Personalized Retail Promotions Through a Directed Acyclic Graph–Based Representation of Customer Preferences

• Published in: Operations research 2022-03, Vol.70 (2), p.641-665
• Main Authors: Jagabathula, Srikanth, Mitrofanov, Dmitry, Vulcano, Gustavo
• Format: Article
• Language: English
• Subjects: Brand preferences; choice models; Consumer behavior; Customers; Customization; customized promotions; Graph theory; Graphical representations; Logit models; multinomial logit; Operations and Supply Chains; Operations research; Product choice; promotion optimization; rank-based choice model; Retail stores; retailing; Sales promotions
• ISSN: 0030-364X; 1526-5463
• DOI: 10.1287/opre.2021.2108

The availability of individual-level transaction data allows retailers to implement personalized operational decisions. Although such decisions have been around for several years now in online platforms, recent technological developments open new opportunities to extend similar practices to bricks-and-mortar settings (e.g., by using electronic price tags to show different prices to different customers or by using beacon-based technology to send promotion offers to targeted customers). In “Personalized Retail Promotions through a DAG-Based Representation of Customer Preferences,” Jagabathula, Mitrofanov, and Vulcano propose a back-to-back procedure for running customized promotions in retail operations contexts, from the construction of a nonparametric choice model where customer preferences are represented by directed acyclic graphs to the formulation of the promotion optimization problem. The empirical validation of their proposal on real supermarket data shows the promising performance of their approach over state-of-the-art benchmarks. We propose a back-to-back procedure for running personalized promotions in retail operations contexts, from the construction of a nonparametric choice model where customer preferences are represented by directed acyclic graphs (DAGs) to the design of such promotions. The source data include a history of purchases tagged by customer ID jointly with product availability and promotion data for a category of products. In each customer DAG, nodes represent products and directed edges represent the relative preference order between two products. Upon arrival to the store, a customer samples a full ranking of products within the category consistent with her DAG and purchases the most preferred option among the available ones. We describe the construction process to obtain the DAGs and explain how to mount a parametric, multinomial logit model (MNL) over them. We provide new bounds for the likelihood of a DAG and show how to conduct the MNL estimation. We test our model to predict purchases at the individual level on real retail data and characterize conditions under which it outperforms state-of-the-art benchmarks. Finally, we illustrate how to use the model to run personalized promotions. Our framework leads to significant revenue gains that make it an attractive candidate to be pursued in practice.