Special customer special price

Advances in information technology are encouraging firms to leverage consumer data in guiding their daily business activities. When a consumer visits a site, “cookies” are typically put onto the user's computer, tracking interactions such as the number of visits to a particular product, the amount of money spent, etc. Offline retailers, such as Costco, the largest membership-only warehouse club in the United States, also take advantage of their rich consumer data.

While firms claim that they gather consumer data to improve their product and better serve their consumers, they are in fact doing far more than that. Companies can learn consumers' preferences and habits through past interactions, and use that information to “tailor” the price offered. That is, if a firm believes that you are a wealthy or brand-loyal customer, it may charge you a higher price for a product compared to a customer judged to be less wealthy or less brand-loyal.

Economists call this practice “behaviour-based pricing”. This is not something new – and a large number of firms are doing it. For example, cash registers print out customised coupons based on the content of customers' grocery carts, and the value of the coupon is based on your “behaviour”, i.e. the content of your grocery carts. When consumers revisit the store, their out-of-pocket prices are different due to the customised coupons. Airlines want passengers to identify themselves before they see fares so that they can be charged based on their booking history. Amazon, the largest e-commerce vendor, sells identical DVD movies for different prices based on customers' purchase history. Credit card companies offer zero interest rates for new customers to transfer balance from a competing company, whereas brand-loyal customers do not always qualify to receive these favourable offers. Product prices are effectively different for new and past customers depending on purchase history. The internet has made behaviour-based pricing much easier than it used to be – there is no privacy on the internet, and whatever you do is readily available to the sellers.

Clearly, no one likes paying a higher price for a product or service. Such practices have drawn particular attention from the general public and the government. For example, the Council of Economic Advisers of the White House has been working on this issue and has released several reports since 2014. There is general speculation that behaviour-based pricing “transfers value from consumers to shareholders, which leads to an increase in inequality and can therefore be inefficient from a utilitarian standpoint”¹. Moreover, this is “particularly true in settings where there is no competition, and few consumers would exit the market, even if a firm raised prices dramatically”.

Both consumers and policy makers are critical of the practice, because they worry it could benefit firms at the expense of consumers. However, a number of economists and marketers have questioned this view, arguing that behaviour-based pricing in fact benefits consumers and hurts firms². While this result is surprising, it has been confirmed in a number of follow-up studies³. The argument is as follows: When firms adopt behaviour-based pricing, consumers are reluctant to buy early at a high price because it guarantees that they will face a high price in the future when they make a new purchase. In the face of this reluctance, a firm has to lower its price to induce initial purchases. As a result, consumers benefit from the price cut whereas firms are worse off.

Clearly, the above findings are somewhat disconcerting because sellers are making massive investments into building information infrastructures that allow them to collect, store and analyse consumer data. So, why would firms engage in behaviour-based pricing even though it may hurt their profit?

Firstly, most companies are committed to collecting data, and haven't factored in any downside as described above. Secondly, the various regulatory frameworks currently in place around the world, are only just beginning to have an effect. In 2016, the European Union passed the General Data Protection Regulation (GDPR), which went into effect on 25 May 2018. The GDPR sets a higher bar for obtaining personal data than we have ever seen on the internet before. By default, any time a company collects personal data on an EU citizen, it will need explicit and informed consent from that person. Recently, the Facebook scandal has also led people to think about the need for greater transparency and ethics in data.

If a firm is required to give consumers privacy notices whenever it collects consumer data, it may lead to a rethink of that firm's consumer information collection practice. Such regulations may indeed encourage a firm to stop price-discriminating against its consumers. But this may prove to be a false victory. With one revenue stream cut off, firms may choose to raise prices anyway and consumers will suffer. Any data protection policy must therefore be carefully evaluated and adopted with caution.