How Costs and Heterogeneous Consumer Price Sensitivity Interact with Add‐On Pricing

With the rise of the Internet economy, an increasing number of firms are offering their core products through online platforms, but retail add‐ons directly to consumers. Meanwhile, many online platforms have also started adopting the agency (model) contract, where the upstream firms decide the retail prices of products while the downstream platforms take a predetermined cut from each sale. This study examines the interaction between an upstream firm's add‐on strategy and a downstream online platform's distribution contract choice. We find that such a firm prefers bundling the add‐on and the core product together under the wholesale contract, but prefers retailing the add‐on separately under the agency contract. Our research thus is the first to suggest that the distribution contract can critically affect a firm's choice between add‐on pricing and bundling. On the platform side, we show that a higher commission rate does not always result in a higher profit for the platform under the agency contract. We further identify two conditions under which the platform prefers the agency contract over the wholesale contract: The commission rate for the platform cannot be too low, and the market potential of the add‐on cannot be too large. For the overall channel, we show that the interaction between add‐on pricing and distribution contracts leads to sub‐optimal channel performance. That said, it is possible for both the firm and the platform to obtain higher profits under the agency contract than under the wholesale contract. Finally, we also demonstrate the robustness of our findings under several alternative model specifications.

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“…Following Geng and Shulman (), we assume that

α

proportion of consumers can derive a positive utility

θ_{a} = v_{a}

from the consumption of the add‐on . The remaining

1 - α

proportion of consumers do not derive utility (i.e.,

θ_{a} = 0

) from the consumption of the add‐on.…”

Section: The Modelmentioning

confidence: 99%

How Add‐on Pricing Interacts with Distribution Contracts

Geng

Tan

Wei

2018

Production and Operations Management

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184

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“…Allon et al (2012) find that addon pricing can result in cost savings that benefit both firms and consumers, and therefore increase the social welfare. Geng and Shulman (2015) show that cost savings from add-on pricing may lead to profit loss for firms when consumers have heterogeneous price sensitivity. Cui et al (2018) show that uniform pricing and discriminatory pricing of the base good have contrasting effects on the profitability of add-on pricing.…”

Section: Literature Reviewmentioning

confidence: 99%

Add‐On Pricing in a Distribution Channel

Yin

Huang

Kuo

et al. 2021

Production and Operations Management

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W e consider add-on pricing in a distribution channel where a retailer sells a base good and an add-on, supplied by two manufacturers, respectively, to consumers. The retailer decides whether to sell the two products through either bundling or add-on pricing and sets the corresponding retail prices. Under add-on pricing, the add-on price is unobservable to consumers when they make the purchase decision of the base good. Each manufacturer, if independent of the retailer, sets the wholesale price. Under four channel structures differed by whether either manufacturer is independent of the retailer, we specify the scenario that is optimal for the retailer to adopt add-on pricing and show the contrasting impact from the two manufacturers. When all three firms are integrated, the retailer in general prefers add-on pricing to bundling when the cost of base good is low and the cost of add-on is high. Using this case as the benchmark, we show that add-on pricing is more (less) likely to be adopted when the add-on (base) manufacturer is independent, and add-on pricing is again more likely to be adopted when all three firms are independent. In addition to the demand smoothing effect of bundling, we identify two drivers from the supply side: the margin squeezing effect of bundling from the addon manufacturer and the margin smoothing effect of bundling from the base manufacturer, where the former encourages add-on pricing whereas the latter discourages it. The interplay of these drivers largely influences the retailer's add-on strategy and renders the preceding results. Several extensions are discussed, including correlated consumer valuations of base good and add-on, an alternate decision sequence, knowledgeable consumers (about add-on price), simultaneous offering of bundling and add-on pricing, and bilateral monopoly.

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“…The authors show how differing airline business models emerged as some airlines rushed to product unbundling while others chose not to. In literature, unbundled product pricing is also called à la carte, individual sale, add-on pricing or debundled pricing (Wu et al 2008 ; Nason 2009 ; Geng and Shulman 2015 ). Discussion in Nason ( 2009 ) suggests airlines unbundle products: (1) to capture additional revenue from the differing services needed across customers; and, (2) to not be outpriced by competitors, where customers form their purchase decisions on the base airfare.…”

Section: Literature Reviewmentioning

confidence: 99%

Highly debated but still unbundled: The evolution of U.S. airline ancillary products and pricing strategies

Mumbower

Hotle

Garrow

2022

J Revenue Pricing Manag

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This paper investigates how airline pricing strategies and revenues have evolved over time for unbundled flight products, using the eight largest U.S. airlines. Findings indicate that ticket exchange fees are being eliminated by network and low-cost carriers. On the other hand, baggage and seat reservation fees have grown more complex, with some carriers moving towards dynamic pricing. Ancillary revenues from unbundled flight products represent an increasing portion of airlines’ total operating revenues, especially for ultra low-cost carriers. We estimate that the product unbundling trend has decreased revenues to the U.S. Airport and Airway Trust Fund by 4.0%–4.6% due to untaxed baggage and seat reservation fees alone. We also discuss government policies on ancillary revenue disclosure and pricing transparency, and the global COVID-19 pandemic’s impact on ancillaries.

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How Costs and Heterogeneous Consumer Price Sensitivity Interact with Add‐On Pricing

Cited by 32 publications

References 43 publications

How Add‐on Pricing Interacts with Distribution Contracts

How Add‐on Pricing Interacts with Distribution Contracts

Add‐On Pricing in a Distribution Channel

Highly debated but still unbundled: The evolution of U.S. airline ancillary products and pricing strategies

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