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Revenue Management Through Dynamic Cross Selling in E-Commerce Retailing

Wharton School, University of Pennsylvania, 3730 Walnut Street, Suite 500, Philadelphia, Pennsylvania 19104
Graduate School of Business, Columbia University, New York, New York 10027
Leonard N. Stern School of Business, New York University, New York, New York 10012
netessine{at}wharton.upenn.edu
svs30{at}columbia.edu
wx2{at}nyu.edu

We consider the problem of dynamically cross-selling products (e.g., books) or services (e.g., travel reservations) in the e-commerce setting. In particular, we look at a company that faces a stream of stochastic customer arrivals and may offer each customer a choice between the requested product and a package containing the requested product as well as another product, what we call a "packaging complement." Given consumer preferences and product inventories, we analyze two issues: (1) how to select packaging complements, and (2) how to price product packages to maximize profits.

We formulate the cross-selling problem as a stochastic dynamic program blended with combinatorial optimization. We demonstrate the state-dependent and dynamic nature of the optimal package selection problem and derive the structural properties of the dynamic pricing problem. In particular, we focus on two practical business settings: with (the Emergency Replenishment Model) and without (the Lost-Sales Model) the possibility of inventory replenishment in the case of a product stockout. For the Emergency Replenishment Model, we establish that the problem is separable in the initial inventory of all products, and hence the dimensionality of the dynamic program can be significantly reduced. For both models, we suggest several packaging/pricing heuristics and test their effectiveness numerically.

Subject classifications: dynamic programming/optimal control; models; marketing; pricing; buyer behavior.
History: Received May 2004; revision received July 2005; accepted August 2005.

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