Behavior-based price discrimination and consumer switching

Abstract

A common practice among utility companies is to offer discounts to consumers who use a rival's services in an attempt to induce them to switch suppliers. This chapter examines a two-period model of price competition on a Hotelling line that captures this type of price discrimination. In the first period, firms have no information about individual consumers' preferences and, therefore, they post a single price. In the second period, each firm gains information about consumers' first-period purchase decisions. We show that firms have an incentive to use this information to price discriminate. A firm charges a lower price to its rival's customers (`pays consumers to switch') whenever the firm is not too disadvantaged with respect to its marginal cost. Even when consumers' switching costs are non-trivial, a re-segmentation of the market prevails in the unique subgame-perfect equilibrium to the game. An analysis of the impact of this kind of price discrimination on consumer surplus, firm profits, and social welfare is also presented.