Optimal Pricing for a Menu of Service Plans – An Application to the Digital Music Industry

Services vary widely in whether they offer their customers only subscription-based plans, à la carte plans or a mix of both. A priori, it is not obvious which type of plans a retailer should offer and what their optimal prices would be. What makes this analysis complex is that such decisions have to incorporate consumers’ expectation of usage, which may itself be influenced by the offered pricing schemes. To determine optimal prices for a menu of plans then, it is necessary to accommodate the two way dependence between the offered pricing schemes and consumers’ expected usage. This paper addresses such issues for optimal pricing for a menu of plans. We propose an economics-based utility model and analyze how consumers choose among subscription-based and à la carte plans. The model is applied in the context of the digital music industry and is estimated using data from a choice-based conjoint experiment. We find that consumers’ utility from the service is lower if they are charged under a subscription-based pricing scheme than under an à la carte plan. Our model also allows us to infer consumers’ underlying expected usage from their choices of service plans. We use the inferred demand to identify the type of plans a retailer should offer and their optimal prices. An additional benefit of the model is to determine the optimal price that record labels (“manufacturers”) should charge retailers. Our results show that record labels may be overcharging the music retailers to the detriment of overall channel profits.