A WTP-Choice Model: Empirical Validation, Competitive and Centralized Pricing

Willingness To Pay (WTP) of customers plays an anchoring role in pricing. This study proposes a new choice model based on WTP, incorporating sequential decision making, where the products with positive utility of purchase are considered in the order of customer preference. We compare WTP‐choice model with the commonly used (multinomial) Logit model with respect to the underlying choice process, information requirement, and independence of irrelevant alternatives. Using WTP‐choice model, we find and compare equilibrium and centrally optimal prices and profits without considering inventory availability. In addition, we compare equilibrium prices and profits in two contexts: without considering inventory availability and under lost sales. One of the interesting results with WTP‐choice model is the ‘loose coupling’ of retailers in competition; prices are not coupled but profits are. That is, each retailer should charge the monopoly price as the collection of these prices constitute an equilibrium but each retailer's profit depends on other retailers' prices. Loose coupling fails with dependence of WTPs or dependence of preference on prices. Also, we show that competition among retailers facing dependent WTPs can cause price cycles under some conditions. We consider real‐life data on sales of yogurt, ketchup, candy melt, and tuna, and check if a version of WTP‐choice model (with uniform, triangle, or shifted exponential WTP distribution), standard or mixed Logit model fits better and predicts the sales better. These empirical tests establish that WTP‐choice model compares well and should be considered as a legitimate alternative to Logit models for studying pricing for products with low price and high frequency of purchase.