Effects of Micro-Transactions on Firm's Pricing and Product Strategies

In many markets, consumers have time-varying needs for product or service quality. However, due to the lack of real-time processing capability or the high transaction costs to process or deliver consumers' requests, firms had not been able to allow their customers to frequently alter their subscribed level of service or product quality to dynamically adjust to their changing needs. With advances of mobile and information technologies as well as fast shipping and delivery, the transaction costs for processing these frequent changes or adjustments have significantly decreased and many firms are now capable of dynamically altering a customer's service quality on demand. These firms can now allow for and process a customer's request for short-term (e.g., daily or hourly) product or service upgrade/downgrade, and efficiently manage these micro-transactions. This paper provides an analytical model to examine the effects of a firm's micro-transaction capabilities on its optimal pricing and product line decisions in a market where consumers' needs for a product vary over time and different types of consumers have different ex ante probabilities of getting in a high need state. We find that when it is relatively cost-efficient to produce the high-end product, if consumers' needs for a product have substantial time variations and the segment size of each type of consumers is large enough, micro-transaction capabilities will strictly improve the firm's profit. When it is relatively cost-inefficient (but not prohibitively) to produce the high-end product, micro-transaction capabilities can easily improve the firm's profit. However, when it is prohibitively inefficient to produce the high-end product, micro-transaction capabilities will not improve the firm's profit. One may intuit that micro-transaction capabilities will lead to a lower quality for the low-end product of the firm's product line since that will make it easier to convince customers to upgrade from the low-end to the high-end product. Interestingly, we find that micro-transaction capabilities may actually lead to an increase in quality for both the high-end and the low-end products