Does Uncertainty Matter? Consumer Behavior under Three-Part Tariffs

In communication, information, and other industries, three-part tariffs are becoming increasingly popular. A three-part tariff is defined by an access price, a usage allowance, and a marginal price for any usage in excess of the allowance. The nonlinear-pricing literature has focused primarily on two-part tariffs. We show that consumer behavior differs under three-part tariffs, in particular regarding the impact of consumers’ usage uncertainty on tariff choice. We develop a discrete/continuous model of tariff choice among three-part tariffs and estimate the model using consumer-level data on Internet usage. By allowing consumers to switch from their current provider to a competitor, we model behavior in competitive industries. Our results show that demand uncertainty is a key driver of choice between three-part tariffs. For a given tariff and average usage, the expected bill increases with the variation in consumer demand, steering consumers towards tariffs with high usage allowances. Consequently, demand uncertainty decreases consumer surplus and increases provider revenue. In addition, we analyze consumers’ responsiveness to the different elements of a three-part tariff. We find that the access price is the main driver of consumer tariff choice, whose effects dominate any sensitivity to the usage price or the allowance. Based on our results we derive implications for pricing with three-part tariffs.