Doing More with Less: Price Discrimination with Three-Part vs. Two-Part Tariffs

Adib Bagh, Hemant K. Bhargava
2008 Social Science Research Network  
We show that a relatively small menu of three-part tariffs (3PTs) can be more profitable and, sometimes, socially more desirable than a larger menu (more items) of two-part tariffs (2PTs). Often, a single three-part tariff can beat a sorting menu comprising multiple two-part tariffs. Moreover, this 3PT menu can be designed with less information about consumer preferences, relative to the menu of two-part tariffs which, in order to segment customers optimally, needs fine-grained information
more » ... preferences. Our analysis reveals a counterintuitive insight that more ornamental tariffs need not always be more profitable, the source of ornateness influences how efficiently the tariff can price discriminate. The 3PT structure not only produces higher profit, but has lower managerial and decision complexity. Management Insight Paragraph Multi-part tariffs, such as menus of two-part tariffs and three-part tariffs, are widely used in industry, especially for pricing of information goods, online services, telecommunications products, etc. This paper examines the effectiveness of these price structures for price discriminating between heterogeneous customers. We show that a relatively small menu of three-part tariffs (3PTs) can be more profitable and, sometimes, socially more desirable than a larger menu (more items) of two-part tariffs (2PTs). Often, a single three-part tariff can beat a menu of multiple two-part tariffs. Moreover, this 3PT menu has lower "hidden costs" -it can be designed with less information about consumer preferences, relative to the menu of two-part tariffs. The 3PT structure not only produces higher profit, but has lower managerial and decision complexity.
doi:10.2139/ssrn.1134387 fatcat:q6tgumoxnbfoxe5c7vcyu4ebnu