Pricing of Digital Content – An Experimental Evaluation of Firm

strategies when consumers maintain mental accounts

Ranjan Dutta, Mary Ridgon and Kerem TomakUniversity of Texas, Austin

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Agenda

• Motivation• Theory• Model • Analytical Results• Current and Future Research

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• Six months ago, you saw an ad for a theater event and called to reserve a $50 ticket. Yesterday you went to the box office and paid $50 in cash for your ticket, which is non-refundable. This morning, you woke up with the flu. The event is tonight. Will you go to the theater or stay at home?

• Six months ago, you saw an ad for a theater event and purchased the ticket for $50, which is non-refundable. This morning, you woke up with the flu. The event is tonight. Will you go to the theater or stay at home?

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• Does temporal separation of consumption and payment matter to consumers?

• Traditional Microeconomic theories predict that to a “rational” consumer it does not matter

• However……• Mental accounting of payment and consumption (Thaler,

85; Prelec and Loewenstein, 1998)– Coupling / Decoupling of payment and consumption– Payment as a disutility (“pain”) and consumption as a utility

(“pleasure”)

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To

tal d

isu

tilit

y o

f a

pay

men

t

Disutility of money spent: the utility that could be realized by spending the money in the best available alternative if the payment were not made

Hassle, effort, or annoyance of the actual actions required to make payment

Pain of paying: psychological aversion to parting with the payment, above and beyond the economic disutility and the hassle

Source: Dan Ariely

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Motivation• Distribution of Digital Content - difficult to devise pricing

schemes that will adequately match consumer’s willingness to pay (Jagannathan, 2002)– Intangibility of product, lack of definition of value for information

products, uncertainty over quality, generally not reusable– IS pricing literature espouses only a traditional microeconomic

viewpoint

• IT enabled payment mechanisms and their use in digital environments – Mobile payment solutions, prepaid Internet scratch cards, direct

debiting e-wallets etc– IT increases the flexibility to use different pricing schemes– Costs of implementing these schemes not prohibitive

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IT Enabled Payment Plans

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Timing of Payment Plans for Digital Content

Balance

SUBSCRIPTION (Sub)

Pay

Read Read Read Read Read Read

PRE-PAYMENT (Pre)

Pay

Read Read Read

Decide Decide Decide

MICRO-PRICING (Micro)

Pay

Read Read Read

Decide PayDecide PayDecide

POST-PAYMENT (Post)

Pay

Read Read Read

Decide Decide Decide

Source: Dan Ariely

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Questions motivating Research

• RQ 1: How does consumer level mental accounting of payment and consumption of digital content impact firm level choices of pricing schemes?

• RQ 2: How does level of customization of digital content interact with choice of payment mechanism when market exhibits MA characteristics?

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Past Work

• Dutta and Tomak (2002, under review) attempted to answer both questions within an analytic framework

• Model Assumptions– Duopoly Market– Firms choose price schemes– Consumption takes place over two periods– Consumers self-select into each firm. Switching is not allowed.– Restrict attention to pure strategies

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Key Concepts

• Residual Effects when payment is separated from consumption (adapted from Prelec and Loewenstein, 1998)– Payment Blow: Disutility that reduces pleasure of consumption

by reminding the consumer about payments that she associates with that consumption

– Consumption Bliss: Utility that reduces the pain from making a payment by reminding the consumer about the pleasures that she associates with that payment

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• Double entry mental accounting (Prelec and Loewenstein, 1998)– One set of entries records the “net” utility derived from

consumption after subtracting the disutility of associated payments i.e. payment blow

– Other set records the “net” disutility of payments after subtracting the utility of associated consumption i.e. consumption bliss

• Residual characteristics (coupling coefficients):

the degree to which payments attenuate the pleasure of consumption

the degree to which consumption buffers the pain of payments

1,0

1,0

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Consumers• Rational

– Maximize net consumer surplus:• is the level of match between the firms’

products and consumers’ expectations• is the utility from consumption• is the price

• Mental Accounting• Separate consumption from payment:

– Consumption net utility:

– Payment net disutility:

u p U0,1

u 0,1p

u pA

Payment Blow

p uA

Consumption Bliss

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Firm StrategiesStrategy F: Strategy M1 Strategy M2:

A B A

u u

p

B A

p p

u u

B A

p

u u

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Computations of Payment Blow and Consumption Bliss

pA u t0

t t0

u tt t0

pt

uA p t0

t t0

p tt t0

ut

ut u for t 1,2

Assumption:Consumption that has already been paid for can be enjoyed as if it were free and that the pain associated with payments made prior to consumption is buffered by thoughts of the benefits that the payments will finance.

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Structure of Game

• Demand from each firm calculated by identifying the marginal consumer (a consumer either chooses one firm or chooses to forego consumption)

• Optimal Pay-offs are calculated by maximizing profits with respect to prices

Player 2

Player 1 F M1 M2

F

M1

M2

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Game 1:Rational Consumers

• No matter what the payment scheme is, resulting payoffs are the same for both firms, i.e. payment scheme does not matter.

• The profits are as follows:

2*2

2*1

)4(

)1()1(

)4(

)1)(1(4

with δ being the discount factor

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Game 2: Mental Accounting Consumers

• Payoffs are different for different pricing schemes

• M1 and M2 are dominated strategies for firm 1

• The game has unique NEs depending on the values of coupling coefficients (α and β) and level of match between the firms’ products and consumers’ expectations (θ)

• M1 is also a dominated strategy for firm 2 within a feasible range of discount factor (δ>0.8)

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PRICING DIGITAL CONTENT

Knowledge of mental accounting helps both firms toincrease their profit levels

Firm that provides a more customized content has no incentive to shift from a “pay upfront” pricing scheme Micro-payments (M1, M1) can not be supported in equilibrium for most feasible ranges of the game

As differentiation decreases, the second firm benefitsby shifting to a “delayed payment” scheme

Knowledge of mental accounting helps both firms toincrease their profit levels

Firm that provides a more customized content has no incentive to shift from a “pay upfront” pricing scheme Micro-payments (M1, M1) can not be supported in equilibrium for most feasible ranges of the game

As differentiation decreases, the second firm benefitsby shifting to a “delayed payment” scheme

Analytical ResultsAnalytical Results

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Current Research

• 12 rounds of one-shot games played between firms who are randomly and anonymously matched each round

• The payoff matrices used in the games are derived by using a

simulated consumer market where the consumers are assumed to

exhibit differing levels of MA characteristics• Two levels of payment blow characteristic, α = 0.25 / 0.75 (high /low)• Two levels of consumption bliss characteristic, β = 0.25 /0.75• Three levels of level of customization, θ = 0.5 / 0.8 / 0.95• Assume δ = 0.9 (most commonly accepted value of discount factor in

economics literature)

Objective: Can we find similar results within a experimental set-up?

Pilot Experimental Design – Baseline Evaluation

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Current Research

• Also simulated consumer market• Firm decision space broader – pricing scheme, level of

customization and price• Uses past theory on product differentiation

– Neven and Thisse (1990) – quality and location– Irmen and Thisse (1998) – n dimensional horizontal characteristics

• Objective– In a market exhibiting MA characteristics, does choice of a pricing

scheme become a differentiating mechanism for content providers?

– Between level of customization and pricing scheme, which one is the more dominating dimension?

Experiments under construction

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Firm Side QuestionsWhat happens when there is asymmetric information about mental accounting among firms?How do firms learn and modify equilibrium strategies when there are repeated interactions?

Consumer Side QuestionsHow does temporal separation of consumption and paymentmatter to consumers within an IT rich environment?Do consumers learn from firm strategic behavior and consciously control for their preferences?

Firm Side QuestionsWhat happens when there is asymmetric information about mental accounting among firms?How do firms learn and modify equilibrium strategies when there are repeated interactions?

Consumer Side QuestionsHow does temporal separation of consumption and paymentmatter to consumers within an IT rich environment?Do consumers learn from firm strategic behavior and consciously control for their preferences?

Future ResearchFuture Research

PRICING DIGITAL CONTENTPRICING DIGITAL CONTENT