Friday, April 10, 2015 | 2:00pm–3:30pm | Room 331, HSBC Business School Building

Abstract

Firms often cite cost savings as a reason why they charge separately for add-ons. Firms also often face situations where consumers’ price sensitivity is correlated with their valuation of add-ons. While cost savings may directly translate into profit gains in some scenarios, this paper examines the strategic implications of add-on pricing and is the first to suggest that cost savings from add-on pricing may in fact result in profit loss for firms when consumers are heterogeneous in price sensitivity. This is because add-on pricing can trigger a revenue loss that exceeds any cost savings, thus leading to a negative net profit change for competing firms. Even if firms have the capability to pre-commit to not adopting add-on pricing, we show that competing firms can be locked in a prisoner’s dilemma where all choose to adopt add-on pricing and lose profits (as compared to none adopting add-on pricing). We further show the possibility that the greater the cost of providing the add-on service (and the greater the cost savings generated from add-on pricing), the worse this profit loss gets.