Pricing Ancillary Service Subscriptions

Abstract

We investigate heterogeneous customer choice behavior in the presence of main products, ancillary services with options of pay-per-use and subscription, as well as the outside option. The willingness to pay for service subscription is derived as a closed-form expression, which enables us to characterize the optimal pricing strategy and the impact of service subscription on customer surplus. Analytical results and numerical experiments show that offering service subscriptions may result in “win-win”, “win-win-win”, “win-win-lose”, “lose-lose-win” and other situations for the firm, competitors and customers in a variety of monopolistic and duopolistic scenarios. The advantages of service subscription remain with heterogeneous customers differing on multiple dimensions, e.g., the nominal utility, uncertainty in the need of ancillary service and purchase frequency. We find that if the product quality for both firms, measured by nominal utility, is not significantly different, more fierce price competition by offering service subscription may result in higher customer surplus, compared to that without service subscription. Ancillary service subscription can help firms to better price-discriminate heterogeneous customers through different subscription decisions and subsequent purchase behavior.

Keywords: Revenue Management; Pricing; Ancillary Service; Subscription; Choice Model