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Increasing product variety through the use of alternate package sizes is a commonly observed mechanism in the grocery industry. Under such a scheme, however, the response to pricing decisions for each of the different package sizes is affected by how customers make demand choices. We build a demand model in which customers react smart to retail promotions through stockpiling and package size switching. The demand model combines a customer choice model with a model in which customers differ in their stockpiling and reservation price levels. We utilize data from the German grocery industry for an empirical fitting of the model. We then develop a store-level inventory model for each SKU and optimize price promotions to maximize expected profit. We show the benefit of capturing the smart customer response to price promotions by demonstrating its impact on the reduced inventory costs. We use the …