Customized Dynamic Pricing When Customers Develop a Habit or Satiation

In Dynamic Pricing with Customer State Dependence, Wen Chen, Ying He, and Saurabh Bansal discuss optimal prices that a firm should offer to customers who develop a habit or satiation from consumption. At a high discount (or equivalently a lower price), a habit-prone customer will purchase a large amount in a current period. The firm will earn a low revenue per unit on the amount bought by the customer in this period. However, this large purchase will also create a stronger habit in the customer that the firm can exploit in the future periods. At a low discount, the firm will earn a higher per unit revenue in this period. However, the lower purchase quantity will also result in a weaker habit in the customer for the future periods. This tradeoff exists in every period. These effects are reversed for a satiation-prone customer. Using an analytical model, the authors determine the optimal profit-maximizing dynamic prices that a firm should offer to such habit- or satiation-prone customers. The results are robust for various specifications for habit formation, and yet in each specification they are obtainable tractably.