Optimal Dynamic Mechanism Under Customer Search

Abstract

How to Sell to a Customer Who Searches for Alternative Products Customer searching behavior has been ubiquitous in modern marketplaces. Dynamic pricing, such as giving promotional prices to customers who purchase earlier, has been commonly adopted in practice to discourage customers from searching. In the paper “Optimal Dynamic Mechanism Under Customer Search,” Z. Hu and Y. Xiao characterize that, in the optimal selling mechanism, the seller should offer a menu of American option contracts. Under such a mechanism, the customer is given all the freedom in conducting the search but must pay an up-front deposit from the chosen option contract in order to enjoy the right to purchase the seller’s product anytime during the search at a prespecified strike price. Through deposits, the seller is able to extract the customer’s additional surplus from searching regardless of whether the customer makes the final purchase or not. As a result, the seller can often obtain a much higher profit than dynamic pricing mechanisms that aim to deter searching.