Pricing Services Subject to Congestion: Charge Per-Use Fees or Sell Subscriptions?

Should a firm charge on a per-use basis or sell subscriptions when its service experiences congestion? Queueing-based models of pricing primarily focus on charging a fee per use for the service, in part because per-use pricing enables the firm to regulate congestion—raising the per-use price naturally reduces how frequently customers use a service. The firm has less control over usage with subscription pricing (by definition, with subscription pricing customers are not charged proportional to their actual usage), and this is a disadvantage when customers dislike congestion. However, we show that subscription pricing is more effective at earning revenue. Consequently, the firm may be better off with subscription pricing, even, surprisingly, when congestion is intuitively most problematic for the firm: e.g., as congestion becomes more disliked by consumers. We show that the absolute advantage of subscription pricing relative to per-use pricing can be substantial, whereas the potential advantage of per-use pricing is generally modest. Subscription pricing becomes relatively more attractive if consumers become more heterogeneous in their service rates (e.g., some know they are “heavy” users and others know they are “light” users) as long as capacity is fixed, the potential utilization is high, and the two segments have substantially different usage rates. Otherwise, heterogeneity in usage rates makes subscription pricing less attractive relative to per-use pricing. We conclude that subscription pricing can be effective even if congestion is relevant for the overall quality of a service. Keywords service operations, operations strategy, pricing and revenue management, game theory, queueing theory Disciplines Business | Business Administration, Management, and Operations | Business Analytics | Management Sciences and Quantitative Methods | Marketing | Operations and Supply Chain Management | Sales and Merchandising This technical report is available at ScholarlyCommons: https://repository.upenn.edu/marketing_papers/320 Pricing Services Subject to Congestion: Charge Per-Use Fees or Sell Subscriptions? Gérard P. Cachon Pnina Feldman Operations and Information Management, The Wharton School, University of Pennsylvania, Philadelphia, Pennsylvania 19104, USA Operations and Information Technology Management, Haas School of Business, University of California, Berkeley, California 94720, USA cachon@wharton.upenn.edu feldman@haas.berkeley.edu June 17, 2008; revised July 14, 2009; May 21, 2010; August 10, 2010 Should a rm charge on a per-use basis or sell subscriptions when its service experiences congestion? Queueing-based models of pricing primarily focus on charging a fee per use for the service, in part because per-use pricing enables the rm to regulate congestion raising the per-use price naturally reduces how frequently customers use a service. The rm has less control over usage with subscription pricing (by denition, with subscription pricing customers are not charged proportional to their actual usage), and this is a disadvantage when customers dislike congestion. However, we show that subscription pricing is more e¤ective at earning revenue. Consequently, the rm may be better o¤ with subscription pricing, even, surprisingly, when congestion is intuitively most problematic for the rm: e.g., as congestion becomes more disliked by consumers. We show that the absolute advantage of subscription pricing relative to per-use pricing can be substantial whereas the potential advantage of per-use pricing is generally modest. Subscription pricing becomes relatively more attractive if consumers become more heterogeneous in their service rates (e.g., some know they are heavyusers and others know they are lightusers) as long as capacity is xed, the potential utilization is high and the two segments have substantially di¤erent usage rates. Otherwise, heterogeneity in usage rates makes subscription pricing less attractive relative to per-use. We conclude that subscription pricing can be e¤ective even if congestion is relevant for the overall quality of a service. How should a rm price its service when congestion is an unavoidable reality? Customers dislike congestion, so a rm has an incentive to ensure it provides reasonably fast service. At the same time, the rm needs to earn an economic prot, so the rms pricing scheme must generate a su¢ cient amount of revenue. Furthermore, these issues are closely linked: the chosen pricing scheme inuences how frequently customers use a service, which dictates the level of congestion; congestion correlates with the customersperceived value for the service, and that determines the amount of revenue the rm can generate. A natural option is to charge customers a per-use fee or toll: customers pay a per-transaction fee each time they withdraw money from the ATM; beauty shops and hair salons price on a peruse basis; and car maintenance companies, such as Pep Boys Auto, charge each time a service is