UCL School of Management welcome Professor Professor Sanjay Jain, The University of Texas at Dallas, to host a research seminar discussing ‘Pricing of Services: An Analysis of the Impact of Recency Bias’.
Firms often offer service contracts for consumers. These contracts offer discounted repair prices if the consumer needs service in the future. For example, many extended warranty plans enable the consumers to get free repairs on appliances they bought, provided they buy the service plan at the time of purchase. Extended warranties have often been criticized as being over-priced since the cost to buy such extended service plans exceeds the expected costs without the plans. Reputable sources such as Consumer Reports advise consumers not to purchase extended warranties. Other service plans such as for electrical repairs do not offer free repairs but promise a discounted price for repairs. When purchasing the plan, the consumers are not aware whether they will need the service in the future and whether the service would require minor or major repairs. Consumers may also not be aware of how much they will value the service if the need for repairs arises. Similarly, the firm does not know whether the consumer will need the service in the future and the cost required to perform the service. We assume that consumers form expectations based on recent events such as whether they or someone they know needed repair services recently. Using the behavioral literature on recency bias, we study the design of optimal service plans. We find that recency bias can sometimes benefit consumers at the expense of firms. We also establish conditions under which the firm will offer a plan which offers free repairs and one in which the firm will charge a discounted price at the time of the repair. Our results show that recency bias can lead to firms offering socially wasteful services where the cost of service exceeds the valuation of all consumers. We also show that social welfare with recency bias is lower even under perfect competition.