Effects of Flexible On-Demand Upgrade/Downgrade on Firm’s Pricing and Product Strategies
50 Pages Posted: 20 Sep 2019 Last revised: 2 Jan 2021
Date Written: January 1, 2021
In many markets, consumers have time-varying needs for product or service quality. However, due to the lack of real-time processing capability or the high transaction costs to process consumers’ change requests, firms had not allowed customers to frequently alter their subscribed level of service or product quality to dynamically adjust to their changing needs. With advances in mobile and information technologies as well as in logistical services, the transaction costs for processing these frequent changes have significantly decreased, and more firms are now capable of dynamically altering a customer’s service quality on demand. These firms can allow and efficiently process a customer’s request for short-term (e.g., daily or hourly) product or service upgrade/downgrade. This paper provides an analytical model to examine the effects of a firm’s on-demand product-adjustment capability (OPAC) on its optimal pricing and product-line decisions in a market where consumers have time-varying product needs and different consumer segments have heterogeneous ex ante probabilities of being in a high-need state. We find that OPAC does not always improve the firm’s profit: it does so only when the variation of consumers’ valuations of a product between the two need states is intermediate and each consumer segment is large enough. One may intuit that under OPAC, the firm tends to reduce the optimal quality for the low-end product to convince customers to upgrade from the low-end to the high-end product. Interestingly, we find that OPAC can lead to an increase in quality for both the high-end and low-end products.
Keywords: pricing, micro-transaction, quality, product line, upgrade, micro-payment
JEL Classification: D21, D42, M31
Suggested Citation: Suggested Citation