Abstract

Add-on pricing, also known as drip pricing, is a common practice whereby firms prominently post base prices yet are less forthcoming about add-on prices. Although some consumers find add-on prices before the purchase decision, others only discover the add-on prices later in the purchase process. This paper presents an analytical model predicting the profit and welfare implications of hidden add-on fees. Whereas practitioners posit that hidden add-on pricing benefits firms at the disadvantage of consumers, the consensus from the academic literature is that any gains from hidden add-ons are negated by competition in base prices. This paper has two main preliminary findings. First, it resolves discrepancy between theory and practice by finding a profit improvement effect of hidden add-on prices under circumstances for which prior literature predicts profit irrelevance. In this regard, the model identifies a new mechanism driving the profit-improvement result. Second, it finds when firms can be worse off by having more consumers uninformed of add-on pricing before choosing from which firm to buy. The findings have implications for managers considering hidden add-on pricing as well as policy makers who seek to regulate this practice.

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