Packaging and Costly Consumer Search
10 Pages Posted: 8 Dec 2011 Last revised: 27 Sep 2013
Date Written: December 7, 2010
Firms such as hotels, banks, and telecommunication operators offer packages of a base good and services. This paper asks why firms include services in a package ('packaging') and which services are likely to be included. The main argument is that consumers incur a search cost to discover multiple prices set by a single firm. Consequently firms’ ability to commit to service prices is limited, and firms respond by either packaging or setting monopolistic service prices ('add-on pricing'). Firms prefer add-on pricing to packaging when base good and service valuations are positively correlated and vice versa. Using a dataset of San Francisco hotels I show that more expensive hotels are less likely to include services such as breakfast and internet in the advertised price, and argue that this observation is consistent with the predictions of the model.
Keywords: Bundling, Tying, Packaging, Add-on Pricing, Price Discrimination, Search
JEL Classification: L11, L13, D43
Suggested Citation: Suggested Citation