Price Discrimination with Experience Goods: a Structural Econometric Analysis

Firms often offer menus of two-part tariffs to price discriminate among consumers with heterogeneous preferences. In this paper we study the effectiveness of this screening mechanism when consumers are uncertain about the quality of the good and resolve this uncertainty through consumption experiences. We use consumer-level data to estimate a dynamic structural model of forward-looking consumers with heterogeneous demands, both ex-ante and ex-post, for an experience good sold by a monopolist offering a fixed menu of two-part tariffs. Our analysis highlights four elements that influence consumer behavior and affect pricing strategies: beliefs, switching costs, experiential learning, and (ex-ante) mistakes in tariff choice. Since elements of our data contradict the rational expectations assumption, we impose a slightly weaker beliefs assumption. Despite consumers having, on average, unbiased priors, their beliefs conditional on tariff choice are biased. Consumers on flat fee tariffs tend to have optimistic priors whereas consumers on per-use tariffs tend to have pessimistic priors. Combined with high switching costs, this sorting-induced bias implies that flat fee tariffs can yield high profits for the firm even after optimistic consumers revise their beliefs. Biased priors also lead to biased expectations of consumer surplus. Realized surplus is on average negative, despite expectations of surplus of \$118 per consumer. Regarding the use of menus, we find they are ineffective, yielding almost no gain over the optimal single two-part tariff