Drip Pricing When Consumers Have Limited Foresight: Evidence from Driving School Fees

Abstract

This paper empirically investigates the add-on or drip pricing behavior of firms. We present a model in which consumers purchase a base product and, with some probability, an add-on product from the same firm, but are not always aware of the possible need for the add-on product. We show that a loss leader pricing strategy emerges whereby firms price the base product below single-product pricing levels, but price the add-on at monopoly levels. We test the implications of the model in the Portuguese market for driving instruction where students are frequently forced to pay for additional lessons and repeat driving exams upon failing their initial exam. We benefit from a detailed snapshot of industry data on student characteristics and preferences, school attributes including fees and costs, and market demographics for a cross-section of local markets with differing numbers of school competitors. We find evidence in support of the model predictions. Most notably, prices for the base course of instruction, but not the add-on repeat courses, decline in the number of competitors a firm faces. A consumer survey suggests that approximately one quarter of students are inattentive to repeat fees when making their school choice. This result has important policy implications regarding the cross-subsidization of students who are aware of the add-on by those who are not.