JIE ZHANG and MICHEL WEDEL*

This study investigates the effectiveness of customized promotions at

three levels of granularity (mass market, segment specific, and individual
specific) in online and offline stores. The authors conduct an empirical
examination of the profit potential of these customized promotion
programs with a joint model of purchase incidence, choice, and quantity
and through optimization procedures for approximately 300 conditions.
They find that (1) optimization procedures lead to substantial profit
improvements over the current practice for all types of promotions
(customized and undifferentiated); (2) loyalty promotions are more
profitable in online stores than in offline stores, while the opposite holds
for competitive promotions; (3) the incremental payoff of individual-level
over segment- and mass market–level customized promotions is small in
general, especially in offline stores; (4) for categories that are promotion
sensitive, individual-level customized promotions can lead to a
meaningful profit increase over segment- and mass market–level
customized promotions in online stores; and (5) low redemption rates are
a major impediment to the success of customized promotions in offline
stores. Optimal undifferentiated promotions should be the primary
promotion program in this channel, and firms can benefit from offering a
combination of optimal undifferentiated and customized promotions for
suitable categories in offline stores.

Keywords: customization, profit optimization, retail strategy, competitive

promotions, loyalty promotions, mass market level, segment
level, personalization

The Effectiveness of Customized Promotions

in Online and Offline Stores

Customization is considered a key solution by marketers
looking for ways to improve the effectiveness of promo-
tions. Development of innovative technologies has brought
unprecedented opportunities to deliver customized promo-
tions. The interactive and one-on-one nature of the Internet
makes it an ideal channel to offer customized marketing
activities. As a result, online retailers have experimented
*Jie Zhang is Assistant Professor of Marketing and Harvey Sanders
Fellow of Retail Management (e-mail: jiejie@rhsmith.umd.edu), and
Michel Wedel is PepsiCo Professor of Consumer Science (e-mail:
mwedel@rhsmith.umd.edu), Robert H. Smith School of Business, Univer-
sity of Maryland. The authors thank Information Resources Inc. and an
anonymous online retailer for providing the data used in this study, as well
as Feray Adigüzel for her assistance in data processing. They are grateful
to the two anonymous JMR reviewers and Dick Wittink for their many
valuable comments and suggestions and to participants at the Marketing
Science Conference for their input. This project is supported by a Market-
ing Science Institute research grant (No. 4-1192). Sunil Gupta served as
associate editor for this article.
with offering customized promotions for corporate spon-
sors. For example, the online grocer Peapod offered special
promotion services to consumer product manufacturers
through its Peapod Interactive division, which implemented
and monitored various customized promotions to selected
households for each manufacturer sponsor (Holleran 1997).
Customized promotions have also gained popularity in
bricks-and-mortar retailing through loyalty programs.
These programs prescribe promotions to selected house-
holds using preferred shopper card data. The promotions
are usually delivered through printed coupons, either gener-
ated at checkout registers or sent by direct mail. In most
cases, these customized coupons offer price reductions for
specific brands of products. They can be redeemed at sub-
sequent shopping trips. Some retailers administer cus-
tomized promotion programs using in-house experts (e.g.,
CVS), and others rely on consumer marketing companies to
implement the promotions. For example, Catalina Market-
ing is an industry leader of targeted marketing services for
retailers and manufacturers.

© 2009, American Marketing Association Journal of Marketing Research

ISSN: 0022-2437 (print), 1547-7193 (electronic) 190 Vol. XLVI (April 2009), 190–206
Customized Promotions in Online and Offline Stores
Customized promotions are primarily funded by con-
sumer packaged goods companies on the basis of special
agreements. In business practice, there is usually only one
corporate sponsor in a given product category at a given
time for a given promotion program, such as the services
provided by Peapod and Catalina Marketing. Therefore, in
addition to improved targeting capabilities, customized pro-
motion services offer manufacturers the advantage of being
shielded from competitive retaliations because of the exclu-
sive sponsor arrangement. The promotions are offered to
selected households in a covert manner and are not easily
observed by competitors; thus, it would take substantial
time and effort for competitors to monitor and respond to
these promotions, if they respond at all. As a result, more
and more manufacturers have participated in customized
promotion programs. At the same time, retailers are
embracing customized promotions because these programs
can help increase store visits and shopping basket sizes and
build consumer loyalty to their stores. For example, cur-
rently, Catalina Marketing alone provides services to more
than 170 supermarket and drugstore retailers in the United
States to offer customized in-store promotion programs.1
Along with the development in business practice, cus-
tomized promotions have also received increasing attention
among marketing academics (e.g., Rossi, McCulloch, and
Allenby 1996; Shaffer and Zhang 1995; Zhang and Krish-
namurthi 2004). Although the methodologies for prescrib-
ing customized promotions and the technologies for deliv-
ering them in practice have been developed, some critical
questions remain to be answered. Is more granular cus-
tomization always better? What is the incremental benefit
of offering individual-level over segment-level or mass
market–level customized promotions? What types of cus-
tomized promotions are more profitable in online versus
offline stores? What is the more suitable channel for offer-
ing individual-level customized promotions? In this study,
we provide insights to answer these questions.
RESEARCH PROBLEM AND INTENDED
CONTRIBUTIONS
The purpose of this study is to investigate the profit
potential for promotions customized at various levels of
granularity in online and offline stores. We focus on price
promotions, which are arguably the most important form
of sales promotions. Our research is related to two streams
of literature: that on comparison of purchase behavior
in online and offline stores and that on customized
promotions.
Previous research has investigated how purchase behav-
ior differs across retail formats, including differences
between online stores and traditional supermarkets (e.g.,
Danaher, Wilson, and Davis 2003; Degeratu, Rangaswamy,
and Wu 2000; Fox, Montgomery, and Lodish 2004).
Degeratu, Rangaswamy, and Wu (2000) suggest that Inter-
net shoppers are likely to be more convenience conscious
and less price sensitive, but Alba and colleagues (1997)
postulate that online consumers may be more or less price
sensitive depending on the accessibility of information on
price and nonprice attributes in the electronic shopping
1Source: http://www.catalinamarketing.com/retail_services/how_it_
works.html (accessed September 24, 2007).
191
environment. On the basis of a study of a large number of
product categories, Danaher, Wilson, and Davis (2003)
report that brand loyalty is substantially higher in online
stores than in bricks-and-mortar stores. Although Fox,
Montgomery, and Lodish (2004) call for more research that
investigates why differences in promotion effectiveness
occur across channels, none of the previous studies has
compared promotion effectiveness in online and offline
stores. Our study provides these insights.
Most research on customized promotions has been done
in the context of bricks-and-mortar stores. For example,
Shaffer and Zhang (1995) examine the impact of targeted
coupons in perfectly competitive environments using a
game-theoretical framework. Rossi, McCulloch, and
Allenby (1996) were the first to empirically quantify the
benefits of adopting one-to-one pricing. In a brand choice
modeling framework, they demonstrate how household
purchase history data can be used to offer individual
household-specific pricing and achieve higher profit. More
recently, Zhang and Krishnamurthi (2004) proposed an
approach for offering customized promotions that went one
step further: Promotions are not only tailored to individual
households but also dynamically updated on each shopping
trip. They show that such promotions can lead to substantial
profit increase over the current practice in an online shop-
ping environment. Nonetheless, their study does not com-
pare online and offline stores, nor does it compare promo-
tion programs customized at different levels of granularity.
The main objective of this study is to examine the profit
potential of various customized price promotions in online
and offline stores. We examine customized promotions with
different strategic orientations and at different levels of
granularity (mass market, segment, and individual levels).
For each type of promotion, we derive a profit-maximizing
plan based on a comprehensive consumer purchase behav-
ior model and optimization procedures built on the model.
Using optimization procedures enables us to compare the
best potential for each type of promotion program.
Two broad types of customized price promotions have
been implemented in practice according to whether a con-
sumer purchased the target product previously. For exam-
ple, Catalina Marketing’s Checkout Coupon service deliv-
ers “loyalty coupons” to consumers who purchased the
target brand on the prior purchase occasion and “competi-
tive coupons” to consumers who did not purchase the target
brand on the prior purchase occasion. A manufacturer can
choose to offer either or both types in a promotion cam-
paign through Catalina. Following this practice, we distin-
guish these two types of customized promotions and adopt
Catalina’s terminology for ease of exposition. Specifically,
we define “competitive promotions” as those aimed at con-
sumers who did not purchase the target brand on the previ-
ous purchase occasion, and we define “loyalty promotions”
as those aimed at consumers who purchased the target
brand on the previous purchase occasion. We implement
both types simultaneously in our optimization. For pur-
poses of various comparisons, we first report the results of
competitive promotions and loyalty promotions for their
respective subsamples separately, and then we show the
results of jointly offering the two types for the entire sam-
ple. As a benchmark, we also derive the optimal undifferen-
tiated promotions, which assign the same price discounts to
192
all consumers in a given week regardless of their purchase
history.
Furthermore, we compare customized promotions deliv-
ered at the following three levels of granularity: First, a
mass market–level customized promotion is defined as one
in which the same amount of price discount is offered to all
relevant consumers (i.e., buyers or nonbuyers on the previ-
ous purchase occasion). Currently, this is the most common
customized price promotion in practice (e.g., Catalina’s
competitive and loyalty checkout coupons). Second, a
segment-level promotion is one in which the depth and fre-
quency of the price discount are customized to each seg-
ment of relevant consumers but are not further tailored
toward individuals within a segment. Third, an individual-
level promotion is defined as one that is personalized
for each consumer. This type of promotion represents
customer-centric marketing at the most granular level. Note
that the distinction between previous buyers and nonbuyers
is necessary for the mass market and segment levels of cus-
tomizations, but this is not the case for the individual-level
customizations, because such promotions are determined
for each household and thus would differ between previous
buyers and nonbuyers anyway.
For each of these promotion programs, we derive the
weekly optimal price discounts that maximize the manufac-
turer’s gross profit of the target brand. We work from a
manufacturer’s perspective because most price discounts
for consumer packaged goods are funded by manufacturers
through trade promotions. In addition, manufacturers are
sponsors of the vast majority of customized promotion pro-
grams in practice. They provide financial support to retail-
ers and/or consumer marketing companies for administer-
ing these special promotions for their brands.
We compare the expected optimal profits of various pro-
motion programs in online and offline stores, which will
provide insights to help marketers choose the proper level
of customization for each channel and direct their resource
investments to the most worthy types of promotions.
Specifically, we intend to answer the following questions:
•What is the profit potential of offering optimal customized
promotions over current practice?
•Are competitive promotions aimed at consumers who did not
buy the target brand on the prior occasion more effective
online or offline? What about loyalty promotions that are
aimed at consumers who bought the target brand on the prior
occasion? Do the patterns differ by shopping channel?
•What is the incremental profit of offering individual-level pro-
motions over segment-level and mass market–level customized
promotions in each channel? Does a firm always benefit from
offering finer levels of customization?
•What is the more suitable channel for individual-level cus-
tomized promotions?
•What factors affect the profit potential of customized promo-
tions in a given channel?
MODEL FORMULATION AND OPTIMIZATION
PROCEDURES
A Model of Purchase Incidence, Choice, and Quantity
Our model is a joint model of purchase incidence,
choice, and quantity decisions, similar to the approaches by
Hanemann (1984), Chiang (1991), Bell, Chiang, and Pad-
JOURNAL OF MARKETING RESEARCH, APRIL 2009
manabhan (1999), and Zhang and Krishnamurthi (2004).
We build on the latter model and extend it in various ways
to suit the purposes of this research. Let Iit = 1 if household
i makes a category purchase in week t and 0 if otherwise,
let Bikt = 1 if household i purchases alternative k in week t
and 0 if otherwise, and let Qikt = household i’s purchase
quantity of alternative k in week t. The utility of alternative
k in week t for household i can be expressed in a general
equation:
(1) U ikt = Vikt + ε ikt = β 0 ki + X ktβ1i + β 2 i D ikt
+ β3i D ikt Fikt − β 2 i Δ k , j + ε ikt ,
i
where Xkt is a vector of marketing-mix variables (regular
price and price cut for the online data and these plus feature
advertising and display for the offline data), Dikt equals 1 if
alternative k was chosen by household i on the previous
purchase occasion and 0 if otherwise, Fikt equals 1 if alter-
native k was on price promotion at household i’s last pur-
chase occasion before week t and 0 if otherwise, and Δ k, j
is a measure of distance between alternative k and the alter-
i
native chosen by household i at its previous purchase occa-
sion, ji, and is obtained from a survey and normalized to
fall between 0 and 1. By definition, Δk,k = 0. We include the
distance measure for similarities/dissimilarities across alter-
natives. In Equation 1, β0ki are alternative-specific con-
stants, with the last one fixed to 0 for identification pur-
poses; β1i are coefficients of marketing-mix variables; β2i
reflects state dependence; and β3i captures the moderating
effect of price promotion on state dependence. We expect
β3i to be negative because state dependence should be
reduced if the previous purchase was made on a price pro-
motion (Gedenk and Neslin 1999).
We model purchase incidence by assuming that house-
hold i makes a category purchase in week t if and only if
the utility of at least one alternative in the category exceeds
a threshold, which is specified as follows:
(2) U i 0 t = Vi 0 t + ε i 0 t = θ0 i + θ1i R i + θ2 i LQ it + ε i 0 t ,
where θ0i is a constant, Ri is household i’s purchase fre-
quency in the initialization period, and LQit is the mean-
centered purchase quantity made by household i on its last
category purchase occasion before t. This variable captures
the effect of inventory in spirit (Chintagunta and Haldar
1998; Jain and Vilcassim 1991). Note that it would not be
appropriate to include an inventory variable in our model,
because its computation requires the use of interpurchase
duration, which is endogenous to purchase incidence (Chin-
tagunta and Haldar 1998).
To model purchase quantity, let Q*ikt be a latent variable
that drives household i’s purchase quantity of alternative k
in week t. The observed purchase quantity Qikt = Q*ikt if
Iit = 1 and Bikt = 1; otherwise, Qikt = 0. We specify Q*ikt as
follows:
(3) Q*ikt = Z ikt φi + ξ ikt = φ0 ki + Ykt φ1i + φ2 i Q i + φ3i LQ it + ξ ikt ,
where Ykt is a vector including marketing-mix variables for
alternative k (regular price and price cut); Q i is household
i’s average purchase quantity in the initialization period,
which we use as a control variable; and LQit is household
Customized Promotions in Online and Offline Stores 193

