Consumer-Optimal Market Segmentation

Abstract

Advances in information technologies have enhanced firms' ability to personalize their offers based on consumer data. A central regulatory question regarding consumer privacy is to what extent, if at all, a firm's ability to collect consumer data should be limited. As a 2012 report by the Federal Trade Commission puts it, ?The Commission recognizes the need for flexibility to permit [...] uses of data that benefit consumers. At the same time, [...] there must be some reasonable limit on the collection of consumer data.1 We study consumer surplus when a multi product firm uses data to segment the market and make segment-specific offers. Consider a multi product seller, for example an online retailer such as Amazon. There is a finite number of consumer types. The type of a consumer specifies her valuation for every possible product or bundles of products. We refer to the distribution of consumer types in a population as a market. The seller may be able to observe certain characteristics of its buyers, perhaps noisily, such as age, sex, or location. Based on the available information, the seller may be able to segment the market and offer each market segment a potentially different menu of products and bundles of products. For instance, the seller may offer bundle discounts to consumers in certain locations, or offer products exclusively to different age groups. The resulting producer and consumer surplus depend on how the market is segmented (the segmentation), which in turn depends on the information available to the seller.