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

Abstract

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 .

Add‐On Pricing in a Distribution Channel

“…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. Geng et al (2018) examine the interaction between add-on pricing and distribution contracts.…”

“…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. Geng et al.…”

“…A growing body of add‐on pricing literature addresses the question that when a firm benefits from add‐on pricing, under which a base good and an add‐on are offered separately, and when a firm benefits from bundling, under which a base good and an add‐on are sold together at one price (e.g., Cui et al. 2018, Ellison 2005, Geng and Shulman 2015, Geng et al. 2018).…”

Predictive and Prescriptive Analytics for Location Selection of Add‐on Retail Products

“…and how to price the bundles (Cui et al. 2018b, Ellison 2005, Geng and Shulman 2015, Geng et al. 2018, Shulman and Geng 2013).…”

“…Extant papers discuss when a firm benefits from bundling (Guiltinan 1987). and how to price the bundles (Cui et al 2018b, Ellison 2005, Geng and Shulman 2015, Geng et al 2018, Shulman and Geng 2013. To our best knowledge, no research has studied where to sell the add-on products, that is, the add-on products' location strategy.…”