i’s purchase quantity on its last purchase occasion before t, where qg is the probability of belonging to segment g, T is
as described previously. Parameters φ0ki are brand-specific the number of weeks in the data, and the other terms are as
constants, φ1i represents the effects of marketing-mix described previously.
variables, φ2i is the coefficient of average purchase quantity, Implementation of Customized Promotions
and φ3i captures the effect of last purchase quantity on cur-
rent purchase quantity and is expected to be negative.2 We adopt an exclusive manufacturer sponsor model to
We make the following assumptions about the distribu- implement customized promotions. This is the most com-
tions of error terms in the previous equations: (1) εikt, k = 0, mon arrangement in retail practice for customized promo-
1, 2, …, K, in Equations 1 and 2 follow a generalized tion programs—for example, in the case of Peapod Inter-
extreme value distribution, which leads to the nested logit active marketing services (Holleran 1997). In these
formulation for purchase incidence and choice decisions programs, a retailer offers customized promotion services
with parameter λi ∈ [0, 1] capturing the similarity among to corporate (manufacturer) clients. Usually, there is only
choice alternatives, and thus alleviate the independence- one sponsor for this service in a given product category at a
from-irrelevant-alternatives problem with standard multi- given time, but the retailer may accept other regular trade
nomial logit models; (2) ξikt in Equation 3 follows a logistic promotions. These customized promotions are funded by
distribution with a location parameter 0 and scale parameter manufacturer sponsors and are implemented by the retailer.
δξ; and (3) ξikt and ε *ikt = max(Vijt + ε ijt ) − ε ikt follow a The retailer is compensated for administering the promo-
flexible bivariate distribution that involves a parameter ωi ∈ tions and may get a share of the incremental profits gener-
[–1, 1], reflecting the correlation between incidence/choice ated by the service. Under the arrangement described here,
and quantity, where ωi < 0 indicates a positive correlation the retailer essentially works as the manufacturer’s agent,
and ωi > 0 indicates a negative correlation (Zhang and and thus it has a common profit objective for the cus-
Krishnamurthi 2004). These assumptions on the error terms tomized promotions. In practice, customized promotions
lead to a closed-form expression of the joint probability of are often administered by third-party consumer marketing
purchase incidence, choice, and quantity: companies (e.g., Catalina Marketing), in which case the
marketing service company would act as the manufacturer’s
(4) Pr ( I it , Bikt , Q ikt ) = agent and use the manufacturer’s objective function to pre-
− λi scribe the promotions.
⎛ ⎞
∑
K
e Vikt ⎜ e Vijt ⎟ In a study by Villas-Boas (2007), the vertical contract
⎝ j=1 ⎠ δ ξ eδ ξ (ZZ ikt φi − q ikt )
between manufacturers and retailers in which the profits of
1 − λi 2 both are jointly maximized received dominant empirical
⎛ ⎞ ⎡1 + eδ ξ ( Z ikt φi − q ikt ) ⎤
∑
K
e Vi 0 t + ⎜ e Vijt ⎟ ⎣ ⎦ support. The implied margins under this arrangement are
⎝ j=1 ⎠
those of a vertically integrated monopolist, which shields
⎧ ⎡ ⎛ ⎞ ⎤
− λi ⎫ the manufacturer from competition within the category. It
∑
K
⎪ ⎢ e Vikt ⎜ e Vijt ⎟ ⎥ δ ( Z φ − q ikt )
⎪ also increases the retailer’s incentive to monitor the imple-
⎪ ⎢ ⎝ j=1 ⎠ ⎥ −1 + e ξ ikt i ⎪ mentation process carefully because the profit will be
⎨1 + ω i ⎢1 − 1 − λi ⎥ δ ξ ( Z ikt φi − q ikt ) ⎬
,
⎪ ⎢ e Vi 0 t + ⎛ Vijt ⎞
+ ⎪
∑
K
⎥ 1 e shared by the manufacturer and the retailer. These theoreti-
⎪ ⎜⎝ e ⎟ ⎪
⎢⎣ j=1 ⎠ ⎥⎦ cal advantages of the exclusive manufacturer sponsor
⎩ ⎭
model are another reason we adopt it in this study.
where Vikt and Zikt are the systematic components in Equa- We assume that there are no competitive reactions in
tions 1–2 and Equation 3, respectively. We estimate the constructing the manufacturer’s objective function. Empiri-
parameter ϕi = arcsin(ωi) to ensure that ωi ∈ [–1, 1]. cal evidence in the marketing literature suggests that com-
To capture consumer heterogeneity, we employ a finite- petitors are unlikely to react to customized promotions,
mixture specification in which all parameters in Equations especially not in the short run. Leeflang and Wittink (1996)
1–3 are segment specific (Kamakura and Russell 1989). document that competitors tend to underreact to one
The finite mixture specification has been shown to be another’s marketing actions. Nijs and colleagues (2001)
empirically equivalent to approaches based on continuous conclude that the dominant form of competitive reactions to
distributions, such as the hierarchical Bayes formulation, to conventional price promotions is no reaction. Pauwels
represent consumer heterogeneity (Andrews, Ainslie, and (2004) and Steenkamp and colleagues (2005) confirm this
Currim 2002). The log-likelihood function is given by finding. Given the covert nature of customized promotions,
competitive reactions to them are even less likely to occur,
N ⎧ G T ⎡ especially not in the short run, because even if a competitor
⎪
(5) LL = ∑ log ⎨ ∑ ∏ ⎢⎢⎣Pr (I
qg
⎪⎩g = 1 t =1
g it = 0)1 − I it wanted to, it would take considerable time and effort to
i =1 monitor customized promotions, let alone implement
reactions.
K ⎤ ⎫⎪
∏ Pr (I
k =1
g it = 1, Bikt = 1, Q ikt = q ikt ) I it × Bikt ⎥⎬,
⎥⎦ ⎪⎭
Optimization Procedures
We derive the optimal price discounts that maximize the
gross profit of a brand/alternative under each promotion
plan.3 In doing so, we assume that regular prices take on
2In our empirical analyses, φ was insignificant in three of the four 3Hereinafter, we use the term “brand” for “brand/alternative.” A manu-
3i
samples, and thus we dropped it in the final model for these cases. facturer decides the product unit for customized promotions. The model
194 JOURNAL OF MARKETING RESEARCH, APRIL 2009

