Uncertain Demand, Consumer Loss Aversion, and Flat-Rate Tariffs

The so called flat-rate bias is a well documented phenomenon caused by consumers' desire to be insured against fluctuations in their billing amounts. This paper shows that expectation-based loss aversion provides a formal explanation for this bias. We solve for the optimal two-part tariff when contracting with loss-averse consumers who are uncertain about their demand. The optimal tariff is a flat rate if marginal cost of production is low compared to a consumer's degree of loss aversion and if there is enough variation in the consumer's demand. Moreover, if consumers differ with respect to the degree of loss aversion, firms' optimal menu of tariffs typically comprises a flat-rate contract

Uncertain Demand, Consumer Loss Aversion, and Flat-Rate Tariffs

The so called flat-rate bias is a well documented phenomenon caused by consumers' desire to be insured against fluctuations in their billing amounts. This paper shows that expectation-based loss aversion provides a formal explanation for this bias. We solve for the optimal two-part tariff when contracting with loss-averse consumers who are uncertain about their demand. The optimal tariff is a flat rate if marginal cost of production is low compared to a consumer's degree of loss aversion and if there is enough variation in the consumer's demand. Moreover, if consumers differ with respect to the degree of loss aversion, firms' optimal menu of tariffs typically comprises a flat-rate contract.Consumer Loss Aversion; Flat-Rate Tariffs; Nonlinear Pricing; Uncertain Demand

Modeling the Psychology of Consumer and Firm Behavior with Behavioral Economics

Marketing is an applied science that tries to explain and influence how firms and consumers actually behave in markets. Marketing models are usually applications of economic theories. These theories are general and produce precise predictions, but they rely on strong assumptions of rationality of consumers and firms. Theories based on rationality limits could prove similarly general and precise, while grounding theories in psychological plausibility and explaining facts which are puzzles for the standard approach. Behavioral economics explores the implications of limits of rationality. The goal is to make economic theories more plausible while maintaining formal power and accurate prediction of field data. This review focuses selectively on six types of models used in behavioral economics that can be applied to marketing. Three of the models generalize consumer preference to allow (1) sensitivity to reference points (and loss-aversion); (2) social preferences toward outcomes of others; and (3) preference for instant gratification (quasi-hyperbolic discounting). The three models are applied to industrial channel bargaining, salesforce compensation, and pricing of virtuous goods such as gym memberships. The other three models generalize the concept of gametheoretic equilibrium, allowing decision makers to make mistakes (quantal response equilibrium), encounter limits on the depth of strategic thinking (cognitive hierarchy), and equilibrate by learning from feedback (self-tuning EWA). These are applied to marketing strategy problems involving differentiated products, competitive entry into large and small markets, and low-price guarantees. The main goal of this selected review is to encourage marketing researchers of all kinds to apply these tools to marketing. Understanding the models and applying them is a technical challenge for marketing modelers, which also requires thoughtful input from psychologists studying details of consumer behavior. As a result, models like these could create a common language for modelers who prize formality and psychologists who prize realism

Uncertain demand, consumer loss aversion, and flat-rate tariffs

We consider a model of firm pricing and consumer choice, where consumers are loss averse and uncertain about their future demand. Possibly, consumers in our model prefer a flat rate to a measured tariff, even though this choice does not minimize their expected billing amount—a behavior in line with ample empirical evidence. We solve for the profit-maximizing two-part tariff, which is a flat rate if (a) marginal costs are not too high, (b) loss aversion is intense, and (c) there are strong variations in demand. Moreover, we analyze the optimal nonlinear tariff. This tariff has a large flat part when a flat rate is optimal among the class of two-part tariffs.Consumer loss aversion, flat-rate tariffs, nonlinear pricing, uncertain demand

Credence goods, experts and risk aversion

The existing literature in expert-customer relationship concludes that when: i) consumers are homogenous, ii) consumers are committed with an an expert once this one made a recommendation, and iii) the type of treatment provided is verifiable, an expert finds optimal to serve efficiently his customers. This work shows that the previous result may not occur when consumers are not risk-neutral. Our result, that holds in a monopoly setting and under Bertrand competition, suggests that risk averse consumers have more likely to be mistreated by experts.CREDENCE GOODS;EXPERT SERVICES;RISK AVERSION

Modeling customer bounded rationality in operations management: A review and research opportunities

Many studies in operations management started to explicitly model customer behavior. However, it is typically assumed that customers are fully rational decision-makers and maximize their utility perfectly. Recently, modeling customer bounded rationality has been gaining increasing attention and interest. This paper summarizes various approaches of modeling customer bounded rationality, surveys how they are applied to relevant operations management settings, and presents the new insights obtained. We also suggest future research opportunities in this important area

The impact of intermediary remuneration in differentiated insurance markets

This article deals with the impact of intermediaries on insurance market transparency and performance. In a market exhibiting product differentiation and coexistence of perfectly and imperfectly informed consumers, competition among insurers leads to non-existence of a pure-strategy market equilibrium. Consumers may become informed about product suitability by consulting an intermediary. We explicitly model two intermediary remuneration systems: commissions and fees. We find that social welfare under fees is first-best efficient but fees lead to lower expected profits of insurers and non-existence of a pure-strategy market equilibrium. Commissions, in contrast, cause 'overinformation' of consumers relative to minimal social cost, but yield a full-information equilibrium in pure strategies associated with higher expected profits of insurers. This might explain why intermediaries are generally compensated by insurers. --product differentiation,intermediation,insurance oligopoly

The CFO’s Information Challenge in Managing Macroeconomic Risk

In this chapter we examine the role of the CFO in setting risk management strategy with respect to macroeconomic risk, in particular, and we consider the information requirements for setting a strategy that is consistent with corporate objectives. We argue that macroeconomic risk management requires a broad approach encompassing financial, operational and strategic considerations. Furthermore, several interdependent sources of risk in the macroeconomic environment must be taken into account. Once this interdependence among, for example, exchange rates, interest rates and inflation are taken into account macroeconomic risk management can be considered a relatively self-contained aspect of Integrated Risk Management (IRM) provided relevant information is available to management. Financial risk management cannot be considered a self-contained part of macroeconomic risk management, however, since value increasing investments in flexibility of business operations affect corporate exposure and make it uncertain.Risk Management Strategy; Macroeconomic Risk; Integrated Risk Management; Chief Financial Officer; Information Needs; Corporate Strategy; Financial Risk; Real Options