Dissertation/Thesis Abstract

Packaging of services with base goods
by Eilat, Assaf, Ph.D., Stanford University, 2008, 49; 3313813
Abstract (Summary)

Firms often sell a base good and services, and may prefer to include some services in a package rather than sell the services separately. For example, hotels offer rooms as well as breakfast, internet, minibar, and a swimming pool. Cellular phone operators offer a line as well as minutes, text messaging, internet surfing, and downloading of ringtones and movies. Banks offer an account along with payment cards, checks, bill pay, overdraft protection, and money transfers.

'Packaging' arises when a firm does not sell the base good without the service. Absent transaction costs, packaging is always weakly sub-optimal because a firm that packages gives up a pricing instrument, namely the price of the service. Transaction and metering costs do not seem relevant in many examples of packaging, in particular given that services are often sold separately by some firms. This dissertation is dedicated to the packaging phenomenon.

The first chapter of the dissertation, 'Packaging and Costly Consumer Search', analyzes why firms package and which services are included in the package. The main idea is related to the search cost literature, which suggests that consumers incur a cost to find the prices charged by different firms. The paper extends the search cost rationale to a single firm that sells multiple goods. In order to acquire information about prices, a consumer must incur an incremental search cost for discovering each price. For example, each single hotel charges multiple prices, and a consumer must incur a (possibly small) extra cost to find the prices of breakfast, wireless internet, or minibar drinks prior to booking the hotel. A similar situation arises when consumers open a bank account or choose a calling plan, but cannot easily compare the fee schedules of different banks or cellular phone operators.

Suppose that a hotel offers rooms and a single service, and guests are heterogeneous in their valuations for the room and for the service. Further suppose that guests must incur a cost to find the service price prior to the booking decision (the cost may also be interpreted as difficulty in selecting a hotel based on multiple prices per hotel). Guests may not be willing to incur the cost, which limits the hotel's ability to commit to the service price and leads to add-on pricing. The hotel's profits suffer because the hotel loses the ability to attract guests by reducing the service price. The hotel faces the tradeoff between setting the possibly too high add-on price and not setting a separate service price at all. Consequently, the hotel packages the service only if the service is more valued by lower-valuation guests.

An empirical application investigates packaging of wireless internet and breakfast at San Francisco hotels. Counter-intuitively, the theory predicts that packaging is more likely to arise at lower-quality hotels: Lower-quality hotels offer lower-quality services, which are more likely to be valued by lower-valuation consumers. Findings indicate that indeed more expensive hotels are significantly less likely to include wireless internet and breakfast in the room price.

Packaging gives rise to non-trivial effects that are not present when firms are able to price every good separately. The second chapter of the dissertation, 'Packaging, Selection, and Correlated Firm Behavior,' explores one consequence of packaging in a competitive environment. Packaging may gives rise to multiple equilibria, which dictate that either all firms provide the service or none of the firms does. The intuition is based on consumer selection. If only one firm offers the service, then it attracts a disproportionally high number of service users. This selection is not bad for the firm as long as it can charge users separately for the service. Under packaging, users pay the same price but create extra costs. Consequently, the two firms perform badly when only one firm offers the service: the service-offering firm suffers from bad selection while the other loses from its market share.

The third chapter of the dissertation, 'Optimal Payment Cards Fees: A Credit-Debit Comparison', discusses how policy can solve adverse effects created by packaging. The paper compares optimal interchange fees in credit cards versus debit cards. Compared to debit cards, credit cards raise efficiency by allowing convenient borrowing, but also tax nonholders in order to finance the rebates paid to credit card users. A welfare enhancing and legally feasible policy is suggested, under which the regressive tax is cancelled while the efficiencies of credit cards are preserved. An outcome of the proposed policy is that credit cards are used for credit purposes only, while debit cards are used as a convenient payment instrument. (Abstract shortened by UMI.)

Indexing (document details)
Advisor: Levin, Jonathan
Commitee:
School: Stanford University
School Location: United States -- California
Source: DAI-A 69/05, Dissertation Abstracts International
Source Type: DISSERTATION
Subjects: Marketing, Economics, Business costs
Keywords: Add-on pricing, Base goods, Bundling, Interchange fees, Packaging, Search, Services
Publication Number: 3313813
ISBN: 978-0-549-62975-7
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