Abstract
The rapid advance in information technology now makes it feasible for sellers to condition their price offers on consumers’ prior purchase behavior. In this paper we examine when it is profitable to engage in this form of price discrimination when consumers can adopt strategies to protect their privacy. Our baseline model involves rational consumers with constant valuations for the goods being sold and a monopoly merchant who can commit to a pricing policy. Applying results from the prior literature, we show that although it is feasible to price so as to distinguish high-value and low-value consumers, the merchant will never find it optimal to do so. We then consider various generalizations of this model, such as allowing the seller to offer enhanced services to previous customers, making the merchant unable to commit to a pricing policy, and allowing competition in the marketplace. In these cases we show that sellers will, in general, find it profitable to condition prices on purchase history.
Highlights
1 IntroductionMany industries, including supermarkets, airlines, and credit cards, have compiled vast databases of individual consumer transactions and have used them to study purchase behavior and to make specific offers to individual consumers, via direct mail or other forms of targeted marketing
Following earlier literature on intertemporal price discrimination, we find that in the simplest model, where consumers’ valuations of the good being sold are constant, sellers do not want to condition current price offers on past behavior
We investigate various properties of these models, such as when it is profitable to condition prices, when the conditioning involves “first high price, low price” or the reverse, what is the impact on consumer welfare, and what happens if privacy-enhancing technologies such as anonymized purchases are feasible
Summary
Many industries, including supermarkets, airlines, and credit cards, have compiled vast databases of individual consumer transactions and have used them to study purchase behavior and to make specific offers to individual consumers, via direct mail or other forms of targeted marketing. Since so many transactions are computer mediated, and these computers can be networked to data centers, sellers have the ability to access databases of past purchases in real time This allows them to condition current offers to consumers on their previous purchase behavior. A long literature in economics, dating at least back to Stokey [1979], shows that, under certain conditions, a seller facing strategic customers cannot do better than committing to optimal single period pricing Why, do both online and offline merchants invest so much on tracking technologies?. We focus on cases where the seller can induce the necessary change in consumer valuations by offering various forms of personalized enhanced services to prior purchasers, such as personalized discount coupons (common in supermarket loyalty clubs), lowered transactions costs (such as one-click shopping), or personalized services (such as personalized recommendations). We examine the case of competition and find that if the availability of purchase history allows firms to offer higher value, customized offers to consumers, we will end up with various kinds of lock-in equilibria in which firms first invest in acquiring consumer information, and exploit this information to provide personalized, albeit high priced, service to some consumers
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