Service Pricing with Loss Averse Customers

Abstract

We consider a service system in which customers are loss averse toward both price and delay attributes. That is, customers compare these two attributes to their rational expectations of outcomes, with losses being more painful than equal-sized gains are pleasant. We first study customers equilibrium queueing strategies. We find that unlike the traditional case in which loss aversion is not considered, there may exist three equilibrium strategies, one of which is preferred in the sense that customers’ utility is highest at this equilibrium. We then investigate the optimal pricing problem for a monopoly server and find that loss aversion polarizes queues, making long queues even longer and short queues even shorter. Furthermore, loss aversion toward the delay attribute drives the optimal price down, whereas loss aversion toward the price attribute drives it up. We also find that profit- and welfare-maximizing prices are not the same in a monopoly market. Finally, we consider pricing competition in a symmetric duopoly market and find that the conclusions depend on the size of the service capacity relative to the market size. For fast servers, there exists a unique symmetric price equilibrium. Under certain conditions, the effect of loss aversion on waiting time drives the price down, whereas that on the monetary term drives it up. For moderate-speed servers, there also exists a unique symmetric equilibrium. However, the effect of loss aversion on the two attributes works in reverse compared with that in the fast server case. For slow servers, we show that a symmetric equilibrium may not exist, and we numerically find that there may exist two asymmetric equilibria. Interestingly, with loss-averse customers, a firm can obtain a higher profit in a duopoly market than in a monopoly market.

Keywords: service pricing, loss-averse customers, strategic queueing behavior, service competition