DP16096 Optimal Price Targeting

Author(s): Ishant Aggarwal, Stephan Seiler, Adam Smith
Publication Date: May 2021
Keyword(s): Choice Models, Heterogeneity, Machine Learning, Personalization, targeting
JEL(s): C11, C33, C45, C52, D12, L11, L81
Programme Areas: Industrial Organization
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=16096

We examine the profitability of personalized pricing policies that are derived using different specifications of demand in a typical retail setting with consumer-level panel data. We generate pricing policies from a variety of models, including Bayesian hierarchical choice models, regularized regressions, and classification trees using different sets of data inputs. To compare pricing policies, we employ an inverse probability weighted estimator of profits that explicitly takes into account non-random price variation and the panel nature of the data. We find that the performance of machine learning models is highly varied, ranging from a 21% loss to a 17% gain relative to a blanket couponing strategy, and a standard Bayesian hierarchical logit model achieves a 17.5% gain. Across all models purchase histories lead to large improvements in profits, but demographic information only has a small impact. We show that out-of-sample hit probabilities, a standard measure of model performance, are uncorrelated with our profit estimator and provide poor guidance towards model selection.