Pricing and Financial Issues in Marketing Modeling Consumer Choice among Three-part Tariffs

In recent years, firms in a number of industries have introduced wide menus of pricing plans that grant access to a virtually identical product under different pricing schemes. These menus of tariffs allow consumers to self-select into the tariff that best fits their demand. They include pure pay-per-use tariffs, tariffs where the consumer pays an access price, and a marginal price only for usage that exceeds a pre-defined usage allowance, as well as flat-rate tariffs. Tariff menus are frequently offered for products and services such as telephone service, Internet access, car rental services, health clubs, or even museums and amusement parks. Among different pricing schemes for such tariff menus, three-part tariffs are becoming increasingly popular for new telecommunication services such as mobile phone service or Internet access, but also for services such as car rental. A three-part tariff is defined by a fixed access price, an included usage allowance at no additional charge, and a marginal price for any usage in excess of the allowance. The inclusion of an allowance is the main distinction between the threepart tariff and the other tariff structures mentioned above. Proper modeling of consumer tariff choice and usage behavior under three-part tariffs is of relevance to both the provider’s pricing and the measurement of consumer welfare in such industries. A detailed knowledge of consumer tariff choice and usage behavior under three-part tariffs improves the provider’s ability to match consumers’ heterogeneous tastes in pricing, to ultimately reduce customer churn, and to increase profit. Casual evidence suggests that a large number of providers experiment with the various components of their tariffs primarily based on competitive assessments and market intuition, but less based on insights into consumers’ tariff choices and usage behavior. For example, one European Internet service provider had more than ten changes in its tariff structure over a period of only six months. Pricing complexity increases further for new services, for which usage behavior changes rapidly over time, as is true for Internet access. As Internet usage has grown, flat-rate tariffs have replaced three-part pricing structures in the US Internet access market almost completely, while they continue to be used in many European countries. Apart from differences in the