Price Discriminination

As I write this column I’m flying the friendly skies, strapped into a pressurized aluminum tube that’s punching a hole in the clouds at 15,000 feet. I’m packed like a sardine in a chair that feels like it was built for Mini-Me. The flight attendants have just completed their rounds, offering me my choice of pretzels, cookies, lemonade, and water.

In the name of research I strike up a conversation with the person sitting next to me. I ask him how much he paid for his airline ticket. My new-found friend paid over $700, while I paid just $300. He’s fuming. Same point of departure, same destination, same stale pretzels, same warm lemonade. We even bought the tickets within 24 hours of one another. He paid more than twice what I paid. He doesn’t want to talk to me anymore.

Airline pricing is one of the mysteries of our generation. The airline industry refers to its pricing game as “yield management.” This means prices on the same plane can fluctuate wildly based on available seats at the time of purchase. Airline pricing may seem to defy logic, but there’s a method — an algorithm — to the madness.

Yield management is a form of price discrimination that allows airlines to maximize profits and create economic efficiencies that would otherwise be elusive. Despite the public’s frustration with airline pricing, we’re all better off because yield management exists. Or so modern economics, and Andrew Odlyzko, would have us believe.

The University of Minnesota’s Digital Technology Center director recently published a paper, “Privacy, Economics, and Price Discrimination on the Internet.” Odlyzko makes many interesting points in his paper, particularly:

  • Economically, price discrimination is usually regarded as desirable as it often increases the efficiency of the economy.

  • Incentives for commercial organizations to price discriminate are growing.

  • Commercial organizations’ ability to price discriminate is increasing.

  • Privacy intrusions provide the information that allows commercial organizations to determine buyers’ willingness to pay, and thus is the basis for price discrimination.

Although the term “privacy intrusion” may lead you to think of hackers stealing credit card numbers from a “secure” database, Odlyzko’s definition of privacy intrusion includes information consumers willingly provide to a private enterprise. He makes an interesting point: “One of the many privacy puzzles is that even though the public shows intense concerns about the loss of privacy, it is not doing much to protect itself. Privacy protecting technologies have not fared well in the marketplace and very minor rewards are enough to persuade people to sign-up for grocery store loyalty programs.”

Average consumers talk a big game about protecting their privacy. Offer 10 percent off their first purchase. They’ll tell you everything you want to know and give you the right to run a credit report.

Applying Odlyzko’s definition of privacy intrusion to the Internet, every time a consumer willingly identifies themselves online, either by making a purchase or completing a Web site registration form, that consumer is allowing their privacy to be violated. Consumers who purchase products or services on the Internet exchange anonymity for the convenience of online shopping. That consumer allows the online retailer to track everything, from their surfing patterns to purchase history, and provides that retailer the ability to tie the data to personally identifiable information including name, physical address, email address, telephone and credit card numbers — all required to complete a purchase. Similarly, consumers who use a news Web site requiring registration, such as the New York Times, exchange their anonymity for access to content. The news site can track their surfing habits and tie this data to the personally identifiable information provided at registration.

Odlyzko presents a compelling argument that companies doing business on the Internet possess unparalleled opportunities for price discrimination. Unlike airlines, which rely on supply-and-demand to generate different prices for the same service, Internet companies can use their wealth of customer data to extract every possible dollar from the consumers’ wallets. An Internet enterprise that’s collected substantial amounts of customer data can begin to identify the value each individual buyer places on the product or service they offer. In turn, the enterprise can charge each individual a different price, based on the inferred value of the product or service. The more an individual buyer values the product or service, the more the enterprise can charge for it.

Just because incentives and capabilities for price discrimination exist doesn’t mean it’s about to become the Internet’s next big thing. Odlyzko notes the public has a severe, negative opinion of price discrimination. You may remember the tongue-lashing Amazon.com received a few years ago when it offered lower prices to first time buyers than to repeat customers. Odlyzko points out, “Sellers will be increasingly tempted to engage in differential pricing. However, such practices are fraught with danger, since the public is likely to resent them intensely.” He believes sellers will resort to covert price discrimination. Examples of this include multiple product bundles, product versioning and creating special offers tailored to a buyers’ past purchase history. Sound familiar?

As a marketer, you may already practice price discrimination. Odlyzko points out many enterprises don’t even realize it when they do. Read his paper. It will stretch your mind in directions you’ve likely never considered.

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