The subscription economy as price discrimination

In my last post, I outlined how VinFast selling electric vehicles, with the battery priced separately as a subscription, was an example of two-part pricing. However, not all subscriptions are two-part pricing. Often, first use these subscriptions as a form of price discrimination. Consider the following example from a recent article in The Conversation by Louise Grimmer (University of Tasmania):

From gym memberships to music and movies, to razors, toilet paper, meal kits and clothes, there’s seemingly no place the subscription economy can’t go.

Having conquered the software market – where it gets its own acronym, SaaS (Software as a Service) – the subscription model is now moving into hardware.

Car makers are among the first cabs off the rank, using software to turn on and off optional extras.

German auto maker BMW is offering “in-car microtransactions” to access options for car buyers in Britain, Korea, Germany, New Zealand and South Africa. A heated steering wheel, for example, has a monthly cost of NZ$20 in New Zealand, and £10 in the UK.

Other markets including Australia will soon follow.

In the UK, seven of 13 “digital services” – from heated seats to automatic high beam and driving assistance – are now available in subscription form.

“Welcome to microtransaction hell” is how one headline put it.

But that’s probably overselling the onset of a corporate dystopia where “you will own nothing”. BMW’s motives are pretty straightforward – as is most of what’s driving the subscription economy.

Often, subscription services are taking advantage of customer lock-in - locking customers into buying from the seller, and generating additional profits from the lock-in customers. This was the case with VinFast, and is likely the case with gym memberships, subscription access to movies or music, meal kits, and many others. However, the subscription service that BMW is offering is different. It is different from the more typical subscriptions because it is an add-on to an existing product (the BMW vehicle). It is different from the add-on that VinFast offers, because none of the subscription options from BMW are required in order to operate the vehicle (it will work perfectly fine without a heated steering wheel, I'm sure).

What BMW is doing is price discriminating - charging a higher price for the same product to consumers who have more inelastic demand (and where the price difference doesn't relate to a difference in costs). How does it work? For effective price discrimination, you typically need to meet three conditions:

1. Groups of customers that have different price elasticities of demand (heterogeneous demand);
2. Different groups of customers can be identified; and
3. No transfers across submarkets.

For car buyers, the first condition holds. For buyers with higher income, a BMW takes up a smaller proportion of their income and, as I noted in this post from earlier in the month, that means that car buyers' demand for a BMW will be more inelastic. High income buyers will be less price sensitive than buyers with lower income. So, it makes sense for BMW to charge a higher price to high-income consumers, and a lower price to low-income consumers.

The second condition also holds. Once BMW have created a system where the optional extras like a heated steering wheel cost extra, high-income consumers are more likely to buy the optional extras. The consumers sort themselves into high-income and low-income groups, by the choice they make about optional extras. We refer to this as menu pricing (or second-degree price discrimination). The third condition clearly holds, because you can't transfer your heated steering wheel subscription to someone else (and why would you want to, as you are the one paying for it!).

So, it seems like this is price discrimination. However, as I noted above, price discrimination only occurs where the price is different between consumers, but the cost of providing the good or service is the same for all consumers. Providing a heated steering wheel is costly to BMW, so it seems like that might invalidate it as an example of price discrimination (in the same way that the difference in price between business class airline tickets and economy class airline tickets is not price discrimination). In this case, though, there is no effective difference in cost between the two groups, because the heated steering wheel is already included in every vehicle. It just isn't activated in every vehicle. Activating the heated steering wheel (or other optional extras) simply requires toggling some setting in the car's on-board software to 'on', so there is little cost to BMW at all.

Offering optional extras as a subscription enables BMW to take advantage of price discrimination, selling cars for a lower price to low-income consumers (with the optional extras switched off) and for a higher price to high-income consumers (with the optional extras switched on). Don't get me wrong though - BMW are still taking advantage of locking their customers in as well, because there are no alternative providers of the heated steering wheel for their new BMW.