Pricing and Operational Performance in Discretionary Services

In many services, the value or quality derived by a customer from a service depends upon the time the service provider (SP) devotes to the customer and this valuation differs across customers. Examples of such services are website or landscape design. Customers procure the service based on the expected value to be delivered, prices charged and the timeliness of service. Two commonly used pricing schemes for such services are: fixed fee and a time-based or hourly pricing. We explore the impact of these two pricing schemes as well as a first-best pricing scheme on service performance, including SP’s revenues, demand served, utilization, congestion level, etc. To this end, we propose a novel model that captures the above-mentioned features and wherein both service rate and demand are endogenous and functions of the pricing scheme. Furthermore, service time is not exogenous as is assumed in the queuing-based pricing literature but is an outcome of the heterogeneous valuations of customers and the pricing scheme adopted. We find that the fixed fee scheme serves more customers and has higher utilization than the time-based scheme. Benchmarking with the first-best scheme, the time-based scheme over-serves customers whereas the fixed scheme under-serves customers in terms of average service value. Also, when comparing among the pricing schemes, demand served in a pricing scheme can be higher even though customers are effectively charged more per unit time. Interestingly, our results indicate that a higher utilization rate does not necessarily lead to greater congestion. Both the fixed fee and time-based schemes do well relative to the first-best pricing scheme in terms of revenue in many scenarios. The paper also provides insights into when and why the time-based or fixed fee schemes outperform each other in terms of key performance metrics.