Effects of On-Demand Product Adjustments on Firm’s Pricing and Product Strategies

Abstract

In many markets, consumers have time-varying needs for product or service quality. Recent technology advances equip firms with the on-demand product-adjustment capability (OPAC), which allows them to efficiently process customers’ requests for short-term (e.g., daily or hourly) changes of service quality to meet their time-varying demands. This paper examines how OPAC affects a firm’s optimal pricing and product-line decisions in a market with consumers having time-varying product needs and different average need levels. We show that OPAC does not always improve the firm’s profit: it does so only when consumers’ valuations vary significantly over time or when each segment of consumers with different ex ante probabilities of having a high valuation is not too small. We also find that, although OPAC enables the firm to provide additional options to serve more consumer segments, it may actually induce the firm to optimally serve fewer consumer segments. One may intuit that OPAC would induce the firm to reduce the low-end product’s quality to elicit more upgrades; our analysis shows that, interestingly, OPAC can lead to an increase in quality for both high-end and low-end products.

Keywords: pricing, micro-transaction, quality, product line, upgrade, micro-payment, valuation uncertainty

JEL Classification: D21, D42, M31