Decomposing Purchase Elasticity with a Dynamic Structural Model of Flexible Consumption

It is well known that store level sales respond positively to short term price promotions. Under the assumption of constant consumption rate, previous literature has identified that the sources for this increase are brand switching, purchase acceleration, and stockpiling. However, recent research has shown that the consumption of households is also affected positively by price promotions. In this paper we offer a methodology to decompose the effects of price promotions into brand switching, stockpiling and change in consumption and explicitly allow for consumer heterogeneity in brand preferences and consumption needs. A dynamic structural model of a household that decides when, what, and how much to buy as well as how much to consume to maximize its expected utility over an infinite horizon is developed. By making certain simplifying assumptions we are able to reduce the dimensionality of the problem. We estimate the proposed model using scanner-panel datasets of household purchases in canned tuna and paper towels. The results from the model shed insights on the decomposition of price elasticity into its components. This could help managers to make inferences about which brands sales are most responsive to household stockpiling or consumption expansion as well as to understand how temporary price cuts affect future sales. Contrary to previous literature, we find that brand switching is not the dominant force for the increase in sales. We show that brand loyals respond to a price promotion mainly by stockpiling for future consumption while brand switchers do not stockpile at all. We also find that heavy users stockpile more, while light users mainly increase consumption when there is a price promotion.