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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., baggage delivery) to two types of consumers (high-type and low-type, e.g., business travelers and leisure travelers). We study the firm's decision of whether to unbundle the ancillary service from the main service and charge separate prices. We analyze two types of firms: firms that use uniform pricing of main service and firms that use discriminatory pricing of main service. Our analysis highlights the differences in the structure of optimal ancillary service strategies between the two types of firms. First, a uniform-pricing firm unbundles the ancillary service if the consumers that value the main service higher are also very likely to purchase the ancillary service. On the other hand, a discriminatory-pricing firm unbundles the ancillary service if the consumers that value the main service higher are not very likely to purchase the ancillary service. Second, under uniform pricing, as the firm's proportion of high-type consumers increases, unbundling is more likely to be optimal if the correlation between consumers' main service valuations and ancillary service valuations is high, and bundling is more likely to be optimal if the correlation is low. On the contrary, under discriminatory pricing, as the firm's proportion of high-type consumers increases, bundling is more likely to be optimal if the correlation is high and unbundling is more likely to be optimal if the correlation is low. The differences hinge on the rationale that under uniform pricing, unbundling allows the firm to extract more ancillary surplus from high-type consumers; whereas under discriminatory pricing, bundling allows the firm to extract more ancillary surplus from high-type consumers. Finally, we use these findings to discuss industry practice.