Drip Pricing When Consumers Have Limited Foresight: Evidence from Driving School Fees

Katja Seim and Maria Ana Vitorino

No 19258, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: This paper empirically investigates the add-on or “drip" pricing behavior of firms. We present a model in which consumers purchase a base product and, with some probability, an add-on product from the same firm, but are not necessarily attentive to their possible need for the add-on product. We show that a loss leader pricing strategy emerges whereby firms price the base product below, and the add-on above, standalone pricing levels. We test the implications of the model in the Portuguese market for driving instruction where students frequently pay for repeat driving tests and additional lessons upon failing their initial test. Relying on a detailed, nationwide data set on student characteristics and preferences, school attributes including fees and costs, and market demographics for a cross-section of local markets with differing numbers of school competitors, we find evidence in support of the model predictions. Most notably, prices for the base course of instruction, but not the add-on repeat courses, decline in the number of competitors a firm faces. We complement these results with survey evidence on possible sources of consumer naivete that the observational data do not speak to. The survey suggests that at least one quarter of students are inattentive to repeat fees when making their school choice, driven both by an underestimation of fail propensities and an unawareness of the price of a repeat test.

Date: 2024-07
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