Design and Pricing of Discretionary Service Lines

Abstract

For discretionary services, longer service duration implies higher service quality. We study the optimal design and pricing of discretionary service lines, a range of services that are vertically differentiated through their duration (quality), offered to a market with customers who are heterogeneous in terms of their sensitivity to service duration. In a resource-constrained environment with stochastic arrival of demand, longer service duration also implies longer wait, which all customers dislike. Hence, service line design takes into consideration both customer heterogeneity in quality sensitivity and customer disutility in waiting. We first study the case when the firm serves customers in the order they arrive (first in first out (FIFO)). Then we investigate a processing-time-based sequencing rule with two priority classes (two classes shortest processing time (2-SPT)) as a practical operational improvement of FIFO. We identify service variety reduction as an instrument to mitigate congestion, in addition to service time reduction and throughput control used for discretionary service design. Although FIFO results in a range of closely related service durations and an increasing price schedule, we show that 2-SPT gives rise to a clustered service line with a gap between the ranges of service durations offered for different priority classes, along with a decrease of demand volume and a possible price drop from the lower-quality to the higher-quality cluster. Finally, even without customer heterogeneity, it is still optimal for the firm to offer a variety of services under 2-SPT, driven by operational efficiency improvement, whereas under FIFO the service line collapses to a single service. This paper was accepted by Terry Taylor, operations management.