values as they were in the data. The general approach For mass market customized promotions, the promotions
involves first obtaining parameter estimates of the model; to be derived are the same for all relevant households in a
subsequently forecasting incidence, choice, and quantity in given week τ. The profit function
a 40-week holdout period to compute the expected profit; N G
and simultaneously deriving profit-maximizing price dis-
counts on the basis of these predictions. We account for
(8) Π Ψ ( ) ∑ ∑ qˆ i,g (Ψˆ )Πi,g ( Ψˆ )
ˆ =
i = 1g = 1
uncertainty in the parameter estimates when computing
expected profits. Note that the objective (profit) functions is maximized with respect to {PCk,τ, PCk,τ + 1, ...,
are formulated independent of the likelihood specification, PCk,τ + T – 1}, a common set of T price promotions for all
as Allenby and colleagues (2002) advocate, because the ˆ ) = qˆ L /[∑g qˆ L ] is the poste-
households. Here, qˆ i,g(Ψ g i|g g i |g
likelihood function reflects consumer behavior while the rior probability that household i belongs to segment g, and
profit functions reflect the company’s objectives for deci- Li|g is the likelihood of household i given membership in
sion making. segment g.
Let brand k be the target brand, and let all parameters in For segment-level customized promotions, the optimiza-
our model be denoted by the vector Ψ with maximum like- tion is performed for each segment separately, and the opti-
lihood estimates (MLE) Ψ̂ and asymptotic covariance mal promotions are the same for households within a seg-
matrix Σˆ Ψ . A manufacturer’s expected gross profit of brand ment but are different across segments in a given week τ.
k from household i during a period of length T, given seg- The profit functions
ment g and MLE Ψ̂, is as follows: N
T (9) ( ) ∑ qˆ i,g (Ψˆ )Πi,g ( Ψˆ )
ˆ =
Πg Ψ
(6) Π i ,g Ψ( ) ∑ Pˆg ( Iit = 1, Bikt = 1|Ψˆ )
ˆ =
i =1
t =1
are maximized with respect to {PCg,k,τ, PCg,k,τ + 1, ...,
( ˆ M − PC
E g Q ikt |II it = 1, Bikt = 1; Ψ k ,t )(
ik , t , ) PCg,k,τ + T – 1}, a set of T price promotions common for all
households in segment g.
where Pˆ g(I it = 1, B ikt = 1|Ψ ˆ ) is the expected probability of For individual-level customized promotions, the promo-
household i buying brand k in week t, given segment g; tion decision is derived for each household in a given week
ˆ ) is the expected purchase quantity
Eg(Q ikt|I it = 1, B ikt = 1; Ψ τ, and thus they are completely individual specific. The
of k, given that k is purchased by household i in week t, profit functions
given segment g; Mk,t is the manufacturer’s regular profit G
margin of brand k without a price promotion at t; and PCik,t
is the amount of brand k’s price discount for household i at
(10) ( ) ∑ qˆ i,g (Ψˆ )Πi,g ( Ψˆ )
ˆ =
Πi Ψ
g =1
time t. It can be shown that (Zhang and Krishnamurthi
2004) are maximized with respect to {PCi,k,τ, PCi,k,τ + 1, ...,
(7) E g ( Q ikt |I it = 1, Bikt = 1) = PCi,k,τ + T – 1} for each household i in week τ.
To account for uncertainties in parameter estimates from
1⎡ eδ ξ Z ikt φg ⎤ the model estimation procedure, we integrate each of the
δ ξ ⎢⎣
( )
⎢ log 1 + e ξ ikt g − ω g × (1 − A )
δ Z φ
⎥,
1 + eδ ξ Z ikt φg ⎥⎦
profit functions over the asymptotic distribution of MLE Ψ̂,
which is a multivariate normal distribution denoted by
Φ (Ψ ˆ , Σˆ ). Thus, the final objective functions are as
wheere Ψ
follows:
− λg
⎛ ⎞
∑
K

A=
e Vikt ⎜
⎝ j=1
e Vijt ⎟
⎠
.
(11) E ⎡⎣Π ⎤⎦ =
∫ Π (Ψˆ ) Φ (Ψˆ , Σˆ ) d Ψˆ , where Π (Ψˆ ) = Π(Ψˆ ),
*
Ψ
*

1 − λg
⎛ ⎞
∑
K ˆ ), or Π (Ψ
e Vi 0 t + ⎜ e Vijt ⎟
⎝ j=1 ⎠
To complete the computation of the expected gross profit
of a brand from weeks τ to (τ + T – 1), as given by Equa-
tion 6, we compute the incidence and choice probabilities at
any future time after week τ by enumerating all possible
incidence and choice outcomes and their conditional occur-
rence probabilities at previous times through a conditional
branching process. Equation 6 is computed for each house-
hold in each of the 40 weeks in the holdout sample. We
then compute the objective function for a particular promo-
tion program in a given week on the basis of Equation 6
and the nature of the promotion decision, as we describe
next.
estimation and optimization should incorporate this decision and be car-
ried out at the same unit consistently, as is the case in our study.
ˆ ).
Π g (Ψ i
The integral in Equation 11 is approximated by simulation
(Kamakura and Wedel 2004). We take 500 draws from the
asymptotic distribution of Ψ̂ and approximate the integral
as the average value across the draws.
For each week τ in the holdout sample (τ = 1, …, 40)
and for every promotion program, we maximize the final
expected profit function in Equation 11 numerically using a
simplex algorithm with respect to the appropriate set of
price discounts (for all relevant households, for every seg-
ment, or for every individual household) at a sequence of T
time points. The optimization is done under the following
constraint: 0 ≤ PC*k, t ≤ . 5RPk, t , ∀ t. The upper bound
reflects the deepest discount observed in the data (“buy one
get one free”) and is set to capture the notion that manufac-
turers tend to avoid extremely deep discounts for fear of
eroding brand equity.
Customized Promotions in Online and Offline Stores
In the empirical application, we set T = 3 and update the
promotion decision in each week τ using data up to week
τ – 1. For a particular promotion program in week τ, we
obtain the optimal price discounts {PC*τ , PC*τ + 1, PC*τ + 2},
each at the appropriate level of granularity (mass market,
segment specific, or individual specific). The term PC*τ rep-
resents the optimal price discounts offered in week τ. In
week τ + 1, the same procedure is repeated, and the new
PC*τ + 1 replaces the previous one obtained in week τ and
becomes the optimal price discounts offered in week τ + 1.
This procedure is repeated one week at a time until we
derive the optimal price discounts for the entire 40 weeks
of holdout sample. In other words, we examine a moving
window of three weeks of forecasting horizon for the pro-
motion decisions of each week. In this continuously
updated process, PC*τ is the actual optimal price discounts
offered in week τ, and PC*τ + 1 and PC*τ + 2 are auxiliary
variables in the optimization. We advocate the idea of
updating promotion decisions every week, which allows
firms to use the latest purchase data and use a shorter fore-
casting horizon in the planning process (T = 3 in our case).
In addition to computational convenience, another advan-
tage of employing a short forecasting horizon is that pro-
motion decisions can be made based on the most recent
actual purchase behavior, instead of needing to predict
future purchase outcomes for many periods and make deci-
sions based on such predictions. Our approach may become
computationally intractable beyond T = 5 or 6. This is not a
problem if firms can update their promotion decisions every
week, but if they must use a forecasting horizon longer than
5 or 6 weeks, Bellman’s (1957) approach is more appropri-
ate to evaluate the entire state space. Note that our approach
is conceptually equivalent to Bellman’s approach for a short
forecasting horizon because our approach completely enu-
merates the entire state space.
In practice, the wholesale and retail margins are known
to the parties involved in a customized promotion program.
However, this information is unavailable in our data. There-
fore, we assume a range of values for the wholesale and
retail margins in the optimizations, which provides greater
generality because the results are not dependent on specific
margins. We express Mk,t, the manufacturer’s regular profit
margin of brand k (without a price cut), as a percentage of
its regular retail price RPk,t. Let mm and mr denote the regu-
lar percentage wholesale and retail margins in absence of
promotions, respectively. Then, Mk,t/RPk,t = mm(1 – mr),
which is called the “percentage profit margin” in this study.
We vary the value of mm(1 – mr) in our empirical analyses
to investigate customization under different scenarios.
The optimization procedures we have outlined assume
100% pass-through of price discounts by the retailer to con-
sumers, which represents the best-case scenario for manu-
facturers. In a customized promotion program, the retailer’s
service can be compensated by the manufacturer sponsor
either in the form of fixed payments or by sharing the incre-
mental profit. Therefore, the contract can be structured in
such a way that retailers agree not to pocket any price dis-
counts, as opposed to in traditional trade promotions, in
which retailer pass-through is consistently below 100%
(Dhar and Hoch 1996; Kim and Staelin 1999). In addition,
manufacturers can bypass retailers in applications in which
195
customized promotions are administered by a third-party
consumer marketing company, such as Catalina.
Nonetheless, our customization procedures can be modi-
fied to accommodate situations in which retail pass-through
is known and is less than 100%. Using a pass-through rate
c < 100% in the optimization is essentially equivalent to
using a higher retail margin and, thus, a lower percentage
profit margin mm(1 – mr) in the original procedure. Let
PC*S, c and Π*S, c be the optimal price cut and expected profit,
respectively, with mm(1 – mr) = S and pass-through rate c.
cS,100%/c and ΠS,c = ΠcS,100%/
We can show that PCS,c * = PC* * *
4
c. For example, the optimal price cut (expected profit) with
mm(1 – mr) = 40% and a 75% pass-through equals the opti-
mal price cut (expected profit) with mm(1 – mr) = 30% and
a 100% pass-through divided by .75. Therefore, we can
obtain optimization results for c < 100% by taking the
proper transformation of results with c = 100%. For these
reasons, we present detailed results only for cases with
100% pass-through and discuss the implications of other
pass-through rates subsequently.
Our optimization procedures account for a key difference
between the online and the offline shopping environments
in terms of deliveries of customized promotions. On the
Internet, the store interface can be modified for individual
customers when they log in, and thus customized promo-
tions can be offered for the current shopping trip. In con-
trast, for offline stores, customized promotions are deliv-
ered through printed “coupons” at cash registers when a
shopper checks out, or they are mailed to individual house-
holds. Thus, a customer must redeem the coupon at a future
shopping trip. This difference in the delivery mechanism
leads to a drastic difference in the effective redemption
rates between the two shopping environments (online is
100%), which may have a pervasive effect on the profitabil-
ity of customized promotions in online versus offline chan-
nels. Therefore, we take into consideration the redemption
rates when evaluating the effectiveness of offline cus-
tomized promotions.
EMPIRICAL ANALYSES
Data Description
We use household purchase data provided by Informa-
tion Resources Inc. and a major Internet grocery retailer to
calibrate the model. The data are from the same market and
cover the same period (approximately two years between
1997 and 1999). In this market, the Internet retailer pro-
cured products through a bricks-and-mortar supermarket
chain during the period of data collection. Products ordered
online were hand picked by the online retailer’s staff in the
offline retailer’s stores and delivered to online customers’
homes. We use Information Resources Inc. data containing
only purchases made with this offline retailer in the same
market. This minimizes differences in pricing and merchan-
dising between the two channels and creates a comparable
base to assess the profitability of promotions online and
offline.
We do not adjust for differences in consumer characteris-
tics between the two samples because it is not desirable for
this study. The purpose of this study is to compare the over-
4The results from our numerical optimizations are consistent with this
analytical result.
196 JOURNAL OF MARKETING RESEARCH, APRIL 2009

all profit potential in the two venues, given their customer
compositions. Therefore, the proper comparison should be
made between a sample that is representative of online con-
sumers and a sample that is representative of offline con-
sumers, which is the case in our data. Our optimization pro-
cedures and the results reflect the differences in both the
shopping environments and the consumer characteristics,
which is appropriate. Note that our models account for dif-
ferences among consumers within each channel.
We calibrate the model using two product categories for
which data from both retailers were available during
exactly the same period: stick butter and liquid detergent.
The primary reason for using these two categories was the
availability of data. In addition, they differ in purchase fre-
quency and promotion sensitivity in the online and offline
stores, which enables us to observe different patterns across
categories. To control for differences in product assortment
between the online and the offline stores, we analyze the
major brands that appear in both channels. This procedure
yields the top four brands/alternatives in each category.
They accounted for 99.4% of total category purchases for
butter and 62.2% of total category purchases for liquid
sample size was 115 households for butter and 105 house-
holds for liquid detergent. The sample sizes for the online
butter and liquid detergent data are 129 and 108 house-
holds, respectively.
For both categories online and offline, we use data from
the same first 48 weeks for model estimation and the next
40 weeks for the holdout period. The Bayesian information
criterion statistics (Schwartz 1978) point to a two-segment
model as the best representation of consumer heterogeneity
for all four samples.5 We present model estimation results
for the butter category in Table 1 and for the detergent cate-
gory in Table 2. The signs of all significant coefficients are
as we expected, and there are marked differences between
the segments. For both categories, online consumers are
more state dependent (relative to their responsiveness to
price promotions) than their offline counterparts.6 Note that
the parameter λ in the nested logit model is consistently
5The small number of segments describes consumer heterogeneity in
our data well, which is partly due to the modest sample sizes that resulted
from the need to match the online and offline samples properly.
6Note that the parameter estimates for brand choice are not directly

detergent for the offline retailer and 95.3% and 74.5%,
respectively, for the online retailer. For offline data, we
include in the sample customers who made at least 90% of
their category purchases from the retail chain; the resultant
comparable between samples, because they are identifiable only up to a
scale factor (Swait and Louviere 1993). However, the ratio of any two
parameters is identifiable and can be compared across samples. Our infer-
ence is based on comparisons of the average ratio of the price cut parame-
ter to the state-dependence parameter.

