Contracts, Biases and Consumption of Access Services

Abstract:     
We consider a consumption model that takes into account the valuation and demand uncertainties that consumers face while using access services. Typical examples of such services include telecommunication services, extended warranties for consumer electronics, and club memberships. We demonstrate that consumption is affected by contract structure (pay-peruse vs. three part tariffs) even if the optimal consumption plans are identical. We find that a majority of individuals correctly use a threshold policy that is similar to a nearly optimal heuristic, however they use the free units too quickly leading to overconsumption and lost surplus. These errors are partially driven by mistaken beliefs about the value distribution. We also measure subjects’ willingness to pay for a contract with free access units, and we find that nearly half of subjects are willing to pay at least the full per-unit price, with a substantial fraction willing to overpay. The optimal firm strategy is therefore to offer a contract that pre-sells access units at a very small discount; this strategy increases revenue by 8-15% compared to only offering a pay-per-use contract.

Number of Pages in PDF File: 42

Keywords: access services, pricing contracts, decision biases, experiment

JEL Classification: C91, D03, D12, L11

working papers series