Threshold Discounting: Operational Benefits, Potential Drawbacks, and Optimal Design

We study the use of threshold discounting, the practice of offering service at a discounted price only if at least a given number of customers show interest in it, pioneered by Groupon. We model a capacity-constrained firm offering service to a random-sized population of strategic customers in two representative time periods, a desirable hot period and a less desirable slow period. A comparison with the traditional approach typically employed in such circumstances (slow period discounting or closing) reveals that threshold discounting boosts the firm’s operational performance on account of two advantages. First, the contingent discount incentivizes slow period consumption when the market for the service is large and reduces supply of the service when the market is small, allowing the firm to respond to the service’s unobserved market potential. Second, activation of the threshold discount signals the market size to strategic customers, supplying them with information on service availability, and inducing them into self-selecting the consumption period to one that improves the firm’s capacity utilization and profit. Unlike typical settings with strategic customers, their strategicbehavior in our setting increases the firm’s profits. When threshold discounts are offered through an intermediary, arrangements often used in practice distort the incentives of the intermediary, and typically result in a higher discount and a lower activation threshold relative to what would be optimal for the service firm. We consider alternate deal designs, and we find that the best designs compromise the service provider’s flexibility in order to provide customers with clear offer terms.