Table 1
MODEL ESTIMATION RESULTS FOR BUTTER

Online Offline

Variables/Parameter Segment 1 Segment 2 Segment 1 Segment 2

Brand Utilities
Constants:
Land O’ Lakes: salted .542 (1.230) 2.042 (3.680) 1.881 (5.067) –3.554 (–3.312)
Land O’ Lakes: unsalted .143 (.327) 1.437 (2.489) –1.035 (–1.509) –1.024 (–3.362)
Store brand salted .344 (1.005) 2.364 (5.051) 2.289 (6.181) –.362 (–1.538)
(Store brand unsalted) (0) (0) (0) (0)
Regular price –.823 (–1.800) –.570 (–.978) –.149 (–1.256) .206 (.178)
Price cut 1.075 (2.751) .923 (3.370) .579 (4.064) .680 (2.620)
Display or feature advertisement 1.200 (6.817) .842 (2.593)
State dependence (β2) 2.439 (12.656) .590 (3.284) .637 (6.030) .663 (4.331)
Last purchase on prom on β2 .070 (.210) .024 (.699) –.254 (–1.749) –.369 (–1.352)

Category Threshold
Constant 2.998 (7.751) 2.880 (3.210) 5.976 (9.632) 4.805 (7.116)
Purchase frequency –5.837 (–14.526) –1.417 (–1.132) –8.569 (–15.250) –7.936 (–10.737)
Last purchase volume .295 (.443) 4.408 (2.999) 1.503 (2.275) .368 (.307)

Purchase Quantity
Constants:
Land O’ Lakes: salted –.543 (–1.107) –.555 (–.653) –.634 (–1.531) –.635 (–.497)
Land O’ Lakes: unsalted –.602 (–1.179) –.585 (–.690) –.666 (–.842) –.610 (–.676)
Store brand salted –.515 (–1.187) –.551 (–.756) –.607 (–1.622) –.585 (–.734)
Store brand unsalted –.586 (–1.327) –.588 (–.654) –.621 (–1.314) –.573 (–.721)
Regular price –.324 (–.255) –.196 (–.089) –.090 (–.086) –.236 (–.110)
Price cut .507 (.288) .394 (.136) .339 (.274) .366 (.165)
Average purchase volume 1.194 (1.047) .482 (.284) .910 (.701) .966 (.388)

ϕ –1.570 (–16.893) –1.573 (–10.624) –1.253 (–15.930) –1.110 (–9.060)

λ (brand similarity) .736 .666 .173 .105
Segment size 72.0% 28.0% 73.6% 26.4%

–Log-likelihood 3549.9 3109.3

Number of parameters 39 41
Notes: t-values of parameter estimates are in parentheses.
Customized Promotions in Online and Offline Stores 197

Table 2
MODEL ESTIMATION RESULTS FOR LIQUID DETERGENT

Online Offline

Variables/Parameter Segment 1 Segment 2 Segment 1 Segment 2

Brand Utilities
Constants:
Wisk –.489 (–1.120) 2.807 (3.368) .361 (1.029) .487 (1.012)
All –.436 (–.369) –3.884 (–1.760) –.242 (–.231) –1.406 (–1.311)
Tide .985 (3.068) 3.349 (4.265) .672 (1.844) .252 (.572)
(Cheer) (0) (0) (0) (0)
Regular price –.277 (.505) –2.461 (–2.479) –.117 (–.244) –.595 (–1.226)
Price cut .642 (3.263) .601 (2.439) .440 (1.339) 1.080 (1.917)
Display or feature advertisement 2.092 (10.184) .509 (.247)
State dependence (β2) 1.950 (11.028) 1.838 (6.299) .546 (5.002) 2.896 (4.880)
Last purchase on prom on β2 –.856 (–2.480) .044 (.085) –.101 (–.409) –.251 (–.938)

Category Threshold
Constant 2.662 (3.732) .758 (.467) 5.484 (2.070) 2.566 (.828)
Purchase frequency –4.614 (–11.367) –6.802(–11.224) –13.418 (–9.814) –10.237 (–7.853)
Last purchase volume .038 (2.514) .018 (1.759) .008 (.045) .070 (3.132)

Purchase Quantity
Constants:
Wisk 3.802 (1.977) .579 (.066) 7.860 (2.375) 2.741 (.489)
All 4.706 (1.939) 10.562 (1.949) 8.643 (2.308) .939 (.263)
Tide 4.598 (1.820) 2.966 (2.342) 8.045 (2.396) 1.733 (.300)
Cheer 4.863 (1.340) 6.900 (3.836) 7.945 (2.473) 2.304 (.443)
Regular price .052 (.009) –.402 (–1.033) –.788 (–.978) –5.317 (–2.675)
Price cut .279 (.216) 4.849 (2.613) 2.681 (1.728) .289 (.242)
Average purchase volume .457 (2.403) .896 (4.055) .185 (3.698) 1.101 (1.827)
Last purchase volume .017 (.781) –.272 (–6.489)

ϕ –.897 (–6.178) –.099 (–.779) –1.032 (–7.260) .009 (.045)

λ (brand similarity) .807 .827 .142 .019
Segment size 59.4% 40.6% 67.2% 32.8%

–Log-likelihood 4732.7 2754.3

Number of parameters 39 43
Notes: t-values of parameter estimates are in parentheses.

higher in the online sample than in the offline sample for
each category, implying that the brands/alternatives show
stronger similarity compared with the “outside good” in the
online channel than in the offline channel. We skip discus-
sions of the other parameter estimates here.
Optimal Promotion Results
We perform the optimizations on data of the holdout
period of 40 weeks. We derive profit-maximizing price dis-
counts for the four brands/alternatives in the two categories
for two promotion orientations (competitive versus loyalty
promotions), at three levels of granularity (mass market,
segment level, and individual level), for three levels of per-
centage profit margins (20%, 30%, and 40%), and in the
online and offline channels. The profit margins we used
here cover the range of actual margins for the categories
studied and enable us to examine how the results may vary
with these scenarios.7 As bases for comparison, for each of
the cases, we compute the expected profit of the current
price promotions in the data and also derive profit-
7According to research of the popular press and trade publications, the
wholesale margin is approximately 30%–35% for butter and 40%–50% for
laundry detergent. The retail margin is approximately 20%–25% for butter
and 18%–20% for liquid detergent. Therefore, the range of percentage
profit margin is 23%–28% for butter and 32%–41% for liquid detergent.
maximizing price discounts for undifferentiated promo-
tions, which are the same for all consumers in a given
week, regardless of their purchase history (i.e., no distinc-
tion between competitive versus loyalty orientations).
Furthermore, as we mentioned in the previous section,
our optimization procedure incorporates the difference in
delivery methods of customized promotions in online and
offline stores. Whereas customized price promotions can be
offered online for the current shopping trip and thus can
achieve 100% “redemption rate,” offline customized pro-
motions need to be redeemed at a future shopping trip, and
some consumers will not remember to do so. In the main
results, we use a redemption rate of 15% on the next trip
for offline stores because, to the best of our knowledge, this
is the highest redemption rate of customized promotions
reported by a retailer.8 We choose this high-end estimate to
give offline stores the benefit of the doubt. A lower redemp-
tion rate will result in even larger online and offline differ-
ences than those we report subsequently. In the optimiza-
tion, each targeted household in the offline store has a 15%
chance of getting a customized price discount and an 85%
chance of ignoring the discount and, thus, paying the regu-
8CVS reported that the best-case scenario of its targeted promotions was
15%.
198 JOURNAL OF MARKETING RESEARCH, APRIL 2009

lar price. We draw from a Bernoulli distribution with a
probability of .15 to determine the outcome of redemption
(1/0) using a different random number seed for each house-
hold in each week. To investigate the impact of redemption
rate, we computed and compared additional results for
redemption rates of 30% and 100%. We assume that the
redemption rates are the same for all households in our
main computations. We also examined various scenarios in
which redemption rates are allowed to vary with con-
sumers’ promotion sensitivity and found that the main
results do not change within realistic ranges of redemption
rates. We discuss the details subsequently.
We present optimization results for the butter and deter-
gent categories in Tables 3 and 4, respectively, in terms of
promotion frequency, depth of optimal price cut, and
expected profit. We measure promotion frequency as the
percentage of households to which a price discount is
offered. We measure promotion depth as the average
amount of price cut, given that a discount is offered. We
average these quantities across brands for each category
because the patterns across brands are similar, and we are
not primarily interested in the differences across brands. To
account for minor sample size differences, we convert
expected profits to dollar per brand/alternative for 100
households in the 40-week holdout period for both cate-
gories. All butter alternatives are of the same size (16
ounces) in our data, and thus we report price cuts in dollars
per pound for this category. Liquid detergent comes in dif-
ference sizes. For ease of exposition, we convert all prices
into the price for a bottle of the most common packet size:
100 ounces. Therefore, we report price cuts in dollars per
bottle of 100 ounces for liquid detergent. We describe the
results in detail in the following subsections.
Benefits of optimal promotions versus the current prac-
tice. As we show in Tables 3 and 4, optimized promotions,
regardless of the level of customization and promotion ori-
entation, result in substantially higher expected profit than
the current practice for both product categories in general.
The improvements are especially large for butter in the
online store. For example, in the online store, at the 30%
profit margin, which best represents the butter category, our
optimal mass market promotions lead to 311% higher
expected profit for competitive promotions and 121%
higher expected profit for loyalty promotions over the cur-

