Optimal Menu Pricing Theory

In the past, travellers were concerned by language barriers and potential cultural differences when visiting foreign countries. Today, to remain connected to the Internet and the rest of the world has become the most pressing issue when travelling abroad. When a traveller first touches down, he asks not where the tour guide is, but seems to be more interested in where can he purchase a local call card that allows him to stay contactable throughout his trip.

Being absolutely inexperienced in a foreign country, how should a traveller select a phone plan that is best suited to his needs without paying more than what he would have valued it? In economics terms, how can a traveller determine his optimal bundle of choice given that he has asymmetrical information overseas?

Here we study the decision of an exchange student who visits Australia, Sydney for the first time and has to purchase a phone plan that serves two main functions: sufficient surfing data for daily usage and international call minutes.

Optus is one of the three main phone plan providers in Australia who offers a wide variety of phone plans at different prices.

OPTUS
Optus prepaid phone lines pricing. Optus.com.au

 

For those who are disturbed by chunks of data, a $30-plan (Plan 30) offers 3GB worth of data, with international calls charged at standard rates. A $40-plan (Plan 40) and $50-plan (Plan 50) offers 7GB and 10GB worth of data respectively. Unlimited international calls are available only for Plans 40 and 50.

Unless you’re trained with economics intuition, it is rather unnoticeable that the differences in prices are not proportionate to the package offered. Between Plans 30 and 40, a $10 difference gives you additional 4GB worth of data and unlimited international calls. On the contrary, an identical $10 difference between Plans 40 and 50 offers only additional 3GB worth of data.

The discrepancy in benefits despite paying the same amount is due to the Optimal Menu Pricing theory, which is a fairly common practice in the telecommunications industry.

This theory posits that sellers offer a product line by creating slight variations among the products, for the purpose of second-degree price differentiation. It relies greatly on the belief that rational consumers will always be willing to pay more for increased benefits as long as consumer surplus is maximised, and that it is in the sellers’ interest to extract maximum profit from every transaction. This brings us to our first conclusion: sellers want to price products as high as possible, while consumers want to maximise consumer surplus as much as they can. This will only work if the consumer surplus from paying more exceeds that of a cheaper bundle. How is that possible?

The seller deliberately lowers the quality of the cheaper plan by removing many desirable features so as to decrease prices and consumers’ value towards the plan, hence reducing willingness to pay. On the contrary, the more expensive plan usually includes much better features so as to increase consumers’ value towards the plan. Sellers can then increase the price of the more expensive plan since consumers have a higher tendency to purchase it, as long as prices are set to induce consumers to believe that they gained more surplus than if they had chosen the cheaper plan.

Plans 30, 40 and 50 are prepaid plans, which suggests that they are largely targeted at travellers, international students or those on a business trip. Optus understands this particular group of market, and can accurately pinpoint the features that will drastically affect willingness to pay.

The ability of sellers to artificially reduce the quality of the inferior plan to make the consumers more willing to spend on the expensive plan was no coincidence. It happens because the sellers are aware of what the target market wants, and that this group of people faces an inelastic demand curve for the products. Perfectly competitive market exists because sellers do not have full knowledge about the market and thus have to rely on supply and demand to determine prices. On the other hand, markets of monopolistic nature are sellers that know their target market, and can adjust their product bundles and prices according to what consumers are willing to pay.

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