Price differentiation strategies [Elektronische Ressource] / by Agnieszka Wolk

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Price Differentiation Strategies Dissertation Submitted to the Faculty of Business and Economics University of Frankfurt by Agnieszka Wolk Frankfurt am Main 2007 IIForeword Especially the Internet provides a high number of services that have very high fix costs and very moderate variable costs. This applies, for example, to offers of publishing companies, e.g., the search and retrieval of scientific publications, digital music productions, platforms for the production of weblogs and for online communities like Facebook or Xing. Frequently, companies can only offer such services profitably if they use differentiated prices. Thus every customer who pays a price above the variable costs causes a positive gross margin. Yet, the high fix costs can be covered only if at least some of the customers pay prices which lie substantially above the variable costs. Besides, the application of differentiated prices is favoured by the fact that the digitalized services can be easily changed in some attributes so that those services can be better targeted towards different segments of the market. This allows for price differentiation, a strategy where companies profitably sell fairly similar products to different consumers at different prices.

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Price Differentiation Strategies



Dissertation
Submitted to the
Faculty of Business and Economics
University of Frankfurt








by

Agnieszka Wolk








Frankfurt am Main
2007




IIForeword
Especially the Internet provides a high number of services that have very high fix costs and
very moderate variable costs. This applies, for example, to offers of publishing companies,
e.g., the search and retrieval of scientific publications, digital music productions, platforms
for the production of weblogs and for online communities like Facebook or Xing. Frequently,
companies can only offer such services profitably if they use differentiated prices. Thus every
customer who pays a price above the variable costs causes a positive gross margin. Yet, the
high fix costs can be covered only if at least some of the customers pay prices which lie
substantially above the variable costs. Besides, the application of differentiated prices is
favoured by the fact that the digitalized services can be easily changed in some attributes so
that those services can be better targeted towards different segments of the market. This
allows for price differentiation, a strategy where companies profitably sell fairly similar
products to different consumers at different prices.
The literature, especially in economics, shows that price differentiation frequently allows for
substantially increasing profits. Yet, the number of studies in the marketing area is rather
limited. Therefore, it is very nice that Agnieszka Wolk focuses in her dissertation on these
problems and looks at different forms of the price differentiations more thoroughly. In
particular, she analyses nonlinear pricing schedules. These are pricing schedules where the
average per-unit price varies in a nonlinear form with the quantity being purchased. The most
prominent example is a two-part tariff which consists of a (usage-independent) fixed fee and
a (usage-dependent) per-unit price. Other examples are block tariffs or quantity discounts.
The basic idea of nonlinear pricing schedules is to influence consumers' usage behavior in
order to increase the quantity being consumed and to skim additional consumer surplus to
increase profit (or welfare).
Such nonlinear pricing schedules are especially suitable for non-storable products that are not
transferable from one person to another and for which the consumer would like to consume
more than one unit. The possibilities to influence consumers' usage behavior with such
nonlinear pricing schedules have attracted considerable interest from both, theory and
practice. In practice, these nonlinear pricing schedules are traditionally applied by companies
within the telecommunication and the electric power industry. Yet, more and more companies
start offering nonlinear pricing schedules. Examples are companies within the transportation
IIIindustry (e.g., the German Railway with the so called "BahnCard" or car rental companies) as
well as Internet Service Providers.
In theory, the determination of nonlinear pricing schedules has been especially analyzed by
researchers considering welfare theoretical problems. Starting with the work by Lewis (1941)
and Coase (1946), researchers such as, e.g., Oi (1971), Leland and Meyer (1976), Faulhaber
and Panzar (1977), Willig (1978), Schmalensee (1981), Goldman et al. (1984), Wilson
(1993), have contributed much to our understanding of the welfare implications of such
nonlinear pricing schedules. Lewis (1941) was the first to show that the use of a two-part
tariff instead of a single price allows to increase welfare. Oi (1971) outlined in his seminal
paper how to design optimal two-part tariffs to price differentiate among heterogeneous
consumers. Leland and Meyer (1976) demonstrated that a profit maximizing firm always
prefers a two-part tariff over a uniform price (later on called linear tariff). Murphy (1977),
Faulhaber and Panzar (1977) as well as Willig (1978) extended this analysis and showed that
adding one two-part tariff to a system with n different two-part tariffs always increases profit
as well as welfare as long as there is no tariff whose per-unit price equals marginal cost.
Spence (1977), Goldman et al. (1984) and Wilson (1993) specified the pricing schedule as a
continuous function and achieved additional powerful insights into the characteristics of the
optimal pricing schedule.
Although those papers result in a number of very important characteristics of optimal
nonlinear pricing schedules, this research did not focus on the empirical estimation of
consumers' usage behavior. For the insights being gained by those papers, it was sufficient to
assume that individual demand functions do not cross and that the heterogeneity in consumer
behavior can be characterized either by a single-dimensional type parameter (see the
summaries in Brown and Sibley 1986; Mitchell and Vogelsang 1991) or, in very few cases,
by multi-dimensional type parameters (e.g., Maskin and Riley 1984; Wilson 1996) which
follow certain distributions and describe the deviation from an "average" demand function.
However, those researchers have not focused on the empirical estimation of consumers' usage
behaviour of such tariffs. That is the contribution of the dissertation of Agnieszka Wolk. She
nicely outlines a very promising approach that uses an enhanced method of conjoint analysis
for estimating willingness-to-pay functions and she also presents several empirical studies in
which consumers deviate form the "optimal" behaviour. Hence, her dissertation substantially
enhances our knowledge in the area of price differentiation, especially in the area of
IVnonlinear pricing. Therefore, I strongly recommend researchers and practitioners to carefully
study this dissertation.