Table 3
SUMMARY OF OPTIMIZATION RESULTS FOR BUTTER

A: Competitive Promotions
Online Offline (Redemption = 15%e)
Level of % Profit Average Expected Average Expected
Customization Margina % Promb Price Cutc Profitd % Promb Price Cutc Profitd
Mass market 20% 96.7 .23 64.59 0 0 162.74
30% 100.0 .70 119.96 12.5 .02 244.11
40% 100.0 1.16 222.88 78.8 .22 325.83
Segment 20% 94.1 .36 64.67 0 0 162.74
30% 100.0 .83 120.97 9.4 .05 244.11
40% 100.0 1.27 226.82 62.5 .22 325.85
Individual 20% 96.7 .28 65.63 .5 .02 162.74
30% 100.0 .72 124.39 16.8 .05 244.11
40% 100.0 1.16 235.23 74.1 .24 325.88
Current practice 20% –62.34 36.08
30% 46.9 1.32 29.16 49.4 .76 152.25
40% 120.65 268.41

B: Loyalty Promotions
Online Offline (Redemption = 15%e)
Level of % Profit Average Expected Average Expected
Customization Margina % Promb Price Cutc Profitd % Promb Price Cutc Profitd
Mass market 20% 1.9 .01 503.11 0 0 295.75
30% 38.8 .19 757.43 4.4 .02 443.62
40% 58.1 .37 1,029.57 29.4 .12 591.57
Segment 20% 10.5 .04 503.04 0 0 295.75
30% 44.8 .26 757.57 3.9 .04 443.62
40% 58.9 .47 1,033.10 30.3 .14 591.57
Individual 20% 4.08 .04 503.13 0 0 295.75
30% 43.8 .21 758.59 5.1 .02 443.62
40% 62.5 .41 1,035.11 36.2 .15 591.57
Current practice 20% –40.68 145.28
30% 46.9 1.32 343.49 49.4 .76 325.97
40% 727.93 506.67
a% profit margin = m (1 – m ), where m is the regular % wholesale margin and m is the regular % retail margin.
m r m r
b% prom = percentage of cases with a price cut promotion, averaged across all brands.
cWe measured average price cut as the average across all cases with a price cut, in $/bottle of 100 ounces for liquid detergent,
and then we averaged across
all brands.
dWe measured expected profit as the expected gross profit per brand in dollar amount for 100 households in 40 weeks, averaged across all brands.
eRedemption rate applies to the three levels of customized promotions.
Customized Promotions in Online and Offline Stores 199

Table 4
SUMMARY OF OPTIMIZATION RESULTS FOR LIQUID DETERGENT

A: Competitive Promotions
Online Offline (Redemption = 15%e)
Level of % Profit Average Expected Average Expected
Customization Margina % Promb Price Cutc Profitd % Promb Price Cutc Profitd
Mass market 20% 56.9 .14 23.94 5.60 0.04 28.81
30% 100.0 .85 37.58 69.40 1.02 43.56
40% 100.0 1.63 56.80 88.13 2.13 60.47
Segment 20% 57.7 .14 24.00 30.40 1.07 28.86
30% 99.2 .95 37.77 58.83 1.28 43.86
40% 100.0 1.64 57.13 84.95 1.76 61.24
Individual 20% 46.7 .21 24.06 19.03 0.71 28.90
30% 92.3 .80 38.04 63.70 1.01 44.15
40% 100.0 1.53 57.99 84.21 1.81 61.70
Current practice 20% 15.28 27.50
30% 46.3 .84 32.66 29.40 .55 42.99
40% 50.04 58.48

B: Loyalty Promotions
Online Offline (Redemption = 15%e)
Level of % Profit Average Expected Average Expected
Customization Margina % Promb Price Cutc Profitd % Promb Price Cutc Profitd
Mass market 20% 0 0 247.39 03.1 .01 087.49
30% 05.6 .01 370.99 78.1 .35 132.12
40% 16.3 .11 494.90 99.4 .87 179.96
Segment 20% 0 0 247.39 10.0 .07 087.53
30% 06.2 .03 371.09 55.7 .29 132.23
40% 18.3 .16 495.08 86.3 .82 180.32
Individual 20% 0 0 247.39 16.3 .13 087.36
30% 07.1 .03 371.09 68.1 .47 132.75
40% 19.0 .16 495.12 89.4 .99 181.17
Current practice 20% 164.94 085.45
30% 46.3 .84 300.16 29.4 .55 131.27
40% 435.38 177.09
a% profit margin = m (1 – m ), where m is the regular % wholesale margin and m is the regular % retail margin.
m r m r
b% prom = percentage of cases with a price cut promotion, averaged across all brands.
cWe measured average price cut as the average across all cases with a price cut, in $/bottle of 100 ounces for liquid detergent,
and then we averaged across
all brands.
dWe measured expected profit as the expected gross profit per brand in dollar amount for 100 households in 40 weeks, averaged across all brands.
eRedemption rate applies to the three levels of customized promotions.

rent practice. These profit increases are even higher for
segment- and individual-level promotions. For butter, in the
offline store, optimal mass market promotions lead to 60%
and 36% profit increase for competitive and loyalty promo-
tions, respectively.
For liquid detergent, the profit increases due to cus-
tomization in the online store are lower than for butter, but
they are still substantial. For example, at a 40% profit mar-
gin, which best represents this category, optimal mass mar-
ket promotions increase the expected profit by approxi-
mately 14% for both competitive and loyalty promotions.
However, the increases in profit from optimization for liq-
uid detergent in the offline store are small. These differ-
ences between categories and shopping venues are due to
several factors, which we elaborate on in subsequent
sections.
Tables 3 and 4 also indicate that the magnitude of profit
gains from optimal promotions tends to increase with the
percentage profit margin. If the percentage profit margin
falls below 20%, in general the optimal strategy is not to
promote. As the percentage profit margin increases, the
optimal promotion offerings increase in both frequency and
depth. However, we cannot draw general conclusions about
whether promotion frequency and depth should be
increased or decreased over the current practice. It depends
on the actual profit margin, product category, promotion
orientation, shopping venue, and the nature of the promo-
tion plans that are currently used.
Competitive versus loyalty promotions. We implement
competitive and loyalty promotions simultaneously for the
holdout data. For purposes of various comparisons, we
report the results of the two types of promotions separately
in Tables 3 and 4, followed by results of the two types com-
bined in Tables 5 and 6. Tables 3 and 4 show that optimal
loyalty promotions are more profitable than competitive
promotions under all conditions. The expected profit is
higher when promotions are offered to consumers who pur-
chased the target brand on the previous purchase occasion
than when they are offered to those who purchased com-
petitors’ brands previously. The optimal promotion fre-
quency and depth are lower for loyalty promotions than for
competitive promotions. These patterns also hold at the
individual brand level, except for two offline butter
alternatives.
200 JOURNAL OF MARKETING RESEARCH, APRIL 2009

Particularly noteworthy is the comparison between
online and offline stores for the same promotion orienta-
tion. While loyalty promotions are more profitable in online
stores than in offline stores, competitive promotions are
more profitable in offline stores than in online stores. This
result holds across levels of customization, profit margins,
brands, and categories, as well as for the current practice. It
is driven by differences in the impact of past purchase out-
comes relative to that of current promotions between the
two shopping venues. Our model estimation results (Tables
1 and 2) indicate that online consumers are more state
dependent relative to their responsiveness to current price
promotions than their offline counterparts in both cate-
gories. This means that it is easier to induce consumers to
switch from the brand they purchased previously in offline
stores than in online stores, and thus competitive promo-
tions are more profitable offline. In contrast, loyalty promo-
tions are more profitable online because consumers are
more inertial, and thus it is easier to prevent them from
switching brands. These findings imply that online and
offline stores each have their unique advantages in terms of
promotion effectiveness. Online stores are a more appealing
channel for retaining a brand’s existing customers, and
offline stores present a better channel for attracting com-
petitors’ customers.
Level of customization. Our results show that among the
three levels of customized promotions, the increments in
expected profit for more granular levels of customization
are small in general, but in some cases, the differences are
meaningful. The pattern depends on the product category
and shopping venue. Liquid detergent shows little profit
increase as the level of customization becomes more granu-
lar in both online and offline stores. There is virtually no
difference between the three levels for butter in offline
stores. For butter in the online store, however, the differ-
ences among the three levels are meaningful. On average,
individual-level customized promotions can lead to 4%
increase in expected gross profit over mass market–level
customized promotions (which are only differentiated on
the basis of previous purchase outcomes) for competitive
promotions and 1.4% increase in total profit for the two
types of promotions combined, and these differences are
statistically significant. Our findings imply that there is lit-
tle incremental benefit to offer individual-level customized
promotions in offline stores, and (optimally allocated) mass
market–level customized promotions are sufficient in this
channel. If individual-level customized promotions are to
be pursued, they would be more effective if implemented in
online stores. However, such promotions may pay off in
online stores only for some product categories.
The different patterns between the categories and shop-
ping venues are caused by differences in promotion sensi-
tivity. In addition, customized promotions can be delivered
on the current shopping trip in online stores, but in offline
stores, consumers must redeem customized promotions on
a future shopping trip, which lowers their effectiveness and
reduces the gain from customization. As we show subse-
quently, the redemption rate factor plays a crucial role in
determining the effectiveness of customized promotions in
offline stores.
Customized versus undifferentiated promotions. We now
report the combined results when competitive promotions
and loyalty promotions are implemented simultaneously.
Because these promotions are targeted toward different
households in a given week on the basis of their previous
purchases, the total expected profit for the entire sample

Table 5
COMBINED PROMOTIONS FOR BUTTER

Online Offline (Redemption = 15%e)

Level of % Profit Average Expected Average Expected
Customization Margina % Promb Price Cutc Profitd % Promb Price Cutc Profitd
Mass market 20% 73.1 .23 567.74 0 0 458.48
30% 84.4 .64 877.38 12.1 .02 687.73
40% 88.8 1.03 1,252.46 67.9 .21 917.39
Segment 20% 72.9 .35 567.85 0 0 458.48
30% 85.5 .75 878.54 08.5 .05 687.73
40% 89.3 1.13 1,259.92 52.6 .21 917.42
Individual 20% 73.6 .28 568.76 00.5 .02 458.49
30% 85.3 .65 882.98 15.8 .05 687.73
40% 90.15 1.03 1,270.34 63.2 .24 917.45
Undifferentiated 20% 3.1 .01 565.68 0 0 458.48
30% 53.1 .19 853.84 06.3 .02 687.74
40% 85.0 .43 1,175.86 40.0 .15 919.26
Individual + undifferentiated 20% 00.1 .02 458.49
30% 08.0 .05 687.76
40% 48.9 .21 919.31
Current practice 20% –103.01 181.37
30% 46.9 1.32 372.65 49.4 .76 478.22
40% 848.57 775.08
a% profit margin = m (1 – m ), where m is the regular % wholesale margin and m is the regular % retail margin.
m r m r
b% prom = percentage of cases with a price cut promotion, averaged across all brands.
cWe measured average price cut as the average across all cases with a price cut, in $/bottle of 100 ounces for liquid detergent,
and then we averaged across
all brands.
dWe measured expected profit as the expected gross profit per brand in dollar amount for 100 households in 40 weeks, averaged across all brands.
eRedemption rate applies to the three levels of customized promotions.
Customized Promotions in Online and Offline Stores 201

