Pricing and Operational Performance in Discretionary Services

In many services, for example, website or landscape design, the value or quality derived by a customer depends upon the service time, and this valuation differs across customers. Customers procure the service based on the expected value to be delivered, prices charged, and the timeliness of service. We investigate the performance of the optimal pricing scheme as well as two commonly used pricing schemes (fixed fee and time‐based pricing) for such services on important dimensions such as revenue, demand served, and utilization. We propose a novel model that captures the above features and wherein both service rate and demand are endogenous and functions of the pricing scheme. In particular, service time is an outcome of the pricing scheme adopted and the heterogeneous valuations of customers, unlike in the queueing‐based pricing literature. We find that the service system may benefit from a greater variance in consumer valuations, and the performance of pricing schemes is impacted by the shape of the distribution of customers' valuation of service time and the responsiveness desired by customers. Both the fixed fee and time‐based schemes do well relative to the optimal pricing scheme in terms of revenue in many plausible scenarios, but there are substantial differences between the pricing schemes in some important operational metrics. For instance, the fixed fee scheme serves more customers and has higher utilization than the time‐based scheme. We also explore variants of the fixed and time‐based schemes that have better revenue performance and show that the two‐part tariff which is a combination of fixed and time‐based pricing can do as well as the optimal scheme in terms of revenue.