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

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  • Xianjun Geng
  • Jeffrey D. Shulman

Abstract

type="main" xml:id="poms12400-abs-0001"> 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 study 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 (and the greater the cost savings generated from add-on pricing), the worse this profit loss gets.

Suggested Citation

  • Xianjun Geng & Jeffrey D. Shulman, 2015. "How Costs and Heterogeneous Consumer Price Sensitivity Interact with Add-On Pricing," Production and Operations Management, Production and Operations Management Society, vol. 24(12), pages 1870-1882, December.
    • Handle: RePEc:bla:popmgt:v:24:y:2015:i:12:p:1870-1882
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    File URL: http://hdl.handle.net/10.1111/poms.2015.24.issue-12
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    Cited by:

    1. Naeeni, Hannan Sadjady & Sahin, Funda & Powell Robinson, E., 2023. "Socially responsible product-positioning: Impact of halo/horns spillover on product image," European Journal of Operational Research, Elsevier, vol. 308(2), pages 852-863.
    2. Peter‐J. Jost & Anna Ressi, 2022. "What can I do for you? Optimal market segmentation in service markets," Production and Operations Management, Production and Operations Management Society, vol. 31(7), pages 2838-2852, July.
    3. Wu, Xiangxiang & Zha, Yong & Yu, Yugang, 2022. "The developer’s sourcing strategy in the presence of a competing manufacturer and consumers’ two-dimensional differentiated preferences," Transportation Research Part E: Logistics and Transportation Review, Elsevier, vol. 158(C).
    4. Yao Cui & Izak Duenyas & Ozge Sahin, 2018. "Unbundling of Ancillary Service: How Does Price Discrimination of Main Service Matter?," Manufacturing & Service Operations Management, INFORMS, vol. 20(3), pages 455-466, July.
    5. Marco Savioli & Lorenzo Zirulia, 2020. "Does add-on presence always lead to lower baseline prices? Theory and evidence," Journal of Economics, Springer, vol. 129(2), pages 143-172, March.
    6. Yu‐Hung Chen & Baojun Jiang, 2021. "Dynamic Pricing and Price Commitment of New Experience Goods," Production and Operations Management, Production and Operations Management Society, vol. 30(8), pages 2752-2764, August.
    7. Chen, Claire Y.T. & Sun, Edward W. & Miao, Wanyu & Lin, Yi-Bing, 2024. "Reconciling business analytics with graphically initialized subspace clustering for optimal nonlinear pricing," European Journal of Operational Research, Elsevier, vol. 312(3), pages 1086-1107.
    8. Can Sun & Yonghua Ji & Xianjun Geng, 2023. "Which Enemy to Dance with? A New Role of Software Piracy in Influencing Antipiracy Strategies," Information Systems Research, INFORMS, vol. 34(4), pages 1711-1727, December.
    9. Adam Bockelie & Peter Belobaba, 2017. "Incorporating ancillary services in airline passenger choice models," Journal of Revenue and Pricing Management, Palgrave Macmillan, vol. 16(6), pages 553-568, December.
    10. Zhen Fang & Yi-Chun (Chad) Ho & Xue (Jane) Tan & Yong Tan, 2021. "Show Me the Money: The Economic Impact of Membership-Based Free Shipping Programs on E-Tailers," Information Systems Research, INFORMS, vol. 32(4), pages 1115-1127, December.
    11. Stacey Mumbower & Susan Hotle & Laurie A. Garrow, 2023. "Highly debated but still unbundled: The evolution of U.S. airline ancillary products and pricing strategies," Journal of Revenue and Pricing Management, Palgrave Macmillan, vol. 22(4), pages 276-293, August.
    12. Baojun Jiang & Hongyan Shi & Tianxin Zou, 2022. "Effects of On‐Demand Product Adjustments on Firm's Pricing and Product Strategies," Production and Operations Management, Production and Operations Management Society, vol. 31(3), pages 1252-1270, March.
    13. Zhang, Yu & Huang, Min & Tian, Lin & Cai, Gangshu George & Jin, Delong & Fan, Zhiping, 2023. "Manufacturer’s product line selling strategy and add-on policy in product sharing," European Journal of Operational Research, Elsevier, vol. 308(3), pages 1332-1343.
    14. Qianbo Yin & Kwei‐Long Huang & Chia‐Wei Kuo & Sean X. Zhou, 2021. "Add‐On Pricing in a Distribution Channel," Production and Operations Management, Production and Operations Management Society, vol. 30(11), pages 4069-4088, November.

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