Serving Heterogeneous Buyers Through Price and Effort Differentiation

Abstract

We investigate the performance of three commonly used pricing schemes — fixed fee, time based contract, and two-part tariff — in service contexts where the buyer’s valuation is invisible to the seller and the seller’s effort may or may not be visible to the buyer even though the buyer is charged based on effort instead of realized quality. We show that the seller’s profit is the same under private or public effort in the case of fixed fee or two-part tariff. Under time based contract, the seller may be better (worse) off in keeping effort private than making it public when the cost of providing service is low (high); the trade-off is also affected by the degree of quality uncertainty in a non-monotonic way. We also find that time based contract can do as well as two-part tariff over a sizable parameter regime when effort is private.