Pricing of Conditional Upgrades in the Presence of Strategic Consumers

55 Pages Posted: 30 Jan 2016 Last revised: 29 Nov 2016

See all articles by Yao Cui

Yao Cui

Cornell University - Samuel Curtis Johnson Graduate School of Management

Izak Duenyas

University of Michigan, Stephen M. Ross School of Business

Ozge Sahin

Johns Hopkins University - Carey Business School

Date Written: September 15, 2016

Abstract

In this paper, we study a conditional upgrade strategy that has recently emerged in the travel industry. After a consumer makes a reservation for a product (e.g., a hotel room), she is asked whether she would like to upgrade her product to a higher-quality (more expensive) one at a discounted price. The upgrade, however, is not fulfilled immediately. The firm fulfills upgrades at check-in if higher-quality products are still available, and the upgrade fee is charged to the consumer if and only if she actually gets upgraded. Consumers decide which product type to book and whether to accept an upgrade offer or not based on the anticipated upgrade probability.

We find that conditional upgrades create value by improving demand-supply matching for the firm. The firm can use the conditional upgrade channel to flexibly manage capacity allocations and re-optimize demand segmentation. For a firm that takes product prices as given, offering conditional upgrades is effective in compensating for the firm’s lack of ability in setting prices optimally. For a firm that has the ability to optimize product prices, conditional upgrades generate higher revenues than dynamic pricing.

Keywords: conditional upgrades, strategic consumers, travel industry, revenue management, Bayesian Nash equilibrium, asymptotic analysis

JEL Classification: C62, C72, D11, D40

Suggested Citation

Cui, Yao and Duenyas, Izak and Sahin, Ozge, Pricing of Conditional Upgrades in the Presence of Strategic Consumers (September 15, 2016). Available at SSRN: https://ssrn.com/abstract=2724135 or http://dx.doi.org/10.2139/ssrn.2724135

Yao Cui (Contact Author)

Cornell University - Samuel Curtis Johnson Graduate School of Management ( email )

Ithaca, NY 14853
United States

Izak Duenyas

University of Michigan, Stephen M. Ross School of Business ( email )

701 Tappan Street
Ann Arbor, MI MI 48109
United States

Ozge Sahin

Johns Hopkins University - Carey Business School ( email )

100 International Drive
Baltimore, MD 21202
United States

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