Taxing Your High Volume Customers

When the pricing per unit is not uniform across all units and varies with quantity purchased, it is called non-linear pricing in economics. There are two main reasons a marketer will practice non-linear pricing:

  1. Customers have decreasing marginal utility with every additional unit and the price must change to reflect the reduced value. So if you are a maker of bottled water, you price your single bottle at one price and multi-pack at different price.
  2. Another reason is to reflect your decreased cost to serve the customer who buys high volume. Suppose you made and sold physical components, like the glass pane for LCD panels any customer buying high volume helps to defray  many different costs and  contribute to large proportion of your revenue and profits so you give a discount

Should you always decrease the price with volume? Non-linear does not mean prices will only decrease with quantities purchased, price per unit can increase as well.  There are three primary reasons for this:

  1. The value to customer increases non-linearly with the quantities they buy. For example, a $10 Mbps Internet connection enables new services that are of higher value than that is possible with a 7Mbps connection.
  2. The cost to serve the customer increases non-linearly after certain limit. For example, there is need for new investments or new costs that need to be passed along to the customer.
  3. Allowing the customer to consume high quantities comes at higher opportunity cost in the form of lost sales.

The third reason is exactly the case with cellphone providers. In a NYTimes article on Cellphone pricing plans, economists (surprisingly) described this as “weird”

“The whole pricing thing is weird,” said Barry Nalebuff, an economics professor at the Yale School of Management. “You pay $60 to make your first phone call. Your next 1,000 minutes are free. Then the minute after that costs 35 cents.

”To economists, it simply doesn’t make sense to make chatterboxes pay that penalty. After all, most businesses tend to give discounts to customers who buy more.

It is not weird if you look at how cellphone networks are provisioned. The way said cellphone pricing plans are structured is called three-part tariffs. At any given coverage area, served by one Radio Base Station, there is limited capacity. At any given time only so many users (voice or data) can be supported.  With all pre-paid subscribers a cellphone provider can size their system accordingly knowing how many total users they can support and based on call model how many simultaneous calls they can support.

Admitting a user to consume radio capacity beyond their allocated minutes will come at the expense of not providing service to other paid customers. Charging a higher unit price per minute will discourage those heavy users and nudges them to upgrade to next subscription level. When more such customers upgrade the cell phone provider can make additional investments in capacity.

There is nothing weird in not rewarding your high volume buyers. Cost reasons aside, if the value to the customer increases non-linearly your price should increase non-linearly as well, to capture a fair share of that value.