Pricing 3

Question 1

Two Part Tariffs Context

Answer 1

Context: A customer can consume multiple units of the product (so far, we have worked with 1 unit consumption).
How should a company price its product for multiple customer segments with different WTP?
Particularly relevant for usage-based pricing
- How are gyms priced? Amusement parks? Buffets? Cellphone plans?

Question 2

Types of Two Part Tariffs

Answer 2

Two-Part Tariffs

• Single price plan for one customer segment
• Single price plan for two customer segments
• Menu of two price plans for two customer segments

Question 3

Structure of a Two-Part Tariff

Answer 3

A Two-Part Tariff requires a consumer to pay:

1. A Fixed Fee (F) that gives the consumer the right to purchase units of a product at a specified price.
2. After paying the fixed fee, the consumer can purchase as many units of the product as desired at a specified per-unit price called the Variable Fee (f).
   - Note: We have been working with “f” all along –this is our Price. We simply rename it as “f” instead of “P”. The Fixed Fee is new.

The consumer’s total expenditure is the Fixed Fee plus the Variable Fee times the quantity purchased (F + f x Q)

Question 4

Examples of Two Part Tariffs

Answer 4

• Cell phone plans
• Theme parks (e.g., Disney World)
• Museums
• Gyms

Question 5

Types of Customer Segments

Answer 5

High Value (HV) Users
Ex. Business use for cell phone plan

Low Value (LV) users
Ex. Personal use for cell phone plan

Question 6

Key Lesson: Serving 1 Segment Only

Answer 6

1. The optimal pricing strategy involves setting a usage based fee equaling average variable cost.
2. The fixed fee (F) equals to the consumer surplus of the segment served.
3. Note that here the two-part tariff enables the firm to extract all possible surplus (whole area of the triangle)

Question 7

Key Lesson: Serving Multiple Segments

Answer 7

1. If we are serving multiple segments with different usage intensities, the optimal pricing strategy involves setting a usage based fee higher than average variable (=marginal) cost.
2. The Fixed Fee in this case equals the consumer surplus of the LV user.

Question 8

Definition: Incentive Compatible Constraint

Answer 8

Incentive Compatible Constraint:

Must Prevent HV from choosing the Two-Part Tariff Designed for the LV

Question 9

Designing a Menu of 2-Part Tariffs

Answer 9

This menu design involves:

• Charging a high fixed fee and low usage-based fee for the HV users
• And a low fixed fee and high usage-based fee for the LV users

We have to make sure that the HV users will not want to choose the tariff plan meant for the LV users (incentive-compatibility constraint).

Question 10

Key Learning Points: Menu for Two Part Tariffs

Answer 10

1. Nonlinear price contracts such as two-part tariffs can increase firm profits
2. The more complex forms of nonlinear pricing extract higher value (due to more flexibility in design) but are more difficult to design