Sales-Based Rebate Design

TL;DR

This paper introduces a new class of sales-based rebate mechanisms that leverage network effects to influence consumer behavior and optimize seller revenue in markets with uncertain product quality.

Contribution

It develops a novel rebate design framework using global games and optimization, revealing how to induce beneficial externalities and overcome practical implementation barriers.

Findings

Sales-based rebates can induce positive or negative externalities in consumer utilities.

Optimal rebate schemes can incentivize purchases among consumers with different valuations.

Mechanisms that create positive externalities may reduce profit, while decreasing rebates with sales volume can boost revenue.

Abstract

We propose a novel family of sales-based rebate mechanisms that induce network effects in sales of products that do not exhibit such externalities. The proposed rebate mechanisms enable the seller of a product with uncertain quality to adjust the magnitude and sign of externalities in consumers' payoffs by conditioning the amount of the rebate on the sales volume. Using the machinery of global games and variational optimization techniques, we analyze the revenue implications of such induced externalities in the form of rebates. We identify optimal profitable designs while unraveling the main drivers of profit and further elucidate the main practical barriers associated with their implementation and show how these difficulties can be handled. The key insight of our rebate design is monetizing the strategic uncertainty in consumers' beliefs on others' valuations. The common externality induced in consumers' utilities as a sales-based rebate essentially enables the seller to elicit different prices at different valuations, given the heterogeneity of the beliefs on sales volume and hence on the rebate. Our analysis indicates that a mechanism that creates positive externalities will in fact reduce the profit because it lowers the expected prices at high valuations. On the other hand, sellers can use a sales-based rebate mechanism that is decreasing with sales volume to incentivize purchases at lower valuations by providing higher expected rebates. Our work contributes to the literature on technology-enabled features of digitized markets and demonstrates that real-time sales/subscription data can lead to new revenue management methods.