The Effect of Outsourcing Pricing Algorithms on Market Competition
33 Pages Posted: 9 Mar 2021 Last revised: 20 Jul 2021
Date Written: July 19, 2021
A third party developer designs and sells a pricing algorithm that enhances a firm's ability to tailor prices to a source of demand variation, whether high-frequency demand shocks or market segmentation. The equilibrium pricing algorithm is characterized that maximizes the third party's profit given firms' optimal adoption decisions. Outsourcing the pricing algorithm does not reduce competition but does make prices more sensitive to the demand variation, and this is shown to decrease consumer welfare and increase industry profit. This effect is larger when products are more substitutable.
Keywords: Algortithmic pricing, market competition, third party vendor
JEL Classification: L13
Suggested Citation: Suggested Citation