Fee or free? How much to add on for an add-on
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Fee or free? How much to add on for an add-on Gila E. Fruchter & Eitan Gerstner & Paul W. Dobson
Published online: 6 April 2010 # Springer Science+Business Media, LLC 2011
Abstract Sellers often provide complimentary “no extra charge” add-ons (e.g., free Internet connection) to consumers who buy their primary products (e.g., a hotel stay), but recently add-ons that used to be free are offered for a fee. The conventional wisdom is that unadvertised add-ons for high fees help competitors increase profits that are competed away by advertising low prices for the basic products. This theory cannot explain why complimentary add-ons are still offered by some sellers. We show that providing complimentary add-ons can be profitable for sellers with monopoly power under certain demand conditions. If these demand conditions are not met, it is optimal to charge a supplementary fee for the add-on. We also show how pricing policy can be designed to selectively target or deter different consumer segments from purchasing the add-on to boost sellers’ profits, providing a strategic role for selling add-ons at either below-cost or at exorbitantly high prices. Yet such behavior may have repercussions for economic welfare when it results in socially inefficient giveaways when consumers would be better served with a lower price on the basic product without the add-on or, with the other extreme, when it results in excessively high prices for an add-on that restricts sales and leads to its underprovision from a societal perspective. The paper also provides managerial insights on the design and use of add-ons. Keywords Pricing . Add-ons . Complimentary service . Supplementary fee
G. E. Fruchter (*) Graduate School of Business Administration, Bar-Ilan University, Ramat-Gan 52900, Israel e-mail: [email protected] E. Gerstner Faculty of Industrial Engineering and Management, Technion-Israel Institute of Technology, Haifa 32000, Israel e-mail: [email protected] P. W. Dobson Norwich Business School, University of East Anglia, Norwich NR4 7TJ, UK e-mail: [email protected]
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Mark Lett (2011) 22:65–78
1 Introduction “This service is complimentary.” Customers have been used to receiving free “addon” products and services when they go to concerts (free programs), visit restaurants (free bread) and hotels (free Internet), fly airlines (complimentary movies, food, and drinks), buy computers (free software), or buy cosmetics (receiving free gifts). Recently, however, some sellers have started to charge fees for add-ons that were previously provided for free. Airlines in the USA and Europe started to charge customers for food and drinks served on board and for baggage carried into the airplanes. One airline even announced that it might charge passengers to use the bathroom on board by possibly putting a coin slot on the toilet door (one reporter even called it “a fee to pee”, Wessling 2009). The move from free to fee has been previously observed in the banking industry (e.g., teller machine fees), the hotel industry (e.g., Internet s
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