Locational tying of complementary retail items

We study a selling practice that we refer to as locational tying (LT), which seems to be gaining wide popularity among retailers. Under this strategy, a retailer ‘locationally ties’ two complementary items that we denote by ‘primary’ and ‘secondary.’ The retailer sells the primary item in an appropriate ‘department’ of his or her store. To stimulate demand, the secondary item is offered in the primary item's department, where it is displayed in very close proximity to the primary item. We consider two variations of LT: In the multilocation tying strategy (LT-M), the secondary item is offered in its appropriate department in addition to the primary item's department, whereas in the single-location tying strategy (LT-S), it is offered only in the primary item's location. We compare these LT strategies to the traditional independent components (IC) strategy, in which the two items are sold independently (each in its own department), but the pricing/inventory decisions can be centralized (IC-C) or decentralized (IC-D). Assuming ample inventory, we compare and provide a ranking of the optimal prices of the four strategies. The main insight from this comparison is that relative to IC-D, LT decreases the price of the primary item and adjusts the price of the secondary item up or down depending on its popularity in the primary item's department. We also perform a comparative statics analysis on the effect of demand and cost parameters on the optimal prices of various strategies, and identify the conditions that favor one strategy over others in terms of profitability. Then we study inventory decisions in LT under exogenous pricing by developing a model that accounts for the effect of the primary item's stock-outs on the secondary item's demand. We find that, relative to IC-D, LT increases the inventory level of the primary item. We also link the profitability of different strategies to the trade-off between the increase in demand volume of the secondary item as a result of LT and the potential increase in inventory costs due to decentralizing the inventory of the secondary item.