Optimal Pricing of New Subscription Services: Analysis of a Market Experiment

Abstract

There are now available a number of new subscription services that comprise a dual pricing system of a monthly access fee (rental) and a per-minute usage charge. Examples include cellular phones, the Internet, and pay TV. The usage and retention of such services depend on the absolute and relative prices of this dual system. For instance, a moderate access fee but a low-usage charge might initially appeal to customers, but later a low-usage customer might find the monthly fee unjustified and thereby relinquish the service. Providers of such services, therefore, usually offer several pricing packages to cater to differing customer needs. The purpose of this study is to derive a revenue-maximizing strategy for subscription services, that is, the combination of access and usage price that maximizes revenue over a specified time period. An additional objective is to determine access and usage price elasticities because they have historically played an important role in theoretical pricing models. The application area is the cellular phone market, but for a new rather than an existing product. To help gauge the likely usage rates and customer retention, a field experiment is conducted in which several alternative price combinations are used. Specifically, a sample of potential residential customers (most of whom did not have an existing cell phone) were divided into four treatment groups. The first group were not charged an access fee but did have to pay a small per-minute usage charge. The second group also paid a small usage charge but in addition had three access price increases over the duration of the trial. The third group paid no access fee but had usage charge increases, while the fourth group had both access fee and usage charge increases. Usage levels for each respondent are recorded, as is their month of dropout if they discontinue the service. An initial examination of the data shows that higher access fees result in higher customer attrition, and higher usage cost results in lower usage. Furthermore, usage and retention are related in that declining usage levels over time often signal impending customer attrition. Hence, two phenomena need to be modeled: usage of the service and customer retention conditional on usage. Some seasonal effects are also observed and are allowed for in the model. Modeling customer attrition simultaneously with usage is important because ignoring customer attrition will likely result in an underestimate of price sensitivity. This results from a censoring effect, whereby respondents who remain in the trial tend to be wealthier, and hence, less price sensitive. Given the known problems of ignoring customer attrition, we develop a theoretical model of usage, which explicitly incorporates attrition by extending a time-series model introduced by Hausman and Wise (1979). We make two extensions of the Hausman and Wise model. The first is to generalize it from two to many time periods and the second is to allow for respondent heterogeneity by incorporating latent classes. We fit the mo...

Use of Pricing Schemes for Differentiating Information Goods

“…This is shown in figure 2. Consistent with the findings of Danaher [2002], the reduction in demand from C-type buyers with increases in the site price are due to higher attrition as an increasing number of C-type increase in the unit price is due to reduction in usage levels.…”

“…Several papers have examined fixed fee and usage based pricing schemes. Danaher [2002] analyzes data from a field experiment of mobile phone subscribers who are offered contracts with different access (fixed monthly) fee and usage fees. They estimate price elasticities for the usage and access fees and report different price sensitivity for usage and access fee in their two segment model.…”

Business Models for Media Firms: Does Competition Matter for How They Raise Revenue?

“…Solving @ i =@p i = @ i =@r i = 0 simultaneously for the m media …rms; subject to consumer demand in (3) and advertising demand in (7), gives rise to a unique, symmetric equilibrium. By setting r i = r and p i = p 8i, we …nd:…”

“…7 One of the novelties of their work is to analyze competition between …rms in di¤erent media industries, for instance between a newspaper and a TV channel, an issue not raised here. They also analyze duopolistic competition between media …rms in the same industry, highlighting the impact of competition on media …rms' incentives to underprice (e.g.…”

Pricing of Software Services

“…Essegaier et al(2002) compare two part tariffs with fixed-fee pricing and usage pricing for access service industries under conditions of customer usage heterogeneity and limited capacity. Danaher(2002) conducts a market experiment to compare different two part pricing packages for new subscription services.…”