The bright and dark sides of customer switching

Abstract

We investigate price and stock competition between two retailers selling to a market with uncertain size. Prior to knowing the actual market size, retailers choose stocking quantities before prices under prestocking but adopt the reverse sequence under prepricing. After the actual market size is realized, each customer chooses to purchase from a retailer to maximize utility. Each retailer satisfies its local demand up to availability. A customer with unmet demand at the local retailer may continue to visit the other retailer; we call this phenomenon customer switching. Absent customer switching, retailers always choose the same price and stocking quantity, and tailor decisions to suit market conditions. In the presence of customer switching, product value and market condition are crucial to whether and how retailers adapt their strategies. Retailers can adopt differential strategies, whereby the retailer that overprices the other stocks more as well, to profit from accommodating the spillover demand. Customer switching can also force the retailers to price low and stock less while both could benefit from pricing high and stocking more. These findings are robust with respect to the decision sequence. Compared to prepricing, prestocking weakens retailers’ incentive for strategic divergence but enables them to make higher profits when the market condition is sufficiently optimistic.