A demand-based model for the advance and spot pricing of services

Abstract

Purpose The purpose of this paper is to study the non‐consumption of a service by advance buyers, the re‐selling of relinquished capacity at spot time and the effect on the pricing of advance and spot demand of services.

Design/methodology/approach The paper employs mathematical economics modeling technique.

Findings The model shows that advance prices are always lower than spot prices due to the non‐consumption effect and also that providing a refund to advance buyers, as insurance against non‐consumption, may be. By modeling in the capacity of the firm, the paper also presents the firm's capacity conditions when the firm does not sell in advance and also when market failure occurs i.e. when the firm does not sell in advance nor at consumption time.

Research limitations/implications The model does not consider uncertainty in the spot price and assumes a one‐stage optimization. Furthermore, the model extension with refund is numerically derived.

Practical implications This model informs industry on the significance of non‐consumption of a service and the re‐selling of relinquished capacity. It also highlights the importance of the interaction between capacity and refunds in advance and spot selling.

Originality/value This paper contributes to extant literature by demonstrating that when heterogeneous demand behavior is explicitly modeled with non‐consumption, capacity and refunds, firms would then be able to understand where and how service revenue is being obtained (higher price or higher demand) and the impact of various sensitivities on revenue.