Dynamic Pricing of New Services in Subscription Markets

Abstract

We analyze the dynamic price discrimination strategies of a monopolist who offers new services on a subscription basis. Access to customers' subscription histories permits the monopolist to design pricing policies that can be based on customers' past purchase behavior, and on the time period in which they made their purchases. Uncertainty regarding the value of new features, and heterogeneity in consumers' valuation for existing features, creates inter‐temporal incentives that influence both profits and the rate of adoption of new technology. We find that the comparison of pricing regimes critically depends on whether the monopolist finds it optimal to encourage all consumers to adopt the new technology early. The pricing regimes differ only when the prior heterogeneity in consumer valuation for the existing features is relatively large, in which case the monopolist finds it optimal to serve only the part of the population of consumers that has a relatively high valuation. The monopolist can improve his profits by committing to ignore consumer past behavior, and to vary prices based only on the time period. If a stronger commitment to never utilize any price discrimination is feasible, the profits of the monopolist are even higher. However, the “First Best” outcome cannot be achieved, because it requires the monopolist to discriminate in favor of returning customers, by offering them lower prices than it offers to new customers. We also investigate the effect of positive correlation between the consumer valuations for the existing and the new features of the technology. We find that, as the correlation increases, the gap in profits among the various regimes narrows, while the ranking of the regimes remains the same. In particular, with perfect correlation, time inconsistency issues that arise due to lack of commitment disappear completely for all regimes, and the “First Best” outcome is attainable.