Prof. Dr. Bernd Skiera
University of Frankfurt, Germany
VReferences
Brown, S.J., & Sibley, D.S. (1986). The Theory of Public Utility Pricing. Cambridge et al.
Coase, R.H. (1946). The Marginal Cost Controversy. Economica, 13(54), 168-182.
Faulhaber, G.R., & Panzar, J.C. (1977). Optimal Two-Part Tariffs with Self-Selection. Bell
Laboratories Discussion Paper, No. 74, Bell Laboratories.
Goldman, M.B., Leland, H.E., & Sibley, D.S. (1984). Optimal Nonuniform Pricing. Review
of Economic Studies, 51(April), 305-320.
Leland, H., & Meyer, R. (1976). Monopoly Pricing Structures with Imperfect Discrimination.
Bell Journal of Economics, 7(2), 449-462.
Lewis, A. (1941). The Two-Part Tariff. Economica, 8(31), 249-270.
Maskin, E., & Riley, J. (1984). Monopoly with Incomplete Information. Rand Journal of
Economics, 15(2), 171-196.
Mitchell, B.M., & Vogelsang, I. (1991). Telecommunication Pricing: Theory and Practice.
Cambridge, UK.
Murphy, M.M. (1977). Price Discrimination, Market Separation, and the Multi-Part Tariff.
Economic Inquiry, 15(4), 587-599.
Oi, W.Y. (1971). A Disneyland Dilemma: Two-Part Tariffs for a Mickey Mouse Monopoly.
Quarterly Journal of Economics, 85(1), 77-96.
Schmalensee, R. (1981). Monopolistic Two-Part Tariff Arrangements. Bell Journal of
Economics, 12(2), 445-466.
Spence, A.M. (1977). Nonlinear Prices and Welfare. Journal of Public Economics, 8(1), 1-
18.
Willig, R. (1978). Pareto-Superior Nonlinear Outlay Schedules. Bell Journal of Economics,
9(1), 56-69.
Wilson, R. (1993). Nonlinear Pricing. New York et al.: Oxford University Press.
Wilson, R. (1996). Nonlinear Pricing and Mechanism Design. In H.M Amman, D. Kendrick,
& J. Rust (Eds.), The Handbook of Computational Economics. Amsterdam.



VIPreface
Both practitioners and academics agree about the importance of price and its direct influence
on consumers’ purchase decision as well as the company profit. In the reality, we rarely see a
single price for a given product. One visit in a store already shows that consumers face many
various prices. This strategy of differential prices allows to increase profit but also improves
consumers’ situation and increases welfare.
A wide range of various price differentiation mechanisms exists on the market which makes
price differentiation a very interesting phenomenon. Additionally, market developments
constantly allow for new price differentiation applications. In this work, I research a
fascinating topic of price differentiation, its various forms and new application possibilities in
changing market areas.
I wouldn’t have accomplished this dissertation if it wasn’t for Prof. Dr. Bernd Skiera, whom I
would like to thank for his continuous support, many fruitful discussions and suggestions that
helped to shape this work. I would also like to thank my colleagues and co-authors Anja
Lambrecht, Sven Theysohn, Martin Spann and Christian Schlereth for their engagement and
help. I find our cooperation exciting and very stimulating. Additionally, I would like to thank
the Chair of Electronic Commerce and the Marketing Department of the University of
Frankfurt for great cooperative atmosphere and numerous inspiring discussions. Especially, I
am grateful to Prof. Dr. Daniel Klapper, who together with Prof. Dr. Bernd Skiera, reviewed
this work.
Lastly, I would like to thank my mother, Feliksa Prokopowicz, and my husband, Wojciech
Wolk, for their support in good and bad times.

Agnieszka Wolk
Frankfurt am Main, December 2007
VII VIIITable of content

Synopsis 1
Cumulative Dissertation
I. Der Paid Content-Markt – Eine Bestandsaufnahme und Analyse von 25
Preisstrategien
II. Multi-Channel Pricing Strategy: To Price Differentiate or Not 47
III. Augmented Methods of Conjoint Analysis to Estimate the Willingness 71
to Pay for Multiple-Unit Products
IV. The Influence of Tariff-Specific Preferences on Tariff Choice and 107
Usage
V. Established Phenomenon or Occasional Incident? Persistence of Tariff- 125
Choice Biases across Pricing Schemes
VI. The Effects of Reference Prices on Bidding Behavior in Interactive 151
Pricing Mechanisms






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