High-type Consumers Research Articles

Monopolistic Screening Under Mental Accounting: Applications to Loan Markets with Collateral

AbstractThis paper extends the standard model of monopolistic screening to allow for some consumers who engage in narrow framing, a prominent behavioral bias of mental accounting. Narrow framing generates a bias toward high quality-price ratios, which induces even high-type consumers to choose a menu that targets low-type consumers. To strategically account for narrow framing, when the monopolist induces the high-type consumers to stay with the more expensive menu, there arises a downward quality distortion even at the top and a smaller downward distortion at the bottom. Then, we apply this model to optimal loan contracts to screen heterogeneous borrowers with different default risks. We find that the lender optimally reduces the collateral requirement for low-risk borrowers when some high-risk borrowers are subject to narrow framing. This result empirically implies that narrow framing may lead to smaller credit rationing and lower monitoring intensity in the lending markets.

The Emergence of a Sharing Market: Pricing, Supply, and Consumption

ABSTRACT The emerging sharing economy increases the utilization of existing products/services, reduces the consumption of new resources, and gets more popular in recent years. We consider a market where consumers are differentiated by their preference for the product and develop an analytical model to study how a person-to-person (P2P) sharing market (ideal or imperfect) affects the manufacturer’s pricing strategies, consumers’ consumption time, consumer surplus, and social welfare. Surprisingly, we find that the existence of the sharing market may drive up the selling price of the product if the sharing platform can endogenously determine the commission fee of sharing transactions. Accordingly, depending on the transaction costs and the proportion of high-type consumers, we find that consumers’ total consumption time, consumer surplus, manufacturer’s profit, and social welfare may not improve in the presence of a sharing market. This study also offers guidelines for the sharing platform and optimal pricing strategies for manufacturers.

Location Choice of a Partially–Private Monopoly Supplier

This paper analyzes the location choice of an upstream monopolist who supplies input to asymmetric duopoly firms in a downstream market. The monopolist is partially private, in that it cares not only about its profit maximization but also about the survival of the downstream firms. Based on the Hotelling model, we find that the monopolist is always attracted to locate closer to the efficient downstream firm. In particular, when the efficiency difference between the two downstream firms is not too high, such that no firm is driven out of the market, the monopolist locates at a distance of 1/6 from the efficient firm in the line segment of unit length. Finally, considering the downstream firms’ survival, we show that the upstream monopolist charges a higher input price on the efficient firm. This study may be relevant to the product differentiation framework, in which firms can benefit from producing goods that are close to the preference of high-type consumers; to the pharmaceutical industry, in which pharmacy companies must cover a broad market segment; or to the policymaking process, in which policymakers may have an incentive to make a policy preferred by a particular group of the society. JEL Classifications: D42, L12, L230

Online cash-back shopping with network externalities

Along with the popularity of online shopping, the cash-back industry is witnessing dramatic development. Under this backdrop, retailers who sell products with network externalities make different decisions about affiliating with cash-back sites. In this paper, we set up a cash-back model considering network externalities. Our goal is to identify the condition under which it is profitable for retailers whose products exhibit network externalities to affiliate with a cash-back site and to find out the driving force of the profitability. We find that only when there are more low-type consumers than high-type consumers and the degree of network externalities is lower than a certain threshold is it profitable for such a retailer to affiliate with an independent cash-back site, because the cash-back rate is decreasing in the intensity of network externality. It is the price discriminative effect instead of the promotive effect that makes it profitable. We show that the double-marginalization problem between the retailer and an independent cash-back site leads to the cash-back paradox where all consumers pay more for the product in the presence of a cash-back channel. We also show that when the retailer affiliates with two cash-back sites, each site has the incentive to lower the cash-back rate to take advantage of network externalities, which makes the cash-back paradox more likely to happen and makes it less likely for a retailer to benefit from cash-back channels. Furthermore, we suggest the retailer establish his own cash-back channel. Our work provides implications for retailers as well as for cash-back sites and consumers.

Price guarantee for advance selling in the presence of preorder-dependent social learning

In this paper, we study the price guarantee policies of a seller practicing the advance selling strategy in the presence of preorder-dependent social learning. There are two types of consumers in the market. In the advance selling period, the high-type consumers arrive and make the preorder decision based on their valuation of the product. In the regular selling period, the low-type consumers arrive and make the purchase decision based on their valuation, which is a result of the preorder-dependent social learning. With a price guarantee policy the preorder consumers are compensated, fully or partially, for the difference between the advance selling price and the regular selling price. We model the seller and two types of consumers' sequential decision game within the framework of rational expectation. We investigate two price guarantee policies: 1) the full-price refund policy, in which the refund always covers the full price difference, and 2) the constant refund policy, in which the refund is a fixed constant. We show that, while the advance selling model with constant refund policy is always better or at least not worse than the base model without price guarantee, the model with full-price refund policy is better than the base model if and only if the high-type consumers' valuation exceeds a threshold. We find that the dominance relationship between the full-price refund policy and the constant refund policy is determined by the segment size of the high-type consumers and their valuation of the product. Through numerical study we find that such dominance relationship also depends on the high-type consumers' belief of the rational risk. Our findings provide important managerial insights for managers in the practice of advance selling.

Unbundling of Ancillary Service: How Does Price Discrimination of Main Service Matter?

