E = 9.00 E = 3.00 E = 5.00 E = 7.00 E = 9.00
• Providing a reuse option with a corresponding optimal discount pricing policy not
only reduces a firm's negative impact on the environment via source reduction, but also
improves the consumer surplus while the firm enjoys an increase in the profits.
Conclusion
• Motivated by discount policies, e.g., Starbucks, for reuse.
• Price and discount decisions are not independent.
• Demand is endogenous and is a function of the price and
discount.
• The optimal joint discount pricing policy increases the profits
via source reduction and creates a larger “green” demand,
which in turn reduces the environmental impact.
• Depending on the consumers willingness to pay, transaction
cost of reuse, and the input cost; it may be optimal for a firm
to impose a choice-limiting policy by setting a single
effective price.
Tolga Aydinliyim and Michael Pangburn
1/19/2011 20
University of Oregon
Thank you!
Tolga Aydinliyim – tolga@uoregon.edu
Michael Pangburn – pangburn@uoregon.edu
Decision Sciences Department
Lundquist College of Business
University of Oregon
Eugene, OR
1/19/2011 21
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