Transparency of Behavior-Based Pricing

Abstract

Behavior-based pricing (BBP) refers to the practice in which firms collect consumers' purchase history data, recognize repeat and new consumers from the data, and offer them different prices. BBP is a prevalent practice for firms and a worldwide concern for consumers. Extant research has examined BBP under the assumption that consumers observe firms' practice of BBP. However, consumers do not know this for specific firms and are often unaware of how firms collect and use their data. In this paper, we examine how firms make BBP decisions when consumers do not observe whether firms perform BBP and how the transparency of firms' BBP practice affects firms and consumers. We find that when consumers do not observe firms' practice of BBP and the cost of implementing BBP is low, a firm indeed practices BBP, even though BBP is a dominated strategy when consumers observe it. When the cost is moderate, the firm does not use BBP; however, it must distort its first-period price downward to signal and convince consumers of its choice. A high cost of implementing BBP serves as a commitment device that the firm will forfeit BBP, thereby improving firm profit. By comparing regimes in which consumers observe and do not observe a firm's practice of BBP, we find that transparency of BBP increases firm profit but decreases consumer surplus and social welfare. Therefore, commanding firms to disclose collection and usage of consumer data could hurt consumers and lead to unintended consequences.

Keywords: behavior-based pricing, privacy, transparency, signaling, game theory