Paying Too Much and Being Happy About it: Existence, Causes and Consequences of Tariff-Choice Biases

Abstract

A common assumption underlying the analysis of consumers' choice between optional tariffs is that consumers choose the tariff that maximizes consumer surplus and, thus, the tariff that leads for a given amount of usage to the lowest billing rate. Yet, there is evidence that many users prefer a flat rate even though their billing rate would be lower on a pay-per-use tariff (flat-rate bias) and some users prefer a pay-per-use tariff even though they would save money on a flat rate (pay-per-use bias). The authors conduct four empirical analyses based on three different data sets. They show that the flat-rate bias is more important and has a greater regularity and time-persistence than the pay-per-use bias. They classify potential causes of the flat-rate bias as insurance effect, taxi meter effect, convenience effect, and overestimation effect and show that the insurance, the taxi meter and the overestimation effect lead to a flat-rate bias. They provide evidence that underestimation of usage is a major cause of the pay-per-use bias. They show that the flat-rate bias does not significantly increase customer churn and thus results in a short- and long-term profit increase. In contrast, the pay-per-use bias largely increases churn so that the additional short-term profit is in the long-term offset by higher churn.

Keywords: pricing, nonlinear pricing, flat-rate bias, pay-per-use bias, tariff choice, consumer behaviour, internet

JEL Classification: M3, M30, M31, L1, L11, L86