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., in-flight meal) to two types of consumers (high-type and low-type, e.g., business travelers and leisure travelers). The firm decides whether to unbundle the ancillary service from the main service and charge separate prices for different service components. We study the interaction between the optimal ancillary strategy and the firm's use of main service price discrimination by analyzing two types of firms: firms that use uniform pricing of main service and firms that use discriminatory pricing of main service. We find that a uniform-pricing (discriminatory-pricing) firm should unbundle the ancillary service if the consumers that value the main service higher are also very likely (not very likely) to purchase the ancillary service. The difference hinges 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 achieve so. Moreover, we find that unbundling the ancillary service and using main service price discrimination are strategic complements (strategic substitutes) if the correlation between consumers' main service valuations and ancillary service valuations is low (high)