We consider a setting where the firm sells a main service (e.g., air travel) and an ancillary service (e.g., in-flight meal) to two types of consumers: high type (e.g., business travelers) and low type (e.g., leisure travelers). The firm decides whether to unbundle the ancillary service from the main service and charge separate prices for different service components. We study the interaction between the optimal ancillary unbundling strategy and the firm’s use of main service price discrimination by analyzing two types of firms: firms that use uniform pricing of main service and firms that use discriminatory pricing of main service. We find that a uniform-pricing (respectively, discriminatory-pricing) firm should unbundle the ancillary service if the fraction of high-type consumers who value the ancillary service is large (respectively, small) enough. The difference hinges on the rationale that under uniform pricing, unbundling allows the firm to extract more ancillary surplus from high-type consumers; by contrast, under discriminatory pricing, bundling allows the firm to extract more ancillary surplus from consumers. Moreover, we find that unbundling the ancillary service and using main service price discrimination are strategic complements (respectively, strategic substitutes) if the correlation between consumers’ main service valuations and ancillary service valuations is low (respectively, high). The online appendix is available at https://doi.org/10.1287/msom.2017.0646 .

Joint Decisions on Production and Pricing with Strategic Consumers for Green Crowdfunding Products.

Green crowdfunding is developing as a novel and popular transaction method, which can largely improve the efficiency of raising initial funds and selling innovative green products or services. In this paper, we explore the creator’s joint decisions regarding green crowdfunding products of different quality levels that can sufficiently satisfy consumer preferences. Firstly, considering the characteristics of a green crowdfunding product, we present four pricing strategies when substitutes exist. Then we propose the optimal pricing strategies to maximize the total profit for the creator under different circumstances, facing strategic and myopic consumers. Finally, for the heterogeneity of consumer valuations, we compare the total profits of the four pricing strategies under different values of the substitution coefficient to obtain the optimal pricing and product strategies under the coexistence of strategic and myopic consumers. According to the result, we find that when the fraction of high-type consumers and the gap between high and low valuations is big, or when they are both small, traditional single pricing shows its benefit. However, when the green crowdfunding products are better than their substitute, a line of green products is more likely to be optimal.

Dynamic contracting under adverse selection and renegotiation

We study the effects of renegotiation in an infinitely-repeated screening model with long-term contracts. We propose a simple and tractable recursive formulation to study equilibria in which the monopolist's profit is maximized after every history. We show that the monopolist sequentially screens high-type consumers and characterize second-degree price discrimination policies. The monopolist's ability to extract rent from high-type consumers by distorting the allocation of low-type consumers vanishes as all parties become more patient. As a result, all distortions disappear and the allocation becomes efficient.

Unbundling of Ancillary Service: How Does Price Discrimination of Main Service Matter?

We consider a setting where the firm sells a main service (e.g., air travel) and an ancillary service (e.g., baggage delivery) to two types of consumers (high-type and low-type, e.g., business travelers and leisure travelers). We study the firm's decision of whether to unbundle the ancillary service from the main service and charge separate prices. We analyze two types of firms: firms that use uniform pricing of main service and firms that use discriminatory pricing of main service. Our analysis highlights the differences in the structure of optimal ancillary service strategies between the two types of firms. First, a uniform-pricing firm unbundles the ancillary service if the consumers that value the main service higher are also very likely to purchase the ancillary service. On the other hand, a discriminatory-pricing firm unbundles the ancillary service if the consumers that value the main service higher are not very likely to purchase the ancillary service. Second, under uniform pricing, as the firm's proportion of high-type consumers increases, unbundling is more likely to be optimal if the correlation between consumers' main service valuations and ancillary service valuations is high, and bundling is more likely to be optimal if the correlation is low. On the contrary, under discriminatory pricing, as the firm's proportion of high-type consumers increases, bundling is more likely to be optimal if the correlation is high and unbundling is more likely to be optimal if the correlation is low. The differences hinge on the rationale that under uniform pricing, unbundling allows the firm to extract more ancillary surplus from high-type consumers; whereas under discriminatory pricing, bundling allows the firm to extract more ancillary surplus from high-type consumers. Finally, we use these findings to discuss industry practice.

A Model of the “It” Products in Fashion

One of the characteristics of the fashion marketplace is the unpredictability and apparent randomness of fashion hits. Another one is the information asymmetry among consumers. In this paper, we consider fashion as a means consumers use to signal belonging to a higher social rank and propose an analytical model of fashion hits in the presence of competition and consumers who can coordinate on which product to use. We show that, consistent with the observed market phenomenon, in equilibrium, consumer coordination involves randomization between products chosen, i.e., in randomness of fashion hits. Analyzing optimal consumer choice, we find that whenever low-type consumer demand for a product is positive, a price increase results in a higher probability of high-type consumers choosing this product but lower low-type consumer demand. We also show that although high-type consumers may prefer (higher) prices that would lead to complete separation of the high- and the low-type consumers through product use, in equilibrium, firms always price as to attract positive demand from low-type consumers. The equilibrium price and profits turn out to be nonmonotonic in the low-type consumer valuation of being recognized as belonging to a higher social rank. Equilibrium profits first increase and then decrease in this valuation.

Research Note—When Is Versioning Optimal for Information Goods?

This paper provides insights about when versioning is an optimal strategy for information goods. Our characterization of this class of goods is that variable costs are invariant with quality, including the special case of zero variable costs. Our analysis assumes a monopoly firm that has an existing product in the market and has an opportunity to segment the market by introducing additional lower-quality versions. We derive a simple decision rule for determining the optimality of versioning based on the solution to a single-product maximization problem. Versioning is optimal when the optimal market share of the lower-quality version, offered alone, is greater than the optimal market share of the high-quality version, offered alone. A firm can profitably employ versioning for an information good if it can design the lower quality in a way that, relative to their valuations for the high-end version, high-type consumers have a lower relative valuation for the lower quality than do low-type consumers. When variable costs increase, a firm that offered only one product version need not consider adding another version. When variable costs decrease, the firm should explore adding a lower-quality version.