Table 6
COMBINED PROMOTIONS FOR LIQUID DETERGENT

Online Offline (Redemption = 15%e)

Level of % Profit Average Expected Average Expected
Customization Margina % Promb Price Cutc Profitd % Promb Price Cutc Profitd
Mass market 20% 42.0 .14 271.32 5.1 .04 116.30
30% 75.9 .84 408.57 71.7 .86 175.69
40% 77.46 1.59 551.70 90.7 1.83 240.44
Segment 20% 41.6 .14 271.39 25.4 .92 116.39
30% 75.2 .93 408.86 57.1 1.02 176.10
40% 78.0 1.57 552.21 85.0 1.51 241.56
Individual 20% 32.6 .21 271.44 18.5 .58 116.56
30% 69.6 .79 409.14 64.2 .85 176.90
40% 78.0 1.48 553.11 85.4 1.60 242.88
Undifferentiated 20% 0 0 270.92 3.8 .01 116.29
30% 13.8 .08 406.42 74.4 .39 183.33
40% 50.0 .32 543.48 94.4 1.05 279.56
Individual + undifferentiated 20% 6.4 .43 116.43
30% 75.1 .46 184.44
40% 94.6 1.14 284.84
Current practice 20% 180.22 112.95
30% 46.3 .84 332.82 29.4 .55 174.26
40% 485.42 235.57
a% profit margin = m (1 – m ), where m is the regular % wholesale margin and m is the regular % retail margin.
m r m r
b% prom = percentage of cases with a price cut promotion, averaged across all brands.
cWe measured average price cut as the average across all cases with a price cut, in $/bottle of 100 ounces for liquid detergent,
and then we averaged across
all brands.
dWe measured expected profit as the expected gross profit per brand in dollar amount for 100 households in 40 weeks, averaged across all brands.
eRedemption rate applies to the three levels of customized promotions.

when both strategies are used simultaneously is the sum of
the expected profits from the two programs. We compare
the combined promotions at three levels of customization
with optimal undifferentiated promotions, which are the
same for all consumers in a given week regardless of what
brand they purchased previously. In Tables 5 and 6, we
report the promotion frequency, average amount of dis-
count, and expected profit for these promotion programs
and for the current practice for butter and liquid detergent,
respectively. A salient pattern across categories and shop-
ping venues is that optimal undifferentiated promotions
generate substantial profit increases over the current prac-
tice. The comparison of combined mass market–level cus-
tomized promotions and undifferentiated promotions illus-
trates the benefit of differentiating the two promotion
orientations.
Note that for offline stores, undifferentiated promotions
can be marked down directly on price tags, and thus, unlike
customized promotions, they do not need to be redeemed
on future shopping trips. In other words, undifferentiated
promotions can achieve “100% redemption” in both offline
and online stores. Therefore, the profit differences between
customized and undifferentiated promotions in online
stores reflect the benefits of distinguishing the promotion
orientations, while the profit differences in offline stores
are confounded by the impact of redemption rates. Thus,
we focus on the online store to examine the benefit of dif-
ferentiating promotion orientations according to house-
holds’ previous purchases.
As Tables 5 and 6 show, for both categories in the online
store, differentiating promotions into competitive and loy-
alty orientations (i.e., by consumers’ previous purchase out-
comes) leads to higher expected profits than optimal undif-
ferentiated promotions. For butter, under the most likely
percentage profit margin (30%), such differentiation leads
to 2.8% profit increase if done at the mass market level and
3.4% profit increase if done at the individual level. For liq-
uid detergent, under the most likely percentage profit mar-
gin (40%), such differentiation leads to 1.5% profit increase
if done at the mass market level and 1.8% profit increase if
done at the individual level. Although the percentage
increases (compared with profits of the optimal undifferen-
tiated promotions) are modest, their importance is substan-
tial. Under the margin scenarios we mentioned previously,
the profit increment from undifferentiated to mass market–
level customized promotions is 4.2 times that from mass
market–level to individual-level customized promotions
(23.5 versus 5.6) for butter and 5.8 times for liquid deter-
gent (8.2 versus 1.4). These results imply that most of the
benefit from customization can be achieved by differentiat-
ing promotions according to whether a consumer bought
the target brand on the previous occasion rather than further
fine-tuning the discounts for specific segments or individual
consumers.
However, the patterns in the offline store are different.
Here, expected profits of customized promotions at each of
the three levels are lower than those of the optimal undiffer-
entiated promotions for both categories. The differences are
especially large for liquid detergent under the 40% profit
margin scenario, in which the expected profit for mass
market–, segment-, and individual-level customized promo-
tions is 13%–14% lower than that of the undifferentiated
promotions. The reverse pattern in the offline store is
caused by the low redemption rate in this channel.
To tease apart the impact of customization and redemp-
tion rate in the offline store, we computed the expected
202 JOURNAL OF MARKETING RESEARCH, APRIL 2009

