Consumer Choice of Service Plan: Switching Cost and Usage Uncertainty

A strategy used by firms in industries such as wireless is to bundle several services into a service plan and administer a nonlinear price with different marginal prices for different usage levels. Usually firms offer more than one service plan. While product bundling and nonlinear pricing have been extensively studied separately in the economics and marketing literature there are no theoretical or empirical studies that consider them simultaneously. Consumers may be uncertain about their tastes for different services, their preferences may be correlated, and they may face psychological and out of pocket costs to switch among plans. A firm needs to take these into account in designing its pricing strategy. To explore these issues we develop a structural model of consumers' choice of plans and usage decisions, and estimate the model using a dataset from a wireless service provider. We find that consumers derive utility from both voice call and text message and ignoring the fact that consumers simultaneously determine consumption levels of multiple services may lead to biased estimation results. Moreover, we find a somewhat counterintuitive result that consumer preferences for voice call and text message are positively correlated. We show that incorporating switching costs, consumer uncertainty and learning are important in explaining the switching patterns observed in the data. We also conduct several “what-if” scenarios to illustrate how the service penetration process may be different under various behavioral assumptions.