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

We consider a setting where the firm sells a main service (e.g., air travel) and an ancillary service (e.g., in-flight meal) to two types of consumers: high type (e.g., business travelers) and low type (e.g., leisure travelers). The firm decides whether to unbundle the ancillary service from the main service and charge separate prices for different service components. We study the interaction between the optimal ancillary unbundling strategy and the firm’s use of main service price discrimination by analyzing two types of firms: firms that use uniform pricing of main service and firms that use discriminatory pricing of main service. We find that a uniform-pricing (respectively, discriminatory-pricing) firm should unbundle the ancillary service if the fraction of high-type consumers who value the ancillary service is large (respectively, small) enough. The difference hinges on the rationale that under uniform pricing, unbundling allows the firm to extract more ancillary surplus from high-type consumers; by contrast, under discriminatory pricing, bundling allows the firm to extract more ancillary surplus from consumers. Moreover, we find that unbundling the ancillary service and using main service price discrimination are strategic complements (respectively, strategic substitutes) if the correlation between consumers’ main service valuations and ancillary service valuations is low (respectively, high).

The online appendix is available at https://doi.org/10.1287/msom.2017.0646.