Market Segmentation with Risk: Using Randomized Pricing Schemes for Enhanced Yield Management on the Internet

Whereas most retailers have traditionally striven to indemnify buyers against most kinds of transaction risks, many are now observed to be doing the opposite within their online channels. Buyers, on their parts, contend by behaving more strategically on the Internet while acquiring substantially greater information before making a purchase. Our paper is concerned with the investigation of strategic interactions in which a seller deliberately faces risk-averse buyers with price uncertainties. We establish that the seller may obtain segmentation benefits by randomizing prices in one channel while also offering a risk-free alternative in another. The optimal vehicle of such randomization is a draw from a discrete two-point probability distribution function. We use the model to offer explanations for observed behavior of online sellers and discuss implementation issues in recent e-commerce environments.