Information Structures, Price Discrimination and Demand Uncertainty

Numerous contract scenarios in information technology goods and services, telecommunications, digital entertainment, and supply chain contracting feature demand uncertainty for individual customers (demand is subject to idiosyncratic demand shocks that change marginal valuations). Sellers in these scenarios often use non-linear pricing mechanisms (flat rate, two part tariffs, three-part tariffs, blockdeclining tariffs) in order to price discriminate between heterogeneous consumers. These contracts typically cover a long time, and sellers face a choice about the degree of information they allow the consumers to have about their demand when choosing terms from the contract menu. For example, the seller could ask a consumer to choose from a non-linear price menu at the beginning of the contract period (when the buyer’s demand is still uncertain); such ex-ante contracts occur in sales force compensation, “push” supply contracts between firms, and many online hosting services. Alternately, the seller could allow the customer to choose the terms of contract ex-post after realization of the demand shock (this realization is private information to the buyer). In this case, the only ex-ante decision made by customers is whether or not to sign the contract. The seller, on the other hand, must set the contract terms without knowledge of the demand shock. A striking example of this is Nextel’s Auto Adjust wireless calling plans where, given a menu of plan levels and prices, the contract “automatically adjusts to put you on the lowest plan level based on how much you used your phone.” Other examples are “pull” supply contracts, buyback policies, and wireless calling plans which allow consumers switch their current plan at month-end in order to get a lower total price for that month. Figure 1 illustrates two extremes of information structures. We are interested in the different factors that affect a monopolist’s decision regarding her choice of information structure to impose on buyers. On one hand, forcing the buyers to sign a contract before they resolve idiosyncratic shocks allows the seller to extract entire surplus (minus any information rents to induce self-selection) of the average buyer. But, could the seller extract additional surplus by allowing buyers to resolve demand uncertainty before choosing the terms of a contract? Since the resolution of uncertainty creates a better match between buyers preferences and their consumption patterns, the seller could with some probability—and by using an appropriate pricing mechanism—extract some of