In Depth Differential Pricing

Published on April 28th, 2015 | by Joshua New

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Data-Driven Differential Pricing Benefits Consumers and Companies Alike

One common concern expressed by big data detractors is that retailers may use data to charge different customers different prices, a practice known as differential pricing. Differential pricing has been around for years in various forms, such as stores offering student discounts or airlines charging more for tickets closer to the departure date, but now many companies have access to granular data that could allow them to set prices at the individual level. However, a recent White House report found low potential for data-driven personalized pricing to harm consumers through unfair discrimination or by facilitating deceptive or fraudulent activities, and it identified considerable economic benefits from this practice for both consumers and businesses. Furthermore, for any potential harms identified in the report, existing laws and market forces are generally sufficient to protect consumers.

Concerns that data-driven differential pricing will just lead to companies raising prices are largely unfounded. While the goal of differential pricing is to align prices with what a customer is willing to pay, companies still must keep prices competitive to retain the business of price-sensitive customers. Better understanding of how customers value certain items can actually lead to market expansion and increased customer engagement, creating a better customer experience. For example, matinee pricing at movie theaters allows large groups or those on tight budgets to enjoy a movie and allows theaters to make sales they might have otherwise missed out on. The ubiquity of technologies like social media and e-commerce have helped reduce the cost of collecting more granular demographic and behavioral consumer data, enabling companies to better understand what customers want and how much they value a particular item or service. This allows companies to develop more personalized marketing strategies and pricing, as well as identify potential new customers. But more data also empowers consumers and enhances competition, thereby protecting against exploitative pricing. The Internet makes it easy for consumers to shop around, monitor price fluctuations, and make informed purchasing decisions. Any company offering a customer a higher price, but still a price the company believes the customer would pay, would quickly lose market share to competitors vying for that customer’s business with lower prices.

Exploitative or unfair price discrimination practices against historically disadvantaged groups are generally prevented by market and legal forces. For example, if a retailer tried to charge different prices to its customers based on their race, these customers would quickly start shopping at another store. Additionally, companies using differential pricing to maximize profits will be careful to set prices at a level that will not exclude historically disadvantaged groups that may be more price sensitive than the general population. Furthermore, laws like the Civil Rights Act and the Fair Credit and Reporting Act prohibit inequitable price discrimination, data-driven or otherwise. Some companies may decide to use differential pricing to raise prices for underserved communities where the market is uncompetitive. However, in such cases, the goal of policymakers should be to introduce competition into these markets rather than prohibit differential pricing.

Differential pricing does warrant scrutiny when it is used in potentially deceptive practices like bait-and-switch techniques, or more complex transactions like bundling, which can obscure costs for specific products and services. Bait-and-switch techniques and bundling can make it difficult for less knowledgeable or less-experienced consumers to easily compare prices between sellers. As previously described, the competitive market is strong protection against inequitable use of differential pricing when buyers can shop around and compare prices. When buyers cannot easily understand or compare prices in the marketplace, this reduces market protection. However, deceptive business practices are illegal and the Federal Trade Commission already has authority to investigate such activities. Additionally, policymakers that wish to protect consumers should focus on enhancing competition in these markets rather than restrict the practice of differential pricing and needlessly sacrifice its benefits. Policymakers should be wary of consumer advocates’ suggestion to limit personalized pricing to offline settings to further protect against potentially harmful instances of differential pricing, as such rules would limit the competitiveness of the online marketplace and deny the benefits of differential pricing to both buyers and sellers. Furthermore, policymakers should recognize that buyers have just as strong incentives to seek out the best possible price online as they do offline.

This report is a welcome reminder that differential pricing is neither new nor harmful, and incorporating additional consumer data to fine tune the practice does not somehow invalidate the existing market and legal protections that safeguard against potential abuses. Should a situation arise where differential pricing is used to harm consumers, policymakers should seek to address the root cause of the problem, which would likely be limited consumer access to information or a lack of competition, rather than limit the private sector’s ability to use data to guide decision-making.

This article originally appeared in Real Clear Technology.

Image: MallExpert.

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About the Author

Joshua New is a policy analyst at the Center for Data Innovation. He has a background in government affairs, policy, and communication. Prior to joining the Center for Data Innovation, Joshua graduated from American University with degrees in C.L.E.G. (Communication, Legal Institutions, Economics, and Government) and Public Communication. His research focuses on methods of promoting innovative and emerging technologies as a means of improving the economy and quality of life. Follow Joshua on Twitter @Josh_A_New.



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