Paying Too Much and Being Happy About It: Existence, Causes, and Consequences of Tariff-Choice Biases
By increasingly adopting technologies such as the Internet and smart cards, many companies can now easily monitor consumers� usage volumes. This enables these firms to offer sophisticated, nonlinear pricing schemes, ranging from pure pay-per-use tariffs to flat rates. For example, consumers can choose between optional tariffs for accessing the Internet; online services; local, long-distance, and wireless telephone services; cable; libraries; and even amusement parks or health clubs. Nonlinear pricing schedules have received a lot of attention in the literature, in particular from researchers considering welfare theoretical problems. A common assumption underlying the analysis of consumers� choice among optional tariffs is that consumers choose the tariff that maximizes their surplus and, thus, the tariff that leads to the lowest billing rate for a given amount of usage. Yet there is evidence that many consumers prefer a flat rate even though their billing rate would be lower with a pay-per-use tariff (flat-rate bias), and some consumers prefer a pay-per-use tariff even though they would save money with a flat rate (pay-per-use bias).
The authors conduct four empirical analyses on the existence, the causes, and the consequences of tariff-choice biases using three different data sets. On the basis of transactional data of an Internet service provider, they show that the flat-rate bias is more important and has a greater regularity and time persistence than the pay-per-use bias. They classify potential causes of the flat-rate bias as �insurance effect,� �taxi meter effect,� �convenience effect,� and �overestimation effect.� They show in two surveys that the insurance, the taxi meter, and the overestimation effects lead to a flat-rate bias. In the second survey, they combine survey and transactional data to validate the results and measure real-world behavior. This also provides evidence that underestimation of usage is a major cause of the pay-per-use bias. Finally, the authors analyze the consequences of tariff-choice biases. They show that the flat-rate bias does not significantly increase customer churn and thus results in a short- and long-term profit increase. In contrast, the pay-per-use bias leads consumers to switch to another tariff of the same provider and largely increases churn. Consequently, in the long run, the additional short-term profit of the pay-per-use bias is offset by higher churn and thus does not increase customer lifetime value.
The authors conclude that taxi meter and insurance effects indicate that consumers derive additional benefits from a flat rate that they would not derive from the choice of an alternative tariff. These benefits seem to make consumers happy with their tariff choice, and consequently some consumers pay a flat-rate-specific premium. In contrast, there are no indications for tariff-specific benefits of pay-per-use tariffs. Consumers with pay-per-use bias have a higher likelihood to switch tariffs and a much higher likelihood to churn. Therefore, the authors conclude that these consumers are unhappy with their tariff choice. After they become aware of their mistake in tariff choice, they are ready to switch to another tariff or churn.