profits for both categories, assuming 100% redemption. expected profit of individual-level promotions would still
The patterns are now similar to those for the online cases. be lower than that of optimal undifferentiated promotions.
The changes are especially drastic for liquid detergent: Linear interpolation suggests that the two types of promo-
Under the most likely margin scenario, customization tions would break even if the redemption rate is approxi-
would have led to 6.6% profit increase over optimal undif- mately 60%, under the assumption that all consumers have
ferentiated promotions if done at the mass market level and the same redemption rate. This rate is not feasible given the
12.7% profit increase if done at the individual level, had the current technology.
redemption rate being 100%. This suggests that the current Impact of promotion sensitivity. Another important deter-
redemption rate substantially reduces profitability of cus- minant of the effectiveness of customized promotions is
tomized promotions in the offline store. Next, we examine consumers’ promotion sensitivity, in terms of both its mean
the impact of redemption rate on profits in greater detail. and its variance. If we assume 100% redemption, the higher
Impact of redemption rate. We focus on the liquid deter- the promotion sensitivity and variation in it among con-
gent category to examine the impact of redemption rate for sumers, the greater the profit increase would be from more
offline stores because butter shows small profit differences granular customizations. To compare promotion sensitivity
among the undifferentiated and the three levels of cus- across samples, we compute price cut elasticities because
tomized promotions even at 100% redemption. Table 7 the price cut coefficients in Tables 1 and 2 are not directly
presents the expected profits of the customized promotions comparable. The equations of household-level price cut
at 15%, 30%, and 100% redemption rates, as well as of elasticities for our joint model of purchase incidence,
undifferentiated promotions and the current practice. The choice, and quantity appear in the Web Appendix (http://
results in this table reveal drastic differences in payoffs of www.marketingpower.com/jmrapril09). For each category,
customized promotions across the redemption rates under we compute the price cut elasticity for each observation in
the most likely profit margin scenario. Had the offline the data. We use the same price cut value for the target
redemption been 100%, customized promotions would have brand in the elasticity computation for both online and
been substantially more profitable than undifferentiated offline stores (the average price cut values of the two chan-
promotions. In addition, the incremental benefits of more nels) to control for differences due to discrepancies in price
granular customization would have been much higher. For cuts between the stores, while keeping the values of all
example, individual-level customization would have led to other marketing-mix variables the same as in the data.
a 5.6% ($16.8) profit increase over mass market–level cus- Table 8 presents the mean and standard deviation of the
tomized promotions, instead of the 1% ($2.4) increase at price cut elasticity by brand/alternative, category, and chan-
15% redemption. These patterns indicate that the redemp- nel. It shows that the average price cut elasticity for butter
tion rate factor substantially reduces the potential benefits is higher in the online store than in the offline store, and so
of customized promotions for offline stores. Note that the is its variation among consumers. In contrast, the mean and
15% redemption rate we used to present the main results is standard deviation of the price cut elasticity for liquid
already on the high end for offline stores. Table 7 shows detergent are higher in the offline store than in the online
that even if the redemption rate could double to 30%, the store. These contrasts are likely due to differences in prod-
uct characteristics and how consumers shop the category in
Table 7 an online versus offline grocery store and reveal the need to
EXPECTED PROFITa FOR COMBINED PROMOTIONS BY examine promotion sensitivity in a given channel on a
REDEMPTION RATE (OFFLINE LIQUID DETERGENT)
category-by-category basis. The pattern of price cut elas-
ticities across categories and channels is consistent with our
Redemption Ratec
Level of % Profit Table 8
Customization Marginb 15% 30% 100% PRICE CUT ELASTICITYa BY BRAND, CATEGORY, AND
Mass market 20% 116.30 116.31 116.35 CHANNEL
30% 175.69 177.51 185.53
40% 240.44 250.45 298.14 Online Offline
Segment 20% 116.39 116.60 117.07
30% 176.10 178.28 190.16 Category Mb SDb Mb SDb
40% 241.56 251.19 308.57
Butter
Individual 20% 116.56 116.87 117.75
Land O’Lakes: salted .597 .233 .272 .020
30% 176.90 179.61 193.00
Land O’Lakes: unsalted .688 .189 .305 .016
40% 242.88 253.69 314.97
Store brand: salted .568 .292 .281 .043
Undifferentiated 20% 116.29
Store brand: unsalted .844 .216 .334 .018
30% 183.33
Average .674 .232 .298 .024
40% 279.56
Current practice 20% 112.95
Liquid Detergent
30% 174.26
Wisk .440 .113 .451 .155
40% 235.57
All .537 .134 .540 .186
aWe measured expected profit as the expected gross profit per brand in Tide .306 .220 .617 .203
dollar amount for 100 households in 40 weeks, averaged across all brands. Cheer .416 .077 .429 .141
b%profit margin = m (1 – m ), where m is the regular % wholesale
m r m
Average .425 .136 .509 .171
margin and mr is the regular % retail margin. aPrice cut elasticity refers to elasticity of the expected purchase quantity.
cRedemption rate applies to the three levels of customized promotions. bWe computed mean and standard deviation across all observations.
Customized Promotions in Online and Offline Stores
optimization results that at 100% redemption rate, the profit
increments from customized versus undifferentiated promo-
tions and from segment- and individual-level customiza-
tions versus mass market customizations are higher online
for the butter category but are higher offline for the liquid
detergent category. Nonetheless, the potential benefits of
customization due to high promotion sensitivity are
swamped by the redemption rate factor for liquid detergent
in the offline store.
Impact of consumer heterogeneity in redemption rates. In
our expected profit computations, we assumed that all con-
sumers have the same redemption rate under each scenario.
In reality, promotion-sensitive consumers are more likely to
redeem price discount coupons than those who are not pro-
motion sensitive. To examine the impact of consumer
heterogeneity in redemption rates on the findings reported
in previous sections, we compared a range of scenarios in
which redemption rate is assumed to be positively corre-
lated to a household’s price cut elasticity. We find that for
comparable levels of overall redemption rates and within
realistic ranges of variation, the expected profit of optimal
undifferentiated promotions is still higher than that of the
three levels of customized promotions, though the differ-
ences are smaller than in the cases of homogeneous
redemption rates. This result can be illustrated with an
extreme-case scenario, in which we assume that households
belonging to the top 15% of price cut elasticity always
redeem and that the other households never redeem. For
liquid detergent, this is an approximate break-even point
between optimal undifferentiated and customized promo-
tions. Across brands and percentage profit margins, the
average expected profit (for 100 households in 40 weeks) is
$193.09 for optimal undifferentiated promotions and
$192.90 and $196.17 for mass market– and individual-level
customized promotions, respectively. Note that this
extreme-case scenario is not directly comparable to the case
of 15% homogeneous redemption rate we report in Tables 6
and 7, because it leads to an effective average redemption
rate of 35.8% for individual-level promotions across brands
and percentage profit margins. This is because the opti-
mization procedure already accounts for each household’s
promotion sensitivity, and thus households with a high
price cut elasticity tend to receive promotions more fre-
quently, and the amount of price discounts they receive also
tends to be higher. With the current technology, a 35.8%
redemption rate is unrealistic, even if it is contributed by
the top 15% of households in the marketplace. Thus, our
analysis suggests that expected profits of customized pro-
motions offline are unlikely to be greater than those of opti-
mal undifferentiated promotions within realistic ranges of
redemption level and variation. Although consumer hetero-
geneity in redemption rates is unlikely to change the direc-
tions of the relevant findings reported in this study, our
results indicate that it affects the expected profit. This calls
for more in-depth analysis of redemption patterns across
consumers; however, we leave this for further research.
Effects of combining undifferentiated and customized
promotions in offline stores. The results we presented previ-
ously indicate that firms may benefit from offering a com-
bination of undifferentiated and customized promotions in
offline stores. We examine the expected profits of this strat-
203
egy. To keep results comparable to the main findings
reported in Tables 5 and 6, we assume that all consumers
have the same redemption rate of 15% in this computation.
Each targeted household in the offline store has a 15%
chance of receiving a customized price discount in a given
week, if the customized promotion is greater than the undif-
ferentiated price discount of that week. Otherwise, the
household receives the undifferentiated price discount for
the week, if there is any. We do not allow a household to
receive both the customized and the undifferentiated dis-
counts because of the common policy in practice that deals
cannot be combined. Moreover, offering the sum of both
discounts would lead to lower expected profit due to over-
promotion. We report the results for combining individual-
level customization and undifferentiated promotions in
Tables 5 and 6 because they generate the highest expected
profits among the three levels of customizations. For the
butter category in the offline store (see Table 5), combining
individual-level customization and undifferentiated promo-
tions leads to a minor (almost unnoticeable) increase in
expected profits over undifferentiated promotions alone,
which suggests that firms should focus on optimal undiffer-
entiated promotions for this category. The benefits of the
combined strategy are greater for liquid detergent (see
Table 6). Under the most likely percentage profit margin,
on average, combining individual-level customization and
undifferentiated promotions leads to a 1.9% increase in
expected profits over undifferentiated promotions alone and
a 17.3% increase in expected profits over individual-level
customization alone, and both differences are statistically
significant. We also examined the strategy of combining
optimal undifferentiated and mass market–level customized
promotions and found similar results, except with slightly
lower expected profits in this case. In general, the differ-
ences in expected profits between “undifferentiated promo-
tions + mass market–level customizations” and “undifferen-
tiated promotions + individual-level customizations” are
similar to those between mass market–level customizations
alone and individual-level customizations alone, which are
small, as we discussed previously (less than 1% in general).
This suggests that combining undifferentiated and mass
market–level customized promotions would be sufficient in
offline stores, though using individual-level customization
may generate slightly higher expected profits.
To summarize, the incremental profits from implement-
ing (more granular) customized promotions depend on con-
sumers’ promotion sensitivity to the category in a given
channel as well as the redemption rate. Our analyses indi-
cate that a high mean and variance of promotion elasticity
are necessary conditions for customized price promotions
to pay off, but the redemption rate plays a more prominent
role in the differences in effectiveness of customized pro-
motions between online and offline stores. The key reason
online individual-level customization may pay off for cer-
tain product categories is that the promotions can be offered
to individual consumers on their current shopping trip. The
categories in question also need to exhibit a high mean and
variance of promotion sensitivity in online stores. The
results of both categories in the offline store indicate that
optimal undifferentiated promotions should be the primary
promotion program in this channel. In addition, combining
204
optimal undifferentiated with customized promotions can
lead to meaningful increases in expected profits for suitable
categories in offline stores.
DISCUSSION
The development of innovative technologies has brought
unprecedented opportunities for improving promotion
effectiveness through customization in both online and
offline channels. Yet many important questions regarding
customized promotions remain unanswered. In this study,
we conducted an empirical investigation of the profit poten-
tial of various promotion programs customized at different
levels in the two channels. We derived and compared the
expected profit of these promotion programs across a com-
bination of approximately 300 conditions. The key findings
are as follows:
•Optimization procedures lead to substantial profit improve-
ments over the current practice for all types of promotions,
including customized and undifferentiated promotions.
•Loyalty promotions offered to consumers who purchased the
target brand on the previous occasion are more profitable in
online stores than in offline stores, while the opposite holds
for competitive promotions that are aimed at those who pur-
chased competitors’ brands on the previous occasions.
•The incremental profit of individual-level over segment-level
promotions and of segment-level over mass market–level cus-
tomized promotions is small in general, especially in offline
stores, for which the differences are less than 1% on average.
•For categories that are promotion sensitive, firms can gain
meaningful profit increases from individual-level over
segment-level customized promotions and from segment-level
over mass market–level customized promotions in online
stores. If individual-level promotions are to be implemented,
the Internet is the more suitable channel.
•Customized promotions at all levels are more profitable than
undifferentiated promotions in online stores, but this is not the
case in offline stores. Low redemption rates are a major
impediment to the success of customized promotions in offline
stores. Given the current technology, expected profit from
individual-level customized promotions may be lower than
that generated by optimal undifferentiated promotions. Opti-
mal undifferentiated promotions should be the primary promo-
tion program in offline stores, and firms can benefit from
offering a combination of optimal undifferentiated promotions
and customized promotions for suitable categories in this
channel.
The results from this study highlight the importance of
accounting for the redemption factor, which has not been
considered in previous research on customized promotions.
Our analysis indicates that though both promotion sensitiv-
ity and redemption rate affect the effectiveness of cus-
tomized promotions, the redemption factor plays a more
critical role. The key reason online individual-level cus-
tomized promotions may pay off for certain product cate-
gories is firms’ ability to modify the store interface for indi-
vidual consumers on the Internet so that customized
promotions can be delivered to them on the current shop-
ping trip. However, these categories must also exhibit a
relatively high mean and variance of promotion sensitivity
among consumers for more fine-tuned customizations to
pay off in online stores.
In offline stores, even if a category has a high mean and
variance of promotion sensitivity among consumers, we
find little differences in the optimal profit for customized
JOURNAL OF MARKETING RESEARCH, APRIL 2009
promotions at mass market, segment, and individual levels
under a 15% redemption rate. This rate is already on the
high end given the current technology. So, in practice, the
differences may be even smaller than what we reported in
this study. In addition, because of the redemption factor,
optimal undifferentiated promotions that can be marked
down directly on price tags are likely to be more profitable
than customized promotions in offline stores (within realis-
tic ranges of the level and variation of redemption across
consumers). This suggests that optimal undifferentiated
promotions will remain the primary promotion program in
offline stores and that marketers should invest in informa-
tion technology that calibrates, optimizes, and updates pro-
motions en masse on a regular basis. In offline stores, firms
can benefit from combining optimal undifferentiated with
customized promotions for suitable categories (those
exhibiting sufficiently high mean and variance of price cut
elasticities). In addition, our analysis indicates that if cus-
tomized price promotions are to be implemented in offline
stores, mass market–level customizations would be suffi-
cient, and there is no need to further fine-tune the promo-
tions to segments or individual consumers.
It is worth noting that our results for the offline promo-
tions are not due to the idiosyncratic nature of the data used
in this study. Price elasticities of the two categories in our
data are similar to those reported by Bell, Chiang, and Pad-
manabhan (1999) and Bucklin and Gupta (1992).9 Without
considering the redemption factor, the profit increase from
individual-level customized promotions over undifferenti-
ated promotions would have been 12.7% for liquid deter-
gent under the most likely percentage profit margin, which
is similar in magnitude to those reported by other studies
that did not consider redemption in offline stores. For
example, Rossi, McCulloch, and Allenby (1996) find gains
of 7.6% of individual-level pricing over blanket pricing
based on a choice model, and Duvvri, Ansari, and Gupta
(2007) report gains of 1%–3% to 8.3% of personalization
based on purchase incidence models. The differences
between our results for the offline channel and those
reported in prior customization literature are primarily
driven by the redemption factor.
We used 100% retail pass-through for the main results
presented herein. As we explained previously, the results
with other pass-through rates can be obtained by taking
proper transformations of results with 100% pass-through.
Our analysis indicates that the optimal price cut and
expected profit decrease as retail pass-through drops, but
the extent of the pass-through effect varies substantially by
promotion orientation and product category. In general,
pass-through has minor effects on expected profits for loy-
alty promotions and categories with low promotion sensi-
tivity. Conversely, the impact of retail pass-through is much
greater for competitive promotions in promotion sensitive
categories. For example, for butter, in the online store, at a
fairly high pass-through of 75%, the expected profit would
9Both studies report price elasticities instead of price cut elasticities. In
addition, Bucklin and Gupta (1992) only consider incidence and choice
elasticities for liquid detergent. Therefore, we converted the parameter
estimates in our models to compute various price elasticities (incidence,
choice, quantity, and overall) for the comparison.
Customized Promotions in Online and Offline Stores
drop by approximately 19% across profit margin scenarios
for individual-level competitive promotions, while at a
fairly low pass-through of 50%, the drop would be merely
1.5% for individual-level loyalty promotions. We advocate
the idea that manufacturers should insist on 100% retail
pass-through when entering customized promotion agree-
ments and compensate retailers on the basis of total profit
increments instead. For situations in which it is difficult to
enforce 100% retail pass-through, it would be worthwhile
to study how pass-through may vary with the depth of dis-
counts and to account for this relationship in designing
optimal promotion strategies. Because pass-through infor-
mation is not available in our data, we leave this for further
research.
Previous research has compared various aspects of con-
sumer purchase behavior between online and offline stores
(e.g., Alba et al. 1997; Danaher, Wilson, and Davis 2003;
Degeratu, Rangaswamy, and Wu 2000). Our study adds two
additional insights to the picture. We find that online con-
sumers exhibit a higher degree of state dependence com-
pared with the effects of current marketing activities. In
other words, past purchase outcomes appear to have greater
impact on online consumers than the impact of current pro-
motions. This is likely due to features available in online
stores, such as personal shopping lists and records of previ-
ous orders, which may train consumers to be more reliant
on past purchases when making current purchase decisions
and thus make them more state dependent. This is the key
reason behind our finding that loyalty promotions are more
profitable online than offline, while competitive promotions
are more profitable offline than online. Conversely, if the
impact of past purchases is held constant, online consumers
can be more or less responsive to current price promotions
depending on the product category. As Table 8 shows,
online consumers exhibit a higher mean and variance of
price cut elasticity than offline consumers in the butter cate-
gory, but the liquid detergent category shows the opposite
pattern. Our findings caution against generalizing online
promotion sensitivity. Instead, it should be examined on a
category-by-category basis. Note that our results on state
dependence between online and offline stores are based on
data of grocery products. We do not intend to generalize it
to other types of products.
An issue of possible concern is cannibalization across
channels. Because of the nature of the available data, we
treated online and offline demand as independent, which
does not impose a major problem in our case, because the
online and offline retailers are independent companies.
However, potential cross-channel cannibalization is an
important issue to consider for retailers that sell the same
merchandise both online and offline. If promotions in one
channel take away sales from another channel, the overall
profitability of customized promotions for multichannel
retailers would be lower than our study suggests. A recent
study by Ansari, Mela, and Neslin (2008) on consumer
durable and apparel products sheds light on channel migra-
tion issues. They find that marketing effort is a key driver
of channel migration and that there is a negative enduring
effect of online migrations on sales. It would be worthwhile
to investigate whether the same phenomena occur for con-
sumer packaged goods and to incorporate these possibilities
when studying customized promotions across multiple
205
channels. It is an important direction for further research to
empirically examine profit impact of customized promo-
tions for multichannel retailers and for other types of
products.
A concern about implementing customized promotions is
that some consumers may be offended if they receive less
of a price discount than others (Feinberg, Krishna, and
Zhang 2002). Although this problem could be serious if the
same consumers consistently receive less of a price dis-
count in most categories, it is less likely to be an issue if
different consumers receive discounts in different product
categories or if discounts are tailored according to con-
sumers’ past purchases. The virtue of customized promo-
tions is to deliver discounts when and only when a con-
sumer values them. It does not mean that a marketer should
ignore the less promotion-sensitive and more loyal cus-
tomers. Rather, he or she needs to think of better ways to
reward them. These customers should be provided with
rewards that are mutually beneficial for them and the mar-
keter. For example, they could be offered free samples of
products they are interested in, discounts based on the total
expenditure of the shopping trip, speedy checkout lines in
bricks-and-mortar stores, and free delivery to online store
customers.
Our analysis indicates that the main findings on redemp-
tion rate are unlikely to change direction if redemption rate
is positively correlated with promotion sensitivity, within
realistic ranges of redemption level and degree of variation
across consumers. Nonetheless, who redeems the promo-
tions makes a difference to the expected profits of cus-
tomized promotions. An extension of our study would be to
endogenize redemption rate in the optimization procedure
for offline stores, which demands adding redemption as an
integrated component in the consumer purchase model and
incorporating the effects of potential drivers of redemption
rate (e.g., consumer characteristics, situational factors).
Such an exercise would require individual-level redemption
data and related covariates. Because household promotion
redemption information is unavailable in the current data,
we leave this topic as an important direction for further
research. Finally, it should be pointed out that our results
may not generalize to other types of customizations at dif-
ferent levels of granularity, such as customized e-mail com-
munication systems (Ansari and Mela 2003) and cus-
tomized product offerings (Syam, Ruan, and Hess 2005).
Further empirical research is needed to examine incremen-
tal benefits across different levels of granularity for other
types of customizations.
In conclusion, this study sheds light on many important
issues pertaining to customized price promotions in online
and offline stores. We have examined several key factors
that influence the profit potential of various customization
programs, including shopping venue, promotion orienta-
tion, level of customization, consumer promotion sensitiv-
ity, and redemption rate. Our study helps identify the condi-
tions under which individual-level customized promotions
may be worth pursuing and provides many insights that are
useful for promotion practices. Because more retailers and
manufacturers are exploring innovative customization
strategies, we hope that our study will stimulate further
research in this important area.
206 JOURNAL OF MARKETING RESEARCH, APRIL 2009

REFERENCES Gedenk, Karen and Scott A. Neslin (1999), “The Role of Retail
Promotion in Determining Future Brand Loyalty: Its Effect
Alba, Joseph, John Lynch, Barton Weitz, Chris Janiszewski,
on Purchase Event Feedback,” Journal of Retailing, 75 (4),
Richard Lutz, Alan Sawyer, and Stacy Wood (1997), “Inter-
433–59.
active Home Shopping: Consumer, Retailer, and Manufacturer
Hanemann, W. Michael (1984), “Discrete/Continuous Models of
Incentives to Participate in Electronic Marketplaces,” Journal of
Consumer Demand,” Econometrica, 52 (3), 541–61.
Marketing, 61 (July), 38–53.
Holleran, Joan (1997), “Partnering with Peapod,” Beverage Indus-
Allenby, Greg, Neeraj Arora, Chris Diener, Jaehwan Kim, Mike
try, 88 (October), 38–41.
Lotti, and Paul Markowitz (2002), “Distinguishing Likelihoods,
Jain, Dipak C. and Naufel J. Vilcassim (1991), “Investigating
Loss Functions and Heterogeneity in the Evaluation of Market-
Household Purchase Timing Decisions: A Conditional Hazard
ing Models,” Canadian Journal of Marketing Research, 20,
Function Approach,” Marketing Science, 10 (1), 1–23.
44–59.
Kamakura, Wagner A. and Gary J. Russell (1989), “A Probabilis-
Andrews, Rick L., Andrew Ainslie, and Imran S. Currim (2002),
tic Choice Model for Market Segmentation and Elasticity Struc-
“An Empirical Comparison of Logit Choice Models with Dis-
ture,” Journal of Marketing Research, 26 (November), 379–90.
crete Versus Continuous Representations of Heterogeneity,”
——— and Michel Wedel (2004), “An Empirical Bayes Proce-
Journal of Marketing Research, 39 (November), 479–87.
dure for Improving Individual Level Estimates and Predictions
Ansari, Asim and Carl F. Mela (2003), “E-Customization,” Jour-
from Finite Mixtures of Multinomial Logit Models,” Journal of
nal of Marketing Research, 40 (May), 131–45.
Business and Economic Statistics, 22 (1), 121–26.
———, ———, and Scott Neslin (2008), “Customer Channel
Kim, Sang Yong and Richard Staelin (1999), “Manufacturer
Migration,” Journal of Marketing Research, 45 (February),
Allowances and Retailer Pass-Through Rates in a Competitive
60–76.
Environment,” Marketing Science, 18 (2), 59–76.
Bell, David R., Jeongwen Chiang, and V. Padmanabhan (1999),
Leeflang, Peter S.H. and Dick Wittink (1996), “Competitive Reac-
“The Decomposition of Promotional Response: An Empirical
tion Versus Consumer Response: Do Managers Overreact?”
Generalization,” Marketing Science, 18 (4), 504–526.
International Journal of Research in Marketing, 13 (April),
Bellman, Richard E. (1957), Dynamic Programming. Princeton,
103–119.
NJ: Princeton University Press.
Nijs, Vincent R., Marnik G. Dekimpe, Jan-Benedict E.M.
Bucklin, Randolph E. and Sunil Gupta (1992), “Brand Choice,
Steenkamp, and Dominque M. Hanssens (2001), “The
Purchase Incidence, and Segmentation: An Integrated Modeling
Category-Demand Effects of Price Promotions,” Marketing Sci-
Approach,” Journal of Marketing Research, 29 (May),
ence, 20 (1), 1–22.
201–215.
Pauwels, Koen (2004), “How Dynamic Consumer Response,
Chiang, Jeongwen (1991), “A Simultaneous Approach to the
Competitor Response, Company Support, and Company Inertia
Whether, What, and How Much to Buy Questions,” Marketing
Shape Long-Term Marketing Effectiveness,” Marketing
Science, 10 (Fall), 297–315.
Science, 23 (4), 596–610.
Chintagunta, Pradeep K. and Sudeep Haldar (1998), “Investigat-
Rossi, Peter E., Robert E. McCulloch, and Greg M. Allenby
ing Purchase Timing Behavior in Two Related Product Cate-
(1996), “The Value of Purchase History Data in Target Market-
gories,” Journal of Marketing Research, 35 (February), 43–53.
ing,” Marketing Science, 15 (4), 321–40.
Danaher, Peter J., Isaac W. Wilson, and Robert Davis (2003), “A
Schwartz, G. (1978), “Estimating the Dimension of a Model,”
Comparison of Online and Offline Consumer Brand Loyalty,”
Annals of Statistics, 6 (2), 461–64.
Marketing Science, 22 (4), 461–76.
Shaffer, Greg and Z. John Zhang (1995), “Competitive Coupon
Degeratu, Alexandru, Arvind Rangaswamy, and Jianan Wu (2000),
Targeting,” Marketing Science, 14 (4), 395–416.
“Consumer Choice Behavior in Online and Traditional Super-
Steenkamp, Jan-Benedict E.M., Vincent R. Nijs, Dominique M.
markets: The Effects of Brand Name, Price, and Other Search
Hanssens, and Marnik G. Dekimpe (2005), “Competitive Reac-
Attributes,” International Journal of Research in Marketing, 17
tions to Advertising and Promotion Attacks,” Marketing Sci-
(1), 55–78.
ence, 24 (1), 35–54.
Dhar, Ravi and Stephen Hoch (1996), “Price Discrimination
Swait, Joffre and Jordan Louviere (1993), “The Role of the Scale
Using In-Store Merchandizing,” Journal of Marketing, 60
Parameter in the Estimation and Comparison of Multinomial
(April), 17–30.
Logit Models,” Journal of Marketing Research, 30 (August),
Duvvri, Sri Devi, Asim Ansari, and Sunil Gupta (2007), “Con-
305–314.
sumers’ Price Sensitivities Across Complementary Categories,”
Syam, Niladri B., Ranran Ruan, and James D. Hess (2005), “Cus-
Management Science, 53 (12), 1933–45.
tomized Products: A Competitive Analysis,” Marketing Science,
Feinberg, Fred M., Aradhna Krishna, and Z. John Zhang (2002),
24 (4), 569–84.
“Do We Care What Others Get? A Behaviorist Approach to
Villas-Boas, Sofia Berto (2007), “Vertical Contracts Between
Targeted Promotions,” Journal of Marketing Research, 34
Manufacturers and Retailers: Inference with Limited Data,”
(August), 277–91.
Review of Economic Studies, 74 (2), 625–52.
Fox, Edward, Alan L. Montgomery, and Leonard M. Lodish
Zhang, Jie and Lakshman Krishnamurthi (2004), “Customizing
(2004), “Consumer Shopping and Spending Across Retail For-
Promotions in Online Stores,” Marketing Science, 23 (4),
mats,” Journal of Business, 77 (2), S25–S60.
561–78.