Dynamic pricing in e-services under Demand Uncertainty

Abstract

High volatility of the e-services market, due to increasing competition, low life cycle of products, and easy availability of information about competing service offerings to customers, makes the demand for service offerings quite uncertain. Revenue management in such markets calls for real-time techniques to learn the demand and its dependence on both the price and the service level associated with the service offering. We assume firms reply on exploratory approaches for demand estimation, in which firms experiment with different service offerings in order to simultaneously learn the demand while doing business. Such exploration and learning process can be costly without supervision. As reported by Rothschild (Journal of Economic Theory, 9185-202, 1974), traditional Bayesian dynamic control approaches may conclude with suboptimal offerings. We propose a novel demand learning approach that is guaranteed to converge to the optimal offering. The approach combines simulated annealing algorithm with Bayesian learning. We further present intelligent techniques that adaptively reduce the effort of exploration on suboptimal service offerings so as to improve the long-run average profit. © 2007 Production and Operations Management Society.