Add-on Pricing: A Queuing Perspective
43 Pages Posted: 16 Apr 2020
Date Written: April 2, 2020
This work is motivated by the common practice of add-on pricing, where an add-on is not valuable unless purchased together with the main service. For example, many restaurants serve free bread or complimentary drinks (add-on) while diners are waiting for their entrees (main service) to be prepared. We explore the optimal strategy to sell the main and add-on services in a queuing context with delay-sensitive customers (preparing the entree in the kitchen is a queuing process that involves congestion-prone delays). We focus on two pricing schemes: bundle pricing that charges a single price to sell the two services altogether, and separate selling that charges distinct prices for each service. We show that in the absence of queuing, separate selling strictly dominates bundle pricing across the board. However, when there is queuing at the main service but not the add-on (e.g., entrees must be freshly cooked, but free bread is often prepared in large volumes in advance), bundle pricing is optimal under a large customer demand due to a capacity constraint and an endogenous queuing cost. When congestion takes place at both services, separate selling can dominate under a large customer demand, and when it does, we identify its strength in regulating congestion as the key driving force. These plots of reversals are principally driven by an intricate interplay between pricing, market coverage and congestion, and collectively demonstrate novel operational advantages of each pricing scheme.
Keywords: add-on services, congestion effects, queuing game, revenue management
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