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—and outside option. The willingness to pay for a service subscription is derived as a closed-form expression, which enables us to characterize the optimal pricing strategy and the impact of service subscriptions on customer surplus. Analytical results and numerical experiments show that offering service subscriptions may result in “win-win,” “win-win-win,” “win-win-lose,” or “lose-lose-win” scenarios or in other situations for the firm, competitors, and customers in a variety of monopolistic and duopolistic scenarios. The advantages of service subscription still remain with heterogeneous customers differing on multiple dimensions including 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 a service subscription may result in a higher customer surplus, compared with that without a service subscription. Ancillary service subscription can help firms to better price-discriminate heterogeneous customers through different subscription decisions and subsequent purchase behavior. This paper was accepted by Gad Allon, operations management.