Unbundling of Ancillary Service: How Does Price Discrimination of Main Service Matter?

Abstract

We consider a setting where the firm sells a main service (e.g., air travel) and an ancillary service (e.g., baggage delivery) to two types of consumers (e.g., business travelers and leisure travelers). We study how the firm’s ability to charge discriminatory main service prices affects its decision of whether to unbundle the ancillary service from the main service and charge separate prices. Unlike a firm using uniform pricing of main service that unbundles the ancillary service if the consumers that value the main service higher have a high likelihood of purchasing the ancillary service, a firm using discriminatory pricing of main service unbundles the ancillary service if the consumers that value the main service higher have a low likelihood of purchasing the ancillary service. Moreover, discriminatory pricing of main service makes unbundling more (less) likely to be the optimal ancillary service strategy when consumers’ main service valuations and ancillary service valuations are negatively (positively) correlated. Finally, we characterize how firms’ use of main service price discrimination and consumers’ valuation structure (i.e., whether the correlation between consumers’ main service valuations and ancillary service valuations is positive or negative) jointly determine the ancillary service strategies in an industry.