The impact of tariff structure on customer retention, usage, and profitability of access services

Abstract

Past research in marketing and psychology suggests that pricing structure may influence consumers' perception of value. In the context of two commonly used pricing schemes, pay-per-use and two-part tariff, we evaluate the impact of pricing structure on consumer preferences for access services. To this end, we develop a utility-based model of consumer retention and usage of a new service. A notable feature of the model is its ability to capture the pricing structure effect and measure its impact on consumer retention, usage, and pricing policy. Using data from a pricing field experiment for a new telecommunication service, we find that consumers derive lower utility from consumption under a two-part tariff than pay-per-use pricing, resulting in lower retention of customers and lower usage of the service. Specifically, our demand analysis shows that a two-part tariff structure leads to an average decline of 10.5% in the annual retention rate and an average decrease of 38.7% in yearly usage relative to pay-per-use pricing after controlling for income effects. Despite the higher customer churn and lower usage, we find that the two-part tariff is still the profit-maximizing pricing structure. However, our results show that if firms ignore. the pricing structure (or access fee) effect, then they would overcharge customers for the access fee and undercharge them for the per-minute price. Translated in terms of profitability, the failure to account for the access fee effect leads to a reduction of 11% in firm profit.