Optimizing Multinomial Logit Profit Functions

Abstract

The multinomial logit model is a standard approach for determining the probability of purchase in product line problems. When the purchase probabilities are multiplied by product contribution margins, the resulting profit function is generally nonconcave. Because of this, standard nonlinear search procedures may terminate at a local optimum which is far from the global optimum. We present a simple procedure designed to alleviate this problem. The key idea of this procedure is to find a “path” of prices from the global optimum of a related, but concave logit profit function, to the global optimum of the true (but nonconcave) logit profit function.