Question

Many retail video stores offer two alternative plans for renting films:

• A two-part tariff: Pay an annual membership fee (e.g., \(40) and then pay a small fee for the daily rental of each film (e.g., \)2 per film per day).

• A straight rental fee: Pay no membership fee, but pay a higher daily rental fee (e.g., $4 per film per day).

What is the logic behind the two-part tariff in this case? Why offer the customer a choice of two plans rather than simply a two-part tariff?

Short answer

The logic behind the two-part tariff is to segregate the consumer into different groups as per their need. The customers are offered two plans rather than simply a two-part tariff because every customer has different needs and generates revenue from each customer.

Step-by-step solution

Step 1. Logic of two-part tariff

The strategy of two-part tariff is used to sort the customer into two groups namely, high-volume group, and low-volume group; suppose the high-volume group rent more than 30 movies per year and low-volume group rents less than 30 movies per year. The problem with the two-part tariff is that the firm faces difficulty deciding the entry and rental fees. Thus, the firm charges two different prices for two different groups of customers.

Reason for offering two plans instead of two-part tariff

If the entry fee is high and the rental fee is low, it will benefit the high-volume customer, but it will not benefit the low-volume customers. If the entry fee is low and the rental fee is high, it will benefit the low-volume customer, but it will not benefit the high-volume customers. Hence, the firm keeps both the membership and rent options.