Pricing under quality of service uncertainty: Market segmentation via statistical QoS guarantees

doi:10.1016/j.ejor.2007.07.013

European Journal of Operational Research

Volume 191, Issue 3, 16 December 2008, Pages 1189-1204

https://doi.org/10.1016/j.ejor.2007.07.013 Get rights and content

Abstract

This article examines how performance-contingent pricing schemes with long-term statistical performance guarantees can be applied to many IT services. We study two forms of performance-contingent pricing, with rebate proportional to failure rate and fixed rebate for below-threshold performance. We show that threshold-performance contingency pricing can increase both profits and fairness (customers who receive higher benefits pay higher effective price) relative to standard pricing. But an even better solution is to offer a menu of performance guarantees: this can increase the firm’s profit and segment the market. Only service providers whose performance level is sufficiently better than the industry standard can benefit from this pricing mechanism.

Section snippets

Motivation

Quality of service (QoS) uncertainty is common for many IT goods and services, owing to factors such as unobservability of product, stochasticity in manufacturing or delivery process, lack of end-to-end control (Bhargava and Sundaresan, 2003). Examples include network availability and latency, data rates and signal quality in wireless or Wi-Fi networks, online trading systems, voice over IP, video streaming applications, online digital libraries, and customer service call centers. QoS

QoS Uncertainty and market segmentation

A common tool to price discriminate between heterogeneous customers is non-linear usage-sensitive pricing (usually, quantity discounts). However, when customers are uncertain about future consumption quantities (as is common for many IT services), they often exhibit a strong “flat-rate bias,” meaning that reservation prices are higher for unlimited use than under metered pricing. Such a bias has been observed for various telecommunications products, telephony, internet service, and health clubs

Performance-based pricing

This section specifies a modeling framework for the analysis of performance-based pricing under QoS uncertainty.

Analysis and results: What sort of guarantee?

This section analyzes the pricing schemes discussed above, and we demonstrate that the design of the performance guarantee is crucial in determining whether or not it makes a positive impact on market outcomes.

Menu of guarantees induces segmentation

The previous section demonstrated that performance-based pricing can be effective when QoS uncertainty precludes differential pricing based on quality and flat-rate pricing prevents differentiation based on quantity consumed. In such circumstances, performance-based pricing can extract higher fees from heavy users, increasing fairness as well as the service provider’s profit. In this section, we examine whether these results are improved when the firm offers differential performance guarantees

Conclusions

Performance uncertainty limits the ability of service providers to segment the market by providing differential QoS to different classes of customers. We demonstrate that performance-contingent pricing can increase the service provider’s profits, but also facilitate market segmentation in such settings, thereby increasing profits, market coverage, and social welfare. Performance-contingent pricing with a threshold quality specification outperforms standard pricing even when customers have

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^☆: Authors contributed equally and are listed in alphabetical order.

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Pricing under quality of service uncertainty: Market segmentation via statistical QoS guarantees☆

Abstract

Section snippets

Motivation

QoS Uncertainty and market segmentation

Performance-based pricing

Analysis and results: What sort of guarantee?

Menu of guarantees induces segmentation

Conclusions

Journal of Retailing

Information Economics and Policy

Group buying on the web: A comparison of price-discovery mechanisms

Management Science

Betting on the future: The virtues of contingent contracts

Harvard Business Review

An inverse-optimization-based auction mechanism to support a multiattribute RFQ process

Management Science

Contingency pricing for information goods and services under industry-wide performance standard

Journal of Management Information Systems

Stockout compensation: Joint inventory and price optimization in electronic retailing

INFORMS Journal on Computing

Product risk sharing by warranties in a monopoly market with risk-averse consumers

Journal of Economic Behavior and Organization

Applied Statistical Methods

Statistical performance guarantees in large-scale cross-path packet switch

IEEE/ACM Transactions on Networking

Providing Internet access: What we Learn from INDEX

IEEE Network

partial-repeat-bidding in the name-your-own-price channel

Marketing Science

Measuring the frictional costs of online transactions: The case of a name-your-own-price channel

Management Science

Essays in the Economics of Uncertainty