Behavior-based price discrimination with retention offers

Abstract

This paper is a first step in investigating the competitive and welfare effects of behavior-based price discrimination (BBPD) in markets where firms have information to employ retention strategies as an attempt to avoid the switching of their clientele to a competitor. We focus on retention activity in the form of a discount offered to a consumer expressing an intention to switch. When retention strategies are allowed, forward looking firms anticipate the effect of first period market share on second period profits and price more aggressively in the first-period. Thus, first period equilibrium price under BBPD with retention strategies is below its non-discrimination counterpart. This contrasts with first period price above the non-discrimination level if BBPD is used and retention activity is forbidden. Regarding second period prices, the use of retention offers increase the price offered to those consumers who do not signal am intention to switch; the reverse happens to those consumers who decide to switch after being exposed to retention offers. As in other models where consumers have stable exogenous brand preferences, the instrument of BBPD is bad for profits and welfare but good for consumers. BBPD with the additional tool of retention activity boosts consumer surplus and overall welfare but decreases industry profit.