Arnold Kling  

Price Discrimination and Information

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Safe Investing... Comment of the Week, 2003-07-3...

Andrew Odlyzko has an interesting article on price discrimination in the information age. He sees the databases that companies are gathering (from supermarket membership cards, for example) as tools for charging on the basis of price sensitivity.


price discrimination will grow, but in a concealed form. Stress will be on tactics such as bundling and loyalty programs, which tend to disguise the actual price that is charged. This means that auction mechanisms and micropayments are likely to be used in very limited situations. On the other hand, there will be continued pressure to erode privacy in order to find out just what the willingness to pay is, as well as to control how products and services are used. Thus privacy will continue to erode.

As an aside, he talks about price discrimination in higher education.

A very interesting example is that of U.S. private colleges...all these schools offer financial aid to students, and in some of them, the amount spent on aid (which is determined overwhelmingly on need) comes to about half of the tuition revenues. In essence these institutions are practicing price discrimination on a massive scale, charging according to their estimates of what the students' parents can afford. Parents can preserve their full financial privacy, but at the cost of paying the full tuition.

I remember that when I first read Information Rules, by Hal Varian and Carl Shapiro, it sounded like a cookbook for price discrimination. They saw the information economy as requiring price discrimination because of the nature of information goods--high up-front costs and near-zero marginal costs. Odlyzko also locates a cost factor leading to more price discrimination--the reduced cost of gathering and storing customer data.

For Discussion. In economic models, price discrimination often increases social welfare. Odlyzko gives a theoretical example in which in the absence of price discrimination the good is not produced at all. Is price discrimination in the information economy a good thing or a bad thing?


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COMMENTS (6 to date)
Brad Hutchings writes:

Of course it is a good thing. Odlyzko's most important point is that its long-term effectiveness depends on how it is presented to the public. The public is ammenable to discounts, but does not like surcharges. If the public feels too screwed or too confused by price discrimination, industries may face political sanctions like regulation.

Individual buyers value things differently depending on their unique individual circumstances. It's really all about approach. If you set a reasonable price for your product, you'll get all those people who value it higher to buy it at that dollar price with no additional inconvenience to them. If you then have mechanisms where people can trade information for lower price, some more people will take the time to take you up on the offer. Maybe you don't use the information, but just make it enough of a hassle that they have to be exhibit a certain level of price sensitivity to take advantage of the discount.

I think that last thing is more likely what is really going on widescale with price discrimination. There is a really neat deli near my home. They always have a coupon in the coupon mailers. I used to feel cheap using a coupon there, so I asked the owner whether the coupons (like buy one sandwich, get another free) were effective loss-leaders for them. She said there was no loss in the leader. If the coupons dragged me and my crowd into the restaurant more often, it was great for them. If we wanted to come in and pay full price, that was a bonus. Restaurants don't have quite the low theoretical marginal costs as information products, but they play the game better, don't you think?

-Brad

Eric Krieg writes:

The problem with price discrimination is the name that you econimists have given it! Discrimination is a four letter word.

Come up with a more politically correct name, and it will fly.

Boonton writes:

Suggestions:

Price Targetting
Price Customization
Precision Pricing

or my favorite:

Pricing Enhancement....

The last comes from my job which has taken to referring to layoffs as 'his position has been enhanced'

Jeff Brown writes:

Price discrimination is a dangerous thing. While it allows a seller to "enhance" his profit, it is generally viewed by buyers as unfair.

We're talking about discrimination over the exact same item and service. The same information provided in realtime can be more valuable than that provided delayed such as with stock quotes. While they are the same information, they aren't the same product.

Consider those areas of price discrimination that have been around for years. Car purchases are not viewed well by most due to the variable purchase prices. CarMax came about to exploit this. Or income taxes. Every winter, we are bombarded by ads explaining how we are paying more than we have to. Who feels good about that? The consequence is that everyone feels someone else is not paying their fair share. It is also a marketing practice for sellers to provide purchasers with some protection from upcoming sales to prompt them not to delay purchases.

Price discrimination can lead to maximizing profits but also delaying or avoidance of purchases. Once revealed price discrimination create a market for arbitrage. The only effective way to enhance the price in the long term is to add some value for which some will pay more and the others will accept as fair even though they won't pay. To discriminate against consumers on the exact same product, you risk a backlash from buyers, third party poaching of the margin, and accusations of ethnic, gender, or other prohibited discrimination.

Brad Hutchings writes:

Jeff wrote:

"The consequence is that everyone feels someone else is not paying their fair share."

How do we determine fair share for an information product with high up front development costs, low marginal costs? Should we add up development costs and a "fair" profit, and divide by the number of people who buy to arrive at the fair price after the fact?

If we did that with the standard price discrimination example in Odlyzko's paper, the low price customer would back out of the deal and we'd be left with a loss.

There is a great article in Wired about gaming supermarket club cards. Guess what? The supermarkets don't care.

http://www.wired.com/news/business/0,1367,59589,00.html

I imagine the internal conversation at the supermarket went something like this:

Dilbert Manager 1 (DM1): "Somebody has posted their club card bar code on the net. We should be outraged. Let's call the attorneys and get them locked up under the DMCA."

Dilbert Manager 2 (DM2): "The nerve! How will we be able to collect information about their purchasing habits and cross-reference with public records databases so we can send them condom and aftershave coupons when they file for divorce?"

Clued Manager (CM): "Don't worry guys. They are buying from us. We don't lose money on the club priced items. They think they are getting away with something. We let them think that and they'll buy more stuff."

DM1: Not on my watch!!

DM2: No way. Next thing you know, we won't be arresting people for sneaking 11 items in the express lane. We have to draw the line here!

CM: Guys, come on now. Wired will write a story and we'll say we don't care and people will think we're being more reasonable than we really have to be. Meanwhile, this guy has a site and lots of clones that use his card. Maybe he gets free wine every night for his effort. I saw this work once for that humorist Dave Berry. Go to poetry.com and look up the author "Freemont Harkins".

DM1: Well, you're the boss, but this is exactly how the strike zone got widenned in MLB. It's a slippery slope.

-Brad

Boonton writes:

In theory Price Discrimination can also benefit the consumer. Consider a good with a normal demand curve sloping down. If the supplier must charge a single price, some of the first buyers will be getting a bargain (buying the product for a price that is less than what it is worth to them) while the last buyer 'breaks even' so to speak....All potential customers after that point do not buy because the price is too high.

Now consider a supplier that is able to exercise price discrimination. The first buyers get less of a bargain but now the supplier is able to charge a lower price to more consumers. The result is that more people can obtain a product and those that spend more were willing to spend more in any case.

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