Allowing Customers To Bundle Themselves Boosts Profitability
Family plans make sense for smartphone users who want to share minutes or data. Research from the University of Maryland’s Robert H. Smith School of Business shows why wireless service providers also win when they offer a full menu of individual and group subscription plans.
“Family plans allow the firm to better price discriminate and capture additional surplus from some consumers,” Maryland Smith professor Bo “Bobby” Zhou and two co-authors write in Marketing Science.
The reason relates to consumers’ risk aversion and something called “flat-rate bias.”
Smartphone users generally want to purchase as little data as possible without hitting their limit and paying overage fees. But they don’t know in advance how much data they will need in a particular month, and consumption may vary from one billing period to the next.
The result is a guessing game between consumers and their wireless service providers. To reduce the uncertainty and avoid the hassle of rationing data at the end of the month, the new research, based on game theory, predicts that many consumers will opt for unlimited or flat-rate plans — even when they would be better off paying by the minute or gigabyte of data.
This is the flat-rate bias. “Even if the payments are higher, consumers still prefer the certainty of paying a set amount each month,” Zhou says. “They may use significantly less data than what they have purchased, allowing firms to sell data that remains unused.”
Family plans give firms additional opportunities to extract surplus from bundled consumer groups. They serve as an effective segmentation instrument by the service providers, and can also improve customer satisfaction because consumers are given the flexibility of forming their groups.
Zhou and his co-authors, Preyas Desai and Devavrat Purohit at Duke University, say the pricing strategy works like conventional product bundling, but in reverse. Instead of one consumer buying a bundle of products — like a meal deal at a fast food restaurant or a cable channel package on television — a bundle of consumers buys one product.
“Bundling consumers can be optimal because it allows the firm to offer them a unique product that is not available to individual buyers,” the authors write.
People like sharing minutes/data, which reduces the risk of any one person exceeding his or her allowance and paying overage fees. But friends and family with different smartphone habits tend to produce more unused minutes/data overall when they buy a one-size-fits-all package, than they otherwise would produce if they acted alone.
The introduction of family plans to the product line also allows firms to charge higher rates for certain individual plans. “An important reason a family plan is profitable is that it allows the firm an opportunity to extract additional surplus from high-valuation consumers who are not part of a family,” the authors write.
Their model, which they test in a mathematical scenario with two individual plans and three family plans, produces higher profits even when the strategy does not increase market size.
“We also show that the addition of a family plan can be more profitable even when doing so reduces the number of consumers served by the firm,” the authors write.
Read more: Preyas S. Desai, Devavrat Purohit, Bo Zhou (2018) Allowing Consumers to Bundle Themselves: The Profitability of Family Plans. Marketing Science 37(6):953-969.