Committed versus contingent pricing under cost uncertainty

Abstract

In practice, managers often face a trade‐off of choosing between committed and contingent pricing under cost uncertainty because contingent pricing may increase the firm's profit but may decrease consumer surplus and market share. This article compares the two pricing strategies under cost uncertainty in terms of the firm's profit, consumer surplus, and market share. We find conditions under which committed pricing would lead to higher consumer surplus and market share than contingent pricing and conditions under vice versa. The results highlight the properties of consumers' valuation distribution in the trade‐offs of choosing between committed and contingent pricing, specifically the properties of the so‐called Mills' ratio which is defined as the reciprocal of hazard rate. According to the curvature of Mills' ratio, we define three types of distributions. We then categorize some commonly used continuous distributions into the three types which lead to different preferences in the trade‐offs. Finally, we fit two sets of household income data from China and the United States into income distributions as the proxies of consumers' valuation distributions in an economy to illustrate those trade‐offs embedded in the two